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  • Gaynor Brough
  • Role
    Chairman of Isle of Man Captive Association
    Location
  • “Overall, there’s a general domestic regulatory trend resulting in more and more regulations in every jurisdiction, which in turn puts more pressure on captive managers.”

Chairman of Isle of Man Captive Association

What are your views on some of the key issues affecting the captive industry today, such as Solvency II and costs versus returns?

In today’s low interest rate environment it has become increasingly challenging to meet operational costs from investment income. However, this isn’t preventing companies forming captives as the benefits derived from owning a captive outweigh the frictional costs in most instances. Solvency II, however, is very much an issue. It’s created significant uncertainty and although some countries are already starting to adapt their regulatory framework, it will be a brave man who can predict the actual implementation date - currently estimated as 1 January 2016. This level of uncertainty is impacting the growth of the captive market, especially on this side of the pond. The uncertainty around proportionality and the treatment of captives, coupled with the anticipated spiralling costs of running a captive in a Solvency II environment, are serious detracting features when one is considering the formation of a captive insurance company as part of a risk management programme. The impact of Solvency II is not just limited to hampering new growth but is also having an effect on EU-based captives, especially the smaller captives where the costs of complying with Solvency II will be too rich and the cost vs. benefit argument will prove to be a challenging one.

For domiciles such as the Isle of Man, who are not part of the EU and who are committed to maintaining a regulatory framework which is consistent with the International Association of Insurance Supervisors’ Insurance Core Principles, Solvency II was seen as being likely to prompt interest in new captive formations and potential redomiciliations in cases where the proposed SII framework was perceived as too prescriptive for captive business. I can only speak from an Isle of Man perspective, but when Bermuda announced that it was applying for equivalency, the Isle of Man received a significant number of new enquiries from existing Bermudian domiciled captives, especially those with a UK or EU parent. The influx of enquiries resulted in lifeboat companies being established in the Isle of Man by the parent companies of a number of Bermudian based captives, the game plan being that they could parachute their Bermuda captive into the Isle of Man under the applicable redomiciliation legislation should Bermuda be unsuccessful in its application to ‘carve-out’ captives from the equivalent regime. Although this has not come to bear, it demonstrates the antipathy of some risk managers to operating their captive in such an environment. Markets such as the Isle of Man and Guernsey expected to see similar reactions from EU-based captives. However, this has not really come to fruition and other than a handful of new enquiries from this source, things have been relatively quiet. Where we are seeing increased activity is from potential new captive owners and again I can only speak from an Isle of Man perspective but we are now dealing with more new enquiries than we have in recent years.

How else is the captive industry expanding and developing?

Although the growth in the number of captives has slowed down, it is interesting to note that we are witnessing greater captive utilisation by existing captive owners. There are a number of trends that we have identified: credit insurance was an area where there has been heightened interest and this is essentially a response to the contraction of the conventional risk transfer market. This is not a new phenomenon and we witnessed this back in the 1980s when the bottom fell out of the Casualty market and then in the early 1990s with the withdrawal of terrorism cover. When traditional insurance markets fail to provide cover and the market turns sour, a captive insurance company is attractive as the risks underwritten and pricing will reflect the risk profile of its particular insured rather than the industry as a whole. In addition to this, the increased self-insured retentions and use of a captive provide access to expanded capacity through the wholesale markets. Currently the insurance market is hardening in some areas, for example catastrophe cover in Asia, and inevitably where the insurance market hardens then it influences captive growth. Another example of recent activity within captives is the interest in cyber cover; cyber risks are evolving and the conventional insurance market is continuing to adapt the coverage it provides to meet changing needs. However, in some instances there is a lag between exposure and available policy coverage. Companies are therefore turning to captives to build up a fund against such exposure and to leverage expanded coverage and lower premiums from the conventional markets. There is continued interest in underwriting employee benefits cover through captives and the premium savings estimated to be generated are up to 20%. For multinational organisations the use of a captive in their employee benefit programme can provide distinct advantages and one of the key challenges historically has been the disconnection between the Risk Management function and the HR Department, the latter of which has conventionally been responsible for EB programmes. We certainly have evidence of this changing and our clients are alive to the cost savings that can be achieved.

On a global scale, more countries are starting to tap into captives. Although I don’t see any major opportunities in countries like India and China for a good few years, this will no doubt change over time and certainly from an Isle of Man perspective, we continue to engage in these territories and build sustainable relationships. There is an increasing appetite for captives in Latin America and there is a great deal of captive business development work underway there. From an Isle of Man perspective, we are focusing our efforts on Africa – Isle of Man has long since been a good proven home for South African-owned captives and we certainly view the wider Africa as being a good hunting ground for us. Despite the relatively soft insurance market, there is continued year on year growth in the captive sector and I have no reason to believe that captives will become a thing of the past. Captive insurance companies should be intrinsically linked to a well-thought-out risk management policy and currently, despite protests to the contrary, I haven’t witnessed a viable alternative, especially where there is a global programme in place.

