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CELEBRATING 10 YEARS 2000–2010

INDEPENDENT INSIGHTS

FOR CAPTIVES

www.strategicrisk.co.uk/captiverisk NOVEMBER 2010

ENGULFED A new launch from

BP’S CAPTIVE JUPITER AND THE IMPACT OF THE SPILL

COME TOGETHER

CAPTIVE ON TAP

ARABIAN SIGHTS

HOW TO MAKE A CAPTIVE MERGER WORK

THE MAN BEHIND HEINEKEN’S INSURANCE PLANS

WHAT DOES THE MIDDLE EAST HAVE TO OFFER?

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LEADER | November 2010 www.strategicrisk.co.uk/captiverisk

Staying on top It’s unusual for a captive not to buy reinsurance for cat risks. BP may have thought its pockets would be deep enough to accommodate the risk From the publishers of StrategicRISK

CELEBRATING 10 YEARS 2000–2010

INDEPENDENT INSIGHTS

FOR CAPTIVES

T

he captive for BP, Jupiter, will be bearing significant costs from the Gulf oil catastrophe, it appears. The captive has a policy limit of $700m (€500m) and does not buy reinsurance protection, which means its parent will be bearing the brunt of the cost. It’s unusual for a captive not to buy reinsurance for catastrophic risks. The reason BP didn’t is probably because it couldn’t get the limits it was looking for from the commercial market. And it may have thought its pockets would be deep enough to accommodate the risk. The unravelling story is a graphic illustration of the need for captives to maintain their independence from the parent company (our coverage begins on page 14). Sticking with the oil theme, this issue we’ve turned our attention to the captive environment in the Arabian Gulf region. The market here is in its infancy, but the financial centres are growing quickly and the Gulf states are very keen to be viewed as potential captive domiciles (our regional review starts on page 24). Turning to the business of running a captive, we’ve focused on two key concerns this issue. First is the innovative approaches that captives can take to try to stay relevant, particularly when the commercial insurance market is so soft (more on page 20). Merging two captives can streamline operations and save money, but it can also give rise to new problems. So we have come up with a list of top tips for easing the transition (more on page 22). Elsewhere, we also hear from two experts on the likely impact of Solvency II – will it be good news or bad for the industry? And we’ve turned our attention to the emerging tax status of the Channel Islands and the impact on the captive industry, we’ve considered how Europe’s captive domiciles intend to treat the Solvency II framework and taken a look at Bermuda’s interpretation of the regime. I hope you enjoy reading our second issue and find the news and analysis useful. Please get in touch if you have any observations of your own, to nathan.skinner@strategicrisk.co.uk.

www.strategicrisk.co.uk/captiverisk NOVEMBER 2010

Nathan Skinner is editor of CaptiveRISK and StrategicRISK

DEEP SPACE NINE SUN MOON & STARS

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CONTENTS | November 2010

PEOPLE & OPINION | Eric Bloem

PEOPLE & OPINION | Eric Bloem

Insurance on tap For Heineken International’s group insurance manager, using a captive is not about tax, and it’s not about risk management – it’s about giving the commercial insurance market some serious competition, as Nathan Skinner discovers

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eineken is the largest brewer and cider producer in Europe. The group owns and sells more than 200 international beers and ciders, including Amstel, Foster’s, Murphy’s, Newcastle Brown Ale, Strongbow and Tiger. Last year, the company’s total revenue was over €14bn. But due to a slump in alcohol consumption, profits this year dropped over 70% to around €200m from just over €1bn the previous year. Heineken International’s group insurance manager Eric Bloem runs Heineken’s Netherlands-based captive, Roeminck N.V. He believes risk retention helps support Heineken’s internal risk management process and assists in negotiating with the market by making Heineken a more attractive risk. Where is your captive based? And why did you choose that domicile? Heineken’s captive is called Roeminck N.V and it is based in the Netherlands, just like Heineken’s headquarters, which makes co-operation and contact between the two very quick and easy. How would you describe your captive insurance programme? What are its benefits? Roeminck is involved in property, marine and liability insurance programmes. The benefits that we realise are mainly to do with saving fronting cost and achieving faster processing in general – and claims in particular. With a captive, we can keep things simple and optimise our global programmes. The captive will never be able to carry all our risk entirely, but it is a powerful supporting tool. It can take care of the high-frequency losses. Is your board convinced of the benefits of a captive? The captive was a logical consequence of building a global insurance programme and the ongoing desire to aim for improvements. We did have to explain to the board about the strategic added value of a captive and the potential to

