- Senior Vice President for Marsh Management Services Guernsey Limited
“As an industry we are now asking, what will be the next big thing, the next new technology?”
Clients are winning in the first instance. The competition between captive managers and other service providers such as lawyers and actuaries means client service is constantly under focus. The competition also extends between domiciles. Clients are asking themselves – where should they be? Onshore or offshore? If they see a better opportunity in another domicile, they can and do migrate.
From a global point of view, onshore captives are growing. But it’s not that companies are leaving offshore domiciles; additional or secondary captives are being formed onshore in new domiciles. Texas, Connecticut, New Jersey and Tennessee are viable domiciles now and are keen to attract business. These are mainly Section 831(b) of the Internal Revenue Code micro captives - this regulation is fuelling growth of these structures across the US.
Elsewhere in the world, Malta is on the verge of celebrating 10 years of being a recognised captive domicile. And from that point of view, the days of calling it a ‘developing market’ are almost over. It is a success story within Europe – it started from practically nothing to generate a strong viable industry today.
In terms of ‘product’ change – Insurance Linked Securitisation (ILS) is the big growth area globally. In Guernsey we are seeing the net increase in licences over the last 12 months coming from this innovation.
3) Is Solvency II a burden for all or an opportunity for some? How do you see the rest of the world (outside EU) responding to the directive?
I am a non-executive director of a Maltese resident onshore captive that’s complying with Solvency II hence I can see it at close quarters from a client’s perspective. There is a governance burden placed on Solvency II companies, and clients can take diametrically opposite views on this.
From the Guernsey point of view, I’m still fully supportive of the decision not to be Solvency II equivalent. When this decision was made, a large degree of uncertainty existed over the ultimate format of the legislation – and uncertainty creates difficulties for clients. Guernsey, by opting out, was able to continue with a regime of certainty. Since then, however, Malta has made great strides towards final implementation, as have Dublin and Luxembourg.
Whilst Guernsey decided not to seek Solvency II equivalence, it maintained proportionate compliance with the Insurance Core Principles (ICP) of the International Association of Insurance Supervisors (IAIS). That’s what is being worked on at the moment by both the regulator and industry - the main element of this is a risk-based solvency approach over a one-year timeline.
Clients still have the option to go onshore for Solvency II if they wish, or, they can comply with ICPs. The key is giving clients the choice. If they can decide which regulations they wish to be subject to, they will exercise that choice in the appropriate way for themselves.
4) What innovation have you seen in the industry recently? And what new alternatives are you aware of?
Normally new formations follow on from feasibility studies as the optimum structure and domicile for a potential captive owner. Increasingly all good feasibility studies have exit strategies built into them. So in the future, this enables captive owners to leave a structure easily if they so wish. In fact we’d say best in class feasibility studies – and even some policies – should always have exit strategies in place.
In terms of innovation, ILS is the big news from Guernsey’s perspective. That’s where our growth has come from for the past year. Another very interesting development is the establishment of a longevity risk mitigation structure by a major pension fund of a UK multinational. They have formed their own incorporated cell company containing a cell in to which they put longevity risk, and then 100% re-insured it back out again to a pension longevity re-insurer.
While the technology itself is nothing new, the idea of a pension scheme having their own captives is. To date, mitigating longevity risk has always been a challenge for pension schemes and how some have tackled this is attracting a great deal of interest.
5) Is captive insurance still as effective for risk management, and why? What other risks are coming into play and how can CI provide for these?
Yes, definitely. In fact we’ve got an association captive client that is in the process of renewing professional indemnity insurance. As with previous years the captive manager and risk manager are working together to change the policy wording to influence the risk management behaviour of the association members. It’s incredible the influence this can have. We use the policy wording and excesses to reward positive risk management.
Growth continues in the employee benefits sector, which is good because it’s encouraging a more holistic approach to benefits. Another interesting area of risk is cyber. For example, last year an American retailer had 40 million credit card numbers and 70 million personal details hacked. And while industry is still grappling with the implications of that attack, it is evident that a large financial risk and cost is associated therewith.
So there’s a lot of attention on cyber attacks and there’s a lot of development on the way for this area – undoubtedly captive type structures will have a role within that to assist good risk management.
6) To what degree should captive insurance be a profit centre for its parent? And how can captive companies improve their returns?
This is a shareholder decision. In the UK, the model is predominantly not for profit – it’s meant to break even. But in Europe, some captives are definitely run as profit centres, selling insurance products to large affinity groups. Malta has a number of these companies. It’s the shareholder who sets the tone and the objectives.