Do you think the captive market is affected by tax implications? Are captives returning home for tax reasons?

Tax is now being portrayed by some governments as a moral rather than a legal issue and can produce serious reputational challenges for corporates as evidenced by the well-documented situations which came to light recently. However, the recent changes to the UK CFC rules have created a potential opportunity for some captives, particularly those with a global footprint, which will be assessed for taxation on their profits derived from UK contracts but may not be assessed on profits from non-UK contracts. This is considered a positive outcome for some captive owners and it is testament to the appetite of the UK Government in its desire to attract foreign investment.

What are your views on the evolution of captives in terms of PCCs versus ICCs?

Both PCCs and ICCs form part of a broad and flexible range of risk management tools and their usage depends on a number of factors. We’re currently seeing increased interest in protected cells as a result of Solvency II and this is driven by the fact that a PCC is one legal entity and the individual cell owners can take advantage of the robust governance framework which will exist in sponsored PCC vehicles, such as Aon’s White Rock group of companies. Such an approach shares the cost of governance between cell owners, thereby creating cost efficiencies.

It is exciting times in the world of PCCs/ICCs where we are witnessing their use as SPVS and transformer vehicles for capital market transactions. So we’re essentially seeing fairly new technology providing an alternative solution to allow capital markets the opportunity to compete with the traditional reinsurance market, thereby providing greater choice.

We do anticipate an increase in the use of ICCs and incorporated cells as companies seek to avail themselves of the absolute segregation of assets and liabilities which an ICC structure provides. In a world of increasing governance and oversight, counter-party exposures, however slight, are the feature of much scrutiny and an ICC vehicle provides comfort in this regard. However, there are very few domiciles which have enacted ICC legislation (the Isle of Man is one) and I anticipate that it will only be a matter of time before an increasing number of traditional captive domiciles introduce the appropriate legislation.

How do you evaluate your captive needs, for example, in terms of auditing?

Corporate Governance has come to the fore in recent years and whilst generally captives have operated under good governance, changes in regulatory frameworks have highlighted the need for clearer documentation of that process.

In terms of auditing, licensed entities are required to submit financial statements that have been subject to external audit, and there is usually a strict timetable for the submission of those accounts.

The introduction of the Isle of Man Corporate Governance Code in 2011 highlighted the need for a risk-based approach to auditing and the need for there to be an independent view of a captives internal control. Whilst the process of review may have been in place for some captives, the new regulations prescribe more frequent reviews, albeit this should be proportional to the nature, scale and complexity of the captives’ activities.

On solvency, our experience is that captive Boards will undertake regular reviews of capital adequacy and monitor solvency, although the two are not necessarily aligned. New regulation following review of the IAIS global standards are likely to provide more clarity on the requirements in this area and we’ll see a move to increasing formal governance framework in the future. Larger captive managers like Aon already have their own robust frameworks in place and one wonders whether the increasing regulatory burden will result in some consolidation in the industry.

Are you noticing any changes in fund management?

It very much depends on the client. Major PLCs, which is predominantly the Isle of Man client-base, generally have a Treasury function which utilises its existing banking relationships to manage captive funds, whereas smaller captive insurance companies have greater autonomy and the placement of the funds are dictated by the captive Directors. Generally speaking, most captive insurance companies are risk adverse in terms of investment risk and prefer to deal with cash deposits and there is an obvious need for liquidity bearing in mind the nature of the business. Following the economic downturn in 2008, there was an apparent run for quality and a spreading of the counterparty risk. I’ve seen a little bit more chasing of the rates in recent years but most captives are looking for ‘A’ rated banks, with 85-90% of Isle of Man domiciled funds being held in cash. From a cash flow perspective, the stacking of Letters of Credit (LOC) against long-term liabilities continues to prove to be an issue. This is also coupled with the rising cost of LOCs and as a result we have seen an increase in the interest of trusts during the past twelve months. Trusts can be more flexible, and cost-efficient too, but the main challenge here is their acceptability to the fronting company. 

Although the growth in the number of captives has slowed down, it is interesting to note that we are witnessing greater captive utilisation by existing captive owners. There are a number of trends that we have identified: credit insurance was an area where there has been heightened interest and this is essentially a response to the contraction of the conventional risk transfer market. This is not a new phenomenon and we witnessed this back in the 1980s when the bottom fell out of the Casualty market and then in the early 1990s with the withdrawal of terrorism cover. When traditional insurance markets fail to provide cover and the market turns sour, a captive insurance company is attractive as the risks underwritten and pricing will reflect the risk profile of its particular insured rather than the industry as a whole. In addition to this, the increased self-insured retentions and use of a captive provide access to expanded capacity through the wholesale markets. Currently the insurance market is hardening in some areas, for example catastrophe cover in Asia, and inevitably where the insurance market hardens then it influences captive growth. Another example of recent activity within captives is the interest in cyber cover; cyber risks are evolving and the conventional insurance market is continuing to adapt the coverage it provides to meet changing needs. However, in some instances there is a lag between exposure and available policy coverage. Companies are therefore turning to captives to build up a fund against such exposure and to leverage expanded coverage and lower premiums from the conventional markets. There is continued interest in underwriting employee benefits cover through captives and the premium savings estimated to be generated are up to 20%. For multinational organisations the use of a captive in their employee benefit programme can provide distinct advantages and one of the key challenges historically has been the disconnection between the Risk Management function and the HR Department, the latter of which has conventionally been responsible for EB programmes. We certainly have evidence of this changing and our clients are alive to the cost savings that can be achieved.