resolve some flaws in the insurance market, such as the peaks and troughs of the market cycle. What do captives most look for in their insurance or reinsurance partners? A captive is part of a long-term strategy to finance risk efficiently so the partners, consultants and suppliers preferably need to fit in with that strategy. Insurance partners must have endurance and be equally interested in long-term relationships. How have captives been affected by the financial crisis? The investment policy of Roeminck is prudent, which means pursuing security above profit. So the answer is no, we have not been affected by the financial crisis. The word investment, however, does not seem to be applicable in this near-zero interest rate period. But I assume that most captives weathered the storm as well. How has the prolonged soft market affected your insurance buying decisions and captive strategy? What is soft? We actually increased our involvement in the insurance programmes in our continued efforts to optimise our insurance solutions. Perhaps the market has reached a new equilibrium, because the cost component – for administration, distribution, communication – has come down, thanks to the use of computers. I do not think that the market is hard or soft. Those are just relative terms. The priority is to deliver the best available solutions for the company in a hard or a soft market, with or without a captive. That is all part of the equation and it explains the solution and the result. How is Solvency II going to affect captives? Solvency II will hit captives like it will hit smaller insurance companies of a comparable size. The rules will be equal and so will the pain. So the answer is, it will decimate a number

CAPTIVE BUSINESS | innovations

of insurers and that will not be in favour of the insured. As a result, the need for captives will grow. A number of captives, however, will have to increase their capital. Realistically, this does not always fulfill a purpose other than to be compliant. The same will apply to some insurance companies and thus it will push pricing up as there will be more dead capital. The lower return on capital will not be appreciated by rating agencies, for example. I assume this could lead to downgrades. Also, the issue of the standard model and the room to develop your own model will affect the business and make a distinction between large insurers and small ones. Developing your own model is not cheap and will thus be something only for the large operations. Solvency II will not help to create a level playing field and it will not help transparency nor make the job of the regulator easier.

Rise and shine

To what extent is the decision to form a captive inspired by tax or risk management? A captive is a long-term solution and taxes can change fast. So tax does not play a role. Managing risk is something that comes with understanding the risk and for that an insurance manager does not need a captive. So the inspiration to start a captive is not driven by these issues. It simply starts and ends with the desire to optimise the conventional insurance solutions that are not always cost efficient or at least need a bit of competition.

Risk managers must make their captives work harder in the current soft market. Nathan Skinner studies options including in-house employee benefits and traditionally uninsurable risks such as supply chain upheaval

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How did you become involved in captives? I previously worked for a captive broker and it was there that I became involved in the captive instrument and learned the trade.

t first glance, there may not appear to be much incentive for using a captive right now. The insurance market is in the depths of a prolonged soft cycle without much sign of change, according to most commentators. Capital, often in the form of bank loans, which is needed to set up a captive, could also be hard to come by. “Most companies that could have a captive have done it already or have looked at it and decided not to,” says Nick Wild, head of JLT’s captive management arm in Guernsey. These factors mean that the number of new captive formations has levelled off, following steady growth over the past two decades. New companies are emerging all the time and Wild believes that a moderate sized company today could easily grow within three years into the size of business worthy of a captive. However, he says: “The reality is, though, that the big numbers of captive formations are not there at the moment because first, it is a saturated market and second, the insurance market is so cheap that

How have you seen the industry evolve? It has moved back to the original objective, which is that a captive is an instrument to improve efficiencies in conventional insurance programmes and thus put pressure on the commercial insurance market. That is what a captive should be: competition for the market. Who do you most admire in the insurance world? The happy regulator who understands the business even after Solvency II implementation. Describe a typical day in the office. There is no typical day. Issues can pop up at any time and demand a realignment of your focus and priorities. The only guarantee in this job is change and that is what risk managers need to manage. Q

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frankly it’s difficult to make a new captive make sense.” He continues: “The captive market is in a state of equilibrium. There are just about as many captives going off the books as there are coming on. If you look at the major domiciles they are losing about as many as they are gaining at the moment.” There is little doubt that interest in the captive solution will continue. But given the current tough climate, risk managers are looking for ways to make their captives work even harder for them. Aon’s Derek Millar thinks risk managers’ approaches to captives fall into two categories. “You have the very experienced risk managers who have used captives for a long time and risk managers who are new to the concept: the way they think is completely different. The new kids on the block will think, ‘If [premium] rates in the insurance market go up I’ll look at using my captive to keep the premiums down’. Whereas the more sophisticated risk manager is always

looking for new opportunities to use their captive.”

POOL POTENTIAL One area where it is widely recognised that a captive can save its parent significant sums is through the provision of employee benefits. “People are exploring employee benefits in quite a big way because that is still a relatively untapped area,” says Wild. “Some companies are spending more on their employee benefits than they spend on their conventional insurance programmes. So that’s an area that could be expanded.” But at present only relatively few captives write employee benefits business, he continues. “Most employee benefits business that I’ve seen people attempt to put in a captive is basically the captive taking a position behind a pooled programme.” Cost savings are the prime driver for captive pooled employee benefits. For most commercial risks the insurance market is highly competitive but there are only