How do you improve returns? It’s simple – take more insurance risk. This is what captives do best. As captive managers we are constantly looking at new and innovative ways to expose the captive to more insurance risk and get more returns on capital for our clients.
Since the financial crisis, we’ve seen many more captives up-streaming money to their parent. Groups are collecting cash and re-deploying it elsewhere in the group, which works well for offshore captives but is not so easy for onshore. This is due to the capital charges imposed by Solvency II.
I have touched on the new trends emerging in pensions, employee benefits and ILS already. There’s also growth in the US in investment trusts. They have a federal home loan bank system which has a similar guarantee structure to the UK’s ‘Help to Buy’ scheme. Real estate investment trust (REIT) clients are finding that captives are an efficient way to access this scheme. There’s also talk of the 831(b) captive concept - which is growing in the US - being mirrored in the UK.
This is due to some of the new CFC rule changes that came in at the start of 2013, but the legislation isn’t as clear-cut as the US rules, so it has yet to generate a significant amount of interest.
Whilst we are in a soft insurance market, there are some industries where it’s harder to secure insurance. For instance, in the UK, midwifery has had a hard time getting insurance until recently – a captive was set up which greatly assisted in solving capacity challenges. Independent financial advisers is another area where pooled risk retention works well. The conventional insurance industry does not work well for these advisers and some are struggling to find cover. So there are pockets of hard market conditions out there, despite the general softness of the current market.
8) What changes are you witnessing in the size of businesses using captive insurance, and how do their performance priorities differ with an organisation’s size?
We are not seeing a great deal of change. Businesses are still spread across a range – from owner-managed businesses to the large multinationals. And captives are still used for a variety of reasons, with the scale at which they’re used dependent on the client’s wishes.
For instance, if a client wants an onshore insurance company but they know it’ll take six to nine months to get a licence then offshore can assist. We are working on a perfect example at the moment – setting up a cell structure for a client with an exit strategy already in place whilst they proceed with an onshore application. In Guernsey, they can get a licence within weeks, not months.
9) When interest rates eventually rise, what impact could this have on CI assets? And what action could they take to address this?
From an offshore perspective, most clients lend funds back to parents. Captives retain cash to pay aims and to fund letters of credit required by fronting insurers. When the captive lends back to the parent, it usually receives an arm’s-length rate of interest. If interest rates went up, it would therefore just mean an increase in income from the parent. In this scenario, it’s effectively taking from one pocket and giving it to the other.
The main thing changing would be the opportunity cost of capital. This is the capital that is held for regulatory and solvency purposes and which cannot be recycled. This is the cost of capital for the parent in having a captive. Increasing interest rates would affect this. When undertaking feasibility studies or strategic reviews to see if the captive is still adding value, that cost is taken into account. This might have an impact on more marginal captives, possibly putting them under threat.
10) Given the ongoing squeeze from regulatory and risk versus return pressures, does captive insurance have a future and why? Please give positive/negative reasons.;
One of the things that has developed over the last few years is the realisation of the strength of the human capital centred around financial structures which exists in Guernsey - this is critical to generating new opportunities. Innovative cell structures are generating interest in Guernsey in respect of ILS. There are a lot of bright people looking for the next opportunity to fuel the growth in licenses.
Here and in most domiciles, that’s tied in with pragmatic regulations that recognise that captives are different and need to be regulated in a balanced manner. Captives need a degree of proportionality and that has emerged across a number of domiciles.
Interestingly, Marsh Captive Solutions’ latest global survey found that only 14% of captives are coming in from Latin American, Asia and Africa. This is despite the fact that these are seen as growing economies. This will undoubtedly lead to a rebalance over a period of time but it is uncertain how long this will take.
The onshore growth in the US will continue apace, as each state sees an opportunity to capture captive licensees. The 831(b) micro captives will continue to grow in number too. As for Europe, Solvency II is due in 2016 but as clarity around the form of this legislation continues to spread, we anticipate a large number of new formations. We are currently seeing early signs of strong growth in Malta, Luxembourg and Dublin.
The interesting thing in my mind is that we launched the Guernsey PCC legislation in 2007 but it took us a couple of years to work out what to do with it. It’s the same with the ICC legislation where recently the power of this technology has been demonstrated. As an industry we are now asking, what will be the next big thing, the next new technology?