On a global scale, more countries are starting to tap into captives. Although I don’t see any major opportunities in countries like India and China for a good few years, this will no doubt change over time and certainly from an Isle of Man perspective, we continue to engage in these territories and build sustainable relationships. There is an increasing appetite for captives in Latin America and there is a great deal of captive business development work underway there. From an Isle of Man perspective, we are focusing our efforts on Africa – Isle of Man has long since been a good proven home for South African-owned captives and we certainly view the wider Africa as being a good hunting ground for us. Despite the relatively soft insurance market, there is continued year on year growth in the captive sector and I have no reason to believe that captives will become a thing of the past. Captive insurance companies should be intrinsically linked to a well-thought-out risk management policy and currently, despite protests to the contrary, I haven’t witnessed a viable alternative, especially where there is a global programme in place.

Do you think the captive market is affected by tax implications? Are captives returning home for tax reasons?

Tax is now being portrayed by some governments as a moral rather than a legal issue and can produce serious reputational challenges for corporates as evidenced by the well-documented situations which came to light recently. However, the recent changes to the UK CFC rules have created a potential opportunity for some captives, particularly those with a global footprint, which will be assessed for taxation on their profits derived from UK contracts but may not be assessed on profits from non-UK contracts. This is considered a positive outcome for some captive owners and it is testament to the appetite of the UK Government in its desire to attract foreign investment.

What are your views on the evolution of captives in terms of PCCs versus ICCs? Both PCCs and ICCs form part of a broad and flexible range of risk management tools and their usage depends on a number of factors. We’re currently seeing increased interest in protected cells as a result of Solvency II and this is driven by the fact that a PCC is one legal entity and the individual cell owners can take advantage of the robust governance framework which will exist in sponsored PCC vehicles, such as Aon’s White Rock group of companies. Such an approach shares the cost of governance between cell owners, thereby creating cost efficiencies.

It is exciting times in the world of PCCs/ICCs where we are witnessing their use as SPVS and transformer vehicles for capital market transactions. So we’re essentially seeing fairly new technology providing an alternative solution to allow capital markets the opportunity to compete with the traditional reinsurance market, thereby providing greater choice.

We do anticipate an increase in the use of ICCs and incorporated cells as companies seek to avail themselves of the absolute segregation of assets and liabilities which an ICC structure provides. In a world of increasing governance and oversight, counter-party exposures, however slight, are the feature of much scrutiny and an ICC vehicle provides comfort in this regard. However, there are very few domiciles which have enacted ICC legislation (the Isle of Man is one) and I anticipate that it will only be a matter of time before an increasing number of traditional captive domiciles introduce the appropriate legislation.

How do you evaluate your captive needs, for example, in terms of auditing?
Corporate Governance has come to the fore in recent years and whilst generally captives have operated under good governance, changes in regulatory frameworks have highlighted the need for clearer documentation of that process.

In terms of auditing, licensed entities are required to submit financial statements that have been subject to external audit, and there is usually a strict timetable for the submission of those accounts.

The introduction of the Isle of Man Corporate Governance Code in 2011 highlighted the need for a risk-based approach to auditing and the need for there to be an independent view of a captives internal control. Whilst the process of review may have been in place for some captives, the new regulations prescribe more frequent reviews, albeit this should be proportional to the nature, scale and complexity of the captives’ activities.

Are you noticing any changes in fund management?

It very much depends on the client. Major PLCs, which is predominantly the Isle of Man client-base, generally have a Treasury function which utilises its existing banking relationships to manage captive funds, whereas smaller captive insurance companies have greater autonomy and the placement of the funds are dictated by the captive Directors. Generally speaking, most captive insurance companies are risk adverse in terms of investment risk and prefer to deal with cash deposits and there is an obvious need for liquidity bearing in mind the nature of the business. Following the economic downturn in 2008, there was an apparent run for quality and a spreading of the counterparty risk. I’ve seen a little bit more chasing of the rates in recent years but most captives are looking for ‘A’ rated banks, with 85-90% of Isle of Man domiciled funds being held in cash. From a cash flow perspective, the stacking of Letters of Credit (LOC) against long-term liabilities continues to prove to be an issue. This is also coupled with the rising cost of LOCs and as a result we have seen an increase in the interest of trusts during the past twelve months. Trusts can be more flexible, and cost-efficient too, but the main challenge here is their acceptability to the fronting company.

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