a limited number of carriers who write employee benefits well. It can be cheaper to pool the various programmes in a captive than to purchase individual solutions on the commercial market. “There’s nothing terribly innovative about having a pooled employee benefits programme but a lot of people don’t have one,” says Wild. “Quite often [various regions of] global operations are each doing their employee benefits in their own way. As part of pulling it all together, companies realise they have a big insurance premium spend and they think, ‘Surely there’s part of that risk that I’m passing to the insurance market that I could be keeping myself in the captive?’” But the risk manager needs to be aware of a number of major challenges attached to employee benefits. One big challenge is complying with local regulation. “In every operating environment you need a different solution,” says Dominic Wheatley, chief executive of Willis’ captive management arm. “Every

country has their own rules and laws about employee benefits, about the provision of life cover and health cover, and therefore you need local delivery of that.” Adds Millar: “Employee benefits are the Holy Grail in some ways. If you have a global business and each region does its own thing it ends up being expensive. If you get a captive to front the whole thing then it can be really profitable. But the problem is getting each of the operations to buy into that.” In most global enterprises it is the human resources department which has responsibility for employee benefits so the risk manager has to convince HR that using the captive is the best option. This might involve wresting the department away from commercial employee benefits provider who they have a cosy relationship with. Generally, Millar says, the verdict on placing employee benefits in a captive tends to be: “Would it work? Absolutely. Is it profitable? Definitely. Is it practical? Generally not! I know a lot of clients who have looked at doing this but very few have been able to succeed at it.” More positively, Malcolm Cutts Watson, chair of Willis’ international captive practice, says: “Where we’ve found the most success with captive employee benefits programmes is where the chief financial officer or the group counsel is put in charge of both the general insurance buying and the HR. They can then transfer some of the disciplines over from one silo to the other. When they are kept quite separate it is generally difficult.”

INSURING THE UNINSURABLE “There’s not a great deal of new risks that are obvious candidates for captives,” bemoans Wild. “Captives have been around for some time so they have explored most lines of coverage and if it makes sense they are already in there.” But Millar is more optimistic. “Sophisticated risk managers are thinking about the traditionally un-insurable risks and whether there could be an insurance solution and, if so, whether it is possible to use a captive for that.” He highlights an interesting trend where captives look to tailor bespoke insurance solutions to cover traditional exclusions. He explains: “You insure something that was previously uninsurable within the captive on a net retained basis with a fairly modest limit to begin with. When you get to the renewal, if you’ve had no claims or only small claims then

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Heineken’s Eric Bloem, page 12

REGIONAL REVIEW

CAPTIVE BUSINESS | innovations

you’ve built up some underwriting experience. You may be able to tap into some of the reinsurance markets and they’ll take a small piece of the risk.” Cutts-Watson has noticed a similar trend where captives look to insure risks that the market simply won’t insure. “Other areas are contingency type risks that could be related to supply chain or business interruption. These are the things that the market may not be able to model that well and is therefore not that comfortable writing. So the captive is a good way of warehousing that risk until you’ve built up data about it and then you can decide whether to transfer it to the market or not. “We did a lot of work in the 1990s with banks when they were coming up with new financial products and looking for the market to provide credit insurance on those products. Because they didn’t have the track record the insurance market was unsure about underwriting the risk because they couldn’t model it. So the captives were used as an incubator to put the risk in and then subsequently the banks decided to transfer the risk into the market once they had a better handle on it.”

REGIONAL REVIEW

Captives in the Gulf

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Abu Dhabi-based development firm Mubadala owns Masdar, a future energy firm that is developing the world’s first carbon-free residential city in Abu Dhabi (pictured). Mubadala has set up a captive insurance vehicle in the DIFC

Through a soft cycle, page 20

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18-19 Coming home

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News

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News analysis Tax and regulation in captive centres

‘Captives managers are really trying to get out and talk to people. If people are not aware of the solutions available, then you will not get anything off the ground’ Peter Hodgins, Clyde & Co surrounds the prospects for captives.” So while the regulatory framework is being developed, the number of captives remains low. Dubai, for example, has just two in place, although two more

THE GULF

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Both the Dubai and Qatar financial centres are in early phases of development and are trying to attract companies. Each centre has taken steps to become a key insurance market in its own right. The QFC, for example, in February unveiled intentions to become a captive, reinsurance and asset management centre.

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With so many corporate tax rates falling, is offshoring captives becoming less attractive?

PEOPLE & OPINION

CAPTIVE BUSINESS 20-21 Rise and shine

10-11

Market voices The great Solvency II debate

12-13

Interview

Innovative ways to keep your captive relevant in a soft cycle

22-23 When two become one

Talking to the man behind Heineken’s captive, Eric Bloem

Practical advice for merging two captives

BRIEFING

REGIONAL REVIEW

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24-28 Captives in the Gulf

Not just a drop in the ocean The impact of the Gulf of Mexico oil catastrophe on BP’s captive Jupiter

Editor Nathan Skinner Group production editor Áine Kelly Deputy chief sub-editor Laura Sharp Sales executive Sean Harry tel: +44 (0)20 7618 3082

Managing director Tim Whitehouse

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Essen continues: “The GCC insurance markets are potentially among the world’s most dynamic, considering the low insurance penetration and high potential in each of these countries. However, as an increasing number of international

However, Essen warns: “The attraction of establishing itself as a captive domicile and offering opportunities to self-insure is not unique to Qatar. Nevertheless, there is still a lack of awareness and understanding surrounding captives, as they are a new offering. “A common attraction of the captive structure is the ability to lower premiums, but with GCC insurance prices already being generally low, there is little incentive to self-insure. Nevertheless, optimism

Going to the Gulf, page 24

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COMMON ATTRACTION

companies move into this territory, competition will intensify.” Putting the growth into perspective, Essen explains that although insurance grew 27% year on year in 2008 to $10.6bn (€7.76bn), the GCC’s total 2008 insurance premium volume was only slightly more than two-thirds Singapore’s total premium volume. With that background, it is no surprise that captive insurance is a relatively new concept for the region. However, in light of the competition between the Gulf states, captive insurance is developing fast, with Dubai, Qatar and Bahrain leading the way in terms of regulation and incentives to attract business. Unusually, the UAE and Qatar each have two regulatory regimes in place. As Essen explains, in the UAE, the ISA supervises all aspects of the domestic insurance industry. Meanwhile, the Dubai International Finance Centre offers a zero tax rate on profits, 100% foreign ownership and no restrictions on foreign exchange or repatriation of capital. Qatar’s original 1966 regulatory regime is administered by the ministry of business and trade, and its principal laws relate to the insurance operations of domestic and foreign companies, marine insurance and compulsory third-party liability motor insurance. In 2005, the Qatar Financial Centre (QFC) was established, and companies and individuals are authorised and supervise by the Qatar Financial Centre Regulatory Authority (QFCRA).

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NEWS

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With proven financial resilience and impressive insurance growth, the Gulf states are now keen to attain captive domicile status. But, Liz Booth asks, can they prove they have something unique to offer?

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EXTENDED WARRANTY

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The increase in insurance premiums in GCC member states in 2009

he economic powerhouse that is the Middle East has emerged almost unscathed from the financial crisis that beset the rest of the world. High oil prices helped most Middle Eastern economies sail through the turbulence – and even the crisis in the Dubai’s construction sector has hardly dented the overall picture. This picture has been reflected in the insurance markets, with AM Best head of market analysis and author of a recent report on the region, Yvette Essen, agreeing that the insurance markets of the Gulf Co-operation Council (GCC) “have demonstrated a degree of resilience and are well placed to continue to grow”. Essen says that the United Arab Emirates (UAE), Bahrain, Saudi Arabia, Oman, Qatar and Kuwait have seen the take-up of insurance rise significantly, and while reduced spending on infrastructure may slow that rate of progress in the short term, she is convinced there are other opportunities for insurance growth. She says: “In particular, there is the prospect of an increase in personal lines business, flowing in part from the introduction of compulsory motor and health cover. Changing requirements are expected to drive premium volumes, and tougher rules will alter the insurance landscape. Local insurance regulation shows early signs of adopting global standards, and regulators are introducing higher capital requirements. “More foreign insurers and reinsurers are considering entering this region, which could lead to some takeover activity or the creation of joint ventures.

Third party insurance is another area that captives have looked at to add value to their business. Extended warranty insurance on electrical goods, cars and mobile phones is big business for captives. “There are quite a lot of people out there using captives for customer insurances,” says Wild. “The reason the big players in extended warranty for electrical goods, cars and mobile phones are putting this business into their captives is because it is highly profitable. The customer pays a fairly modest amount on top of their original purchase and normally that’s got a decent profit margin.” Risk managers interested in going down the captive route should pay close attention to the innovative ways in which these vehicles are used to add value to their parent business. If risk managers want to continue to leverage a captive solution for the benefit of their business they’ll have to think creatively about new areas that they could expand into or re-examine traditional risks that the wider market might be excluding. This will require a deep understanding of the business that the captive is serving so that risk managers know what the priorities are and how a captive solution could help. Q

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How established is the insurance market in the Middle East and what does the future hold?

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29/10/2010 14:41


NEWS | round-up

Best of the web TOP

1 0 E SS E NTIAL ON LI N E STO R I E S

1 | Dubai gets two new captives Two new captives are to be established in Dubai this year, doubling the number of captive operations in the UAE state. The new ventures, yet to be formally licensed, are said to include one protected cell company (PCC) and one pure captive. A local source said the PCC was designed to attract slightly smaller businesses. Both captives will operate out of the Dubai International Finance Centre (DIFC), where a spokesman said they were unable to confirm or deny that the new captives were in the pipeline. The boost for the local captive market comes just months after the financial authorities changed the regulatory capital requirements and lowered the costs for establishing a captive in the centre, while at the same time raising the capital requirements of insurance operations. The DIFC is in fierce competition within the region to develop a captive centre – Qatar, for example, has already said it would like to have 15 captives based in its domicile. Dubai is already home to two captives: MDC (Re) Insurance Ltd, owned by the Abu Dhabi-based development firm Mubadala and Dubai Holding Insurance Services PCC Ltd, whose parent Dubai Holding ultimately is owned by the royal family.  goo.gl/F5dV

3 | Top five mega-quake risks Research from Aon identified the areas in the world where an earthquake of magnitude 8+ is most likely to occur. These are the Caribbean, Cascadia in North America, Chile, Indonesia and Japan. Aon’s report outlined the scientific assessment and addressed the insurance implications of a mega-earthquake in each region.  goo.gl/eUXD

2 | Securing capital tops worry list for US captives

4 | Guernsey delegation pays visit to Asia

The biggest concern for captive Which is the most owners in the USA is getting their popular fronting insurer? hands on capital, according to Chubb the Captive Insurance Companies Old Republic Association (Cica) 2010 survey. Captives identified the biggest Discover Re challenges as: collateral concerns Liberty Mutual (27%); regulatory issues (16%); Zurich policyholder retention/growth (16%); and tax and fronting (both at Ace 7%). Other issues like reinsurance, Chartis service, corporate governance, 0% 10% 20% 30% 40% Solvency II, and ease in closing a Source: Cica 2010 survey captive made up the rest. A quarter (24%) of respondents reported that they considered the price of their reinsurance to be “expensive”, 67% reported it as “reasonable”, and 9% as “inexpensive”. A fifth (19%) of respondents said that their reinsurance costs are the same as the previous year, with 43% of respondents reporting an increase and 38% of respondents reporting a decrease. A majority (53%) of respondents cited investment yields of 2%-3%, with another 13% stating investment yields in the 4%-5% range. A total of 22% of respondents reported yields of 0%-1%, but no one reported less than 0%. The majority of the respondents (73%) reported being domiciled in a US jurisdiction, with 27% domiciled offshore. The survey was drafted and approved by a Cica committee and conducted by independent consulting firm Veris Consulting.  goo.gl/Dzcr

A delegation of politicians, officials and business leaders from Guernsey is to visit India and China to enhance financial services links between the jurisdictions. Guernsey minister for commerce and employment, Carla McNulty Bauer, will lead a delegation to Delhi and Mumbai. Chief minister Lyndon Trott will also lead a delegation to Beijing and Shanghai. The trip is intended to enhance relationships with the emerging market governments, regulators, professional associations and individual companies. Guernsey Finance chief executive Peter Niven said: “Guernsey needs to make sure that it maintains its profile in centres such as London, while also developing relationships in emerging markets such as China and India.”  goo.gl/nTtO

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5 | Willis appeals Indian licence rejection Willis appealed a decision by India’s insurance regulator that it is “not inclined to accept” the licence renewal application for the broker’s joint venture in India. The Insurance Regulatory & Development Authority (IRDA) rejected an application by Willis to renew the broking licence of its joint venture in India, Willis India Insurance Brokers Private Ltd. In a statement, Willis said it was “extremely concerned” about the IRDA’s ruling against its joint venture partner, Bhaichand Amoluk Consultancy Services Ltd, which holds a 74% stake in Willis India. Willis added that it was terminating its current relationship with Bhaichand Amoluk as a result of a series of management differences. Willis established the joint venture in 2003. In its decision, India’s regulator cited several problems with Bhaichand Amoluk, including a financial dispute related to reinsurance treaties and its failure “to maintain the ‘insurance bank account’ properly”. Managing director of Willis India Andrew Hicks said Willis was in “advanced contractual discussions” with a new joint venture partner.  goo.gl/6krx

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29/10/2010 14:51


NEWS | round-up

An industrial accident in Hungary released a toxic flood of red sludge over 16 square miles in October

6 | Munich Re proposes $20bn oil drilling cover In response to the Gulf oil disaster, Munich Re has developed a new concept for insuring offshore oil drilling in the USA, which could in theory create cover in the order of $10bn-$20bn (€7.2bn-€14.4bn) per operation. Cover would largely relate to clean-up and removal costs, impairment of natural resources and property damage, as well as loss of earnings in sectors such as fishing or tourism. “Following the catastrophic oil spill in the Gulf of Mexico, it is clear that better provision has to be made for dealing with losses and damage arising in this context,” said Munich Re in a statement. Currently, there is no separate cover for drilling operations, which are insured under the individual liability policies of the companies concerned. Munich Re said it would be prepared to offer coverage capacity in the order of $2bn, but Munich Re board member Torsten Jeworrek added that it would “not be possible to provide the necessary capacity at affordable prices unless sufficient wells are insured”. This could be achieved, he said, with some form of compulsory insurance in the drilling licensing procedure. “Better risk management and financial protection are needed in the field of fossil fuel generation,” Jeworrek added.  goo.gl/K1eG

7 | Risk culture is still lacking, survey reveals A recent risk manager survey found that risk culture is far from embedded in most organisations, despite risk management being a key goal. “There is a significant task ahead to embed risk management in organisational cultures,” said Institute of Risk Management (IRM) deputy head, Alex Hindson, who conducted the poll of the IRM’s Solvency II special interest group. “Few organisations appear to have a coherent strategy and approach to developing risk culture,” Hindson said. The survey asked questions about risk leadership and competence, how the organisation dealt with bad news, rewards, governance and transparency. The full results are available online.  goo.gl/9G8I

India’s dazzling opening ceremony for the Commonwealth Games on 3 October

8 | Business responsible for over $2 trillion of environmental damage Three thousand of the world’s largest companies were responsible for $2.15 trillion (€1.54 trillion) worth of environmental damage in 2008, while the total damage to the environment caused by human activity was in the range of $6.6 trillion (equivalent to 11% of global GDP). This was the headline finding of a UN-backed report into global environmental damage. Those global costs are 20% larger than the $5.4 trillion decline in the value of developed country pension funds caused by the global financial crisis in 2007/08. The study from Principles for Responsible Investment and the UN Environmental Programme Finance Initiative warned businesses that as governments start applying more vigorous ‘polluter pays’ rules for environmental damage, they will face higher insurance premiums, more taxes and the prospect of high clean-up costs. The most environmentally damaging business sectors are: utilities; oil and gas producers; and industrial metals and mining. These accounted for almost $1 trillion worth of environmental harm in 2008, according to the report.  goo.gl/YZy1

9 | Risk managers reveal top insurance concerns

10 | Lloyd’s and Bermuda converging

Risk managers across Europe revealed their top concerns about the insurance market in one of the biggest surveys of the profession. Their biggest bugbear with the insurance market was with regard to its ability to identify and respond to future risks (61% said that this was an issue). The looming hard market was the biggest fear for around half (48%) of the respondents, who were a sample of 780 risk professionals from around Europe. Almost the same number (42%) indicated that their biggest worry was the impact of Solvency II on the availability of insurance capacity. Elsewhere, the survey also found there is reasonable satisfaction with current prices, but also an awareness of the possibility of higher prices as a result of market hardening and the effects of Solvency II. The results of the survey, conducted by AXA Corporate Solutions and Ernst & Young on behalf of Ferma, were announced in London at the Ferma Risk Seminar.  goo.gl/rW3D

The work practices and risk evaluation methods in Lloyd’s and Bermuda are showing signs of converging, according to the Insurance Intellectual Capital Initiative (IICI). The IICI analysed the the reinsurance underwriting and broking practices of the two marketplaces and found that each could learn from the strengths of the other. “‘Lloyd’s v Bermuda’ is not a robust distinction,” said one participant. The report sited improved technology, global regulatory harmonisation, and the use of commercial catastrophe models as reasons for the convergence.  goo.gl/Q6rC ABOUT GOO.GL Type the shortened url address into your web browser to access our recommended articles from strategicrisk.co.uk

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29/10/2010 14:51


NEWS | analysis

Solvency II – yes, no, maybe? As Solvency II looms ever closer, can we expect to see it implemented in a captive centre near us? Sue Copeman finds that at least four – Jersey, Guernsey, Dublin and the Isle of Man – are giving no definite answers just yet

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olvency II is on its way and could have significant implications for captive insurers. But is it too soon to say how European domiciles will enforce the new regime? CaptiveRISK contacted Dublin, Gibraltar, Guernsey, Jersey, Isle of Man, Malta, Luxembourg, Sweden and Switzerland, but only Dublin, Guernsey, Jersey and the Isle of Man were prepared to outline their future intentions. Peter Niven, chief executive of Guernsey Finance, the promotional agency for the island’s finance industry, explains that, as Guernsey sits outside the EU, it is not obliged to introduce Solvency II. “Our government has been working with third-party insurance industry experts to examine whether it is in our interests to introduce Solvency II or an equivalent regime and if so how this might be applied to our captive insurance sector, which is of course the largest in Europe. The review is now in its final stages.” So that’s a maybe then. Jersey Financial Services Commission director, banking and insurance, Mark Sumner, says the number of Jersey-registered insurance companies is very small and the Commission has so far limited its involvement in Solvency II to a watching brief only, so as not to incur unwarranted development costs. “This has included consideration of related papers published by Ceiops and discussions with fellow regulators. The Commission is also currently monitoring the current revision to risk-based solvency requirements of the IAIS [International Association of Insurance Supervisors].” Sumner adds that the Commission will continue to monitor and consider the ramifications of Solvency II, with any proposed

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International Insurance and Management Association (Dima) to ensure suitable submissions were received from captives in order to identify the particular impacts of proposals in past impact studies on the sector. The authority also issued national guidance for captives in QIS4 (mainly focused on capital requirements) to test alternative simplifications to the standard approach set out in the technical specifications, and included the results from these in its country report to Ceiops. The financial regulator has also committed to working with Dima to assess own risk and solvency assessment (Orsa) submissions from captives on a pilot basis. The intention is to provide feedback so that Orsa material can cover the requisite ground in a sensible fashion. “But this clearly does not exclude the possibility that some captives may well need to make additional investment in governance and risk management arrangements,” the regulator said. It’s still early days, however, and until Level 2 implementing measures and Level 3 guidance are finalised, the authority says it cannot be more specific about the application of Solvency II to captives. Perhaps we should call this the ‘wait and see’ response.

ISLE OF MAN CONSIDERS

introduction needing to consulted on. Clearly, Jersey is hedging its bets as well.

IRELAND? WAIT AND SEE The Irish Financial Services Regulatory Authority is also carrying out an assessment for its captive centre, Dublin, recognising that “the risk profile of the captive insurance sector is distinct and different from most other insurers”. The Irish regulator has always been supportive of applying Solvency II’s proportionality principle to captives. This specifies that quantitative and qualitative solvency requirements should be compatible with the nature, scale and complexity of the risks inherent in a company’s activity, provided that policyholder protection doesn’t suffer as a result. But some captive representative bodies, including Ferma, have criticised Ceiops’ latest definition of captives on the basis that it will prevent many captives from qualifying for simplified requirements. Ireland’s financial regulator has liaised with the Dublin

It is an approach that is echoed in comments from the Isle of Man Insurance and Pensions Authority’s chief executive, David Vick. As a ‘third country’ for the purposes of Solvency II, the Isle of Man is not required to implement its provisions directly. But Vick says: “Given the links between Isle of Man insurance businesses and EU markets, the island might still be considered for the purposes of assessing ‘equivalence’ under Solvency II.” He adds: “The island has not yet made a decision as to whether to seek equivalence, as many of the detailed provisions of Solvency II are still in the process of being determined and are not yet available so that a full impact assessment in relation to equivalence might be carried out. Notwithstanding this, the island is continuing to pursue a programme of development of its regulatory framework, which it believes is consistent with the objectives of Solvency II and also with the developing standards of the IAIS.” Is that a ‘maybe’ and a ‘wait and see’ response? So the jury is still out over the route captive domiciles will take. Right now, organisations are fighting to ensure the concerns of their members get a fair hearing before the 2012 deadline. ■ Sue Copeman is editor-in-chief of StrategicRISK

www.strategicrisk.co.uk

29/10/2010 15:50


ANNUAL DINNER 2010

Tuesday 30th November - Lancaster London Airmic would like to invite you to the 47th Annual Dinner at the Lancaster London Hotel in London. Join the Chairman, Board and our members for the most celebrated occasion in the insurance and risk management calendar. For more information on prices or to book tickets visit: www.airmicdinner.com

Together Leading in Risk

TM


St Peter Port in a storm Attempts by the EU to bring corporate tax in the Channel Islands in line with Europe could affect Guernsey captives. Executives tell Nathan Skinner that captives are not tax avoidance tools and should not be treated as such

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uernsey’s position as Europe’s leading captive domicile could be under threat as powerful forces seek to impose higher tax requirements on the offshore jurisdiction. The EU is worried that businesses in tax havens such as the Channel Islands (the principal financial centre of which is Guernsey) are denying cash-strapped member states their tax revenues. Guernsey’s corporate tax regime came under the scrutiny of the EU Code of Conduct Group earlier this year, and the island agreed to carry out a review to amend its regime in line with European business tax standards. The European Commission says that the current 0% tax rate is not in the spirit of the EU, and in October last year the islands were told by the UK Treasury that the so-called ‘Zero 10’ tax regime is considered predatory by EU member states. The rumour on Guernsey is that the UK Treasury is taking a harder line than the EU. Either way, the pressure is being piled on Guernsey to raise its tax rate to bring it more into line with the main European states. It is understood that Guernsey’s new corporate tax regime will be revealed in the island’s budget in December. Guernsey chief minister Lyndon Trott said recently that details are not yet known, but the regime must meet certain aims. “Any new corporate tax regime for Guernsey must be competitive, must be internationally acceptable, must promote a sustainable economy, must be based on a similar solid rationale and not be overcomplicated, and must give rise to other

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benefits such as double taxation agreements,” he said.

IMPOSING SANCTIONS Guernsey introduced Zero 10 in 2008, applying a headline corporate income tax rate of 0% on most activities, but the taxation review could mean that the tax on Guernseybased companies leaps to 10%. As it is outside the single market, Guernsey doesn’t have to comply with European orders, but the EU could make it difficult for Guernsey if it failed to do so. The Commission could, for example, impose sanctions on citizens or the global consultancy firms that work on Guernsey – thus making it a less attractive place to do business. A tax that affects captives is not welcomed by the industry in Guernsey because it could hinder the domicile’s ability to attract business. Offshore domiciles would not look so attractive if they had similar tax rates to the mainland. Perhaps a major economy could become an attractive location for captives? Whatever happens, it seems unlikely that Guernsey will be the only offshore domicile affected by a tax hike. Trott says that Guernsey is working closely with Jersey and that the islands’ outcomes will be similar. Any changes will probably be reflected across both the Channel Islands as well as the Isle of Man, making it less likely that captives would decamp from one to another. Chief executive at Willis’ captive management practice on Guernsey and chairman of the Guernsey International Insurance Association, Dominic Wheatley,

Image: Visit Guernsey

NEWS | analysis

says: “As it stands, Guernsey’s tax system allows captive owners to have a tax-neutral position. In other words, their group tax position is not affected by the presence of the captive, which is exactly what we want to sustain. “We support a tax regime that will enable people to continue to have a neutral tax position as a result of the captive.” Wheatley argues that captives are not tax avoidance tools: “Having a zero tax rate applied to the captive is not tax avoidance because the tax is paid by the parent group. “The EU is concerned about unfair tax competition. Their concerns are with business that is attracted offshore by tax savings, but you don’t save tax by having a zero rate on captive profits in Guernsey. It is a neutral position because those revenues are still taxed at group level. We’re not the focus of their concerns, which are much more to do with offshore fiduciary funds, so I don’t think we’re in the firing line.”

TAX A ‘HOT POTATO’ While the EU action may not be directed at captives specifically, they will still be caught by changes to the island’s corporate tax rate. This is why the captive industry on Guernsey is campaigning for exclusion. Tax is a hot potato for Guernsey, adds Aon Guernsey’s executive director Derek Millar. He says: “We need to make sure we are not doing something uncompetitive, so we’re not going to make a decision before Jersey and the Isle of Man do. My gut feeling is that we will all do the same, and it will be between 0% and 10%. All the jurisdictions will be keen not to put themselves in a non-competitive jurisdiction.” Head of JLT’s captive management arm on Guernsey, Nick Wild, says tax changes could have an adverse effect on Guernsey’s captive business. He says: “Guernsey is trying to tread a difficult path so we can continue to facilitate business being done here without being seen to be offside with the EU.” ■

www.strategicrisk.co.uk

29/10/2010 09:54


NEWS | analysis

Euro firms may see fees rise Bermuda’s push for Solvency II equivalence does not currently include captive insurers, reports Helen Yates. European companies with Bermuda captives may see less administration, but fronting charges could increase

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uropean parents with Bermuda-based captives have been watching and waiting to see whether the jurisdiction will be granted third-country equivalence under Solvency II. Bermuda intends to have a regime equivalent to Solvency II in place by 2012. But attempts to achieve equivalence have so far only been for class three and four insurers, and not for class one and two insurers, the usual captives’ category. “The scope of the group-wide supervision regime will initially apply to the jurisdiction’s Class 4 and Class 3B (re)insurers, the largest firms with the highest risk profiles,” confirmed the Bermuda Monetary Authority (BMA) in a statement in February. “However, it will be expanded in line with changes in the international regulatory environment.” Because captives are currently excluded from the bid to achieve equivalence, it could affect certain risk transfer arrangements.

A POSITIVE DEVELOPMENT Lane, Clark and Peacock partner Charl Cronje says: “If you have a Bermuda-based captive and you make extensive use of fronting arrangements, you need to bear in mind that all this talk of Solvency II equivalence is not going to solve your problems. It’s just not going to apply to captives – and therefore you’re going to have to talk to your fronting insurers and suss out if they’re going to increase their charges.” The fact that equivalence is not being sought for captives could be seen as a positive development, according to Cronje. “The plus

side if you’re running a Bermuda-based captive is that you’re not going to have as tough a time regulation-wise as if you were a class three or four insurer.”

CAPITAL IMPLICATION But fronting charges could increase for European parents with captives based in Bermuda or other non-EU captive domiciles. This is because European insurers that regularly act as fronting insurers could find their risk transfer arrangements treated differently under Solvency II. “If the captive is not part of a third-country equivalent regime, it leaves the fronting insurer with a problem, because it is actually going to get penalised slightly for the risk they’re passing on,” Cronje explains. “Their regulator will not give them full credit for passing the risk away.” Fronting insurers may pass on 100% of the risk and premium to the captive, but could still be required to hold more capital. “They will have to hold some extra capital under Solvency II themselves for the slight risk that the captive might not be able to pay the claims,” Cronje says. “In the past, there was no real capital implication for a fronting insurer, because they were just passing all the risk away, but under Solvency II there will be. We’ve had a lot of

discussions with people in the captive industry. They have been pressing the big insurers that do fronting arrangements to find out if these insurers are going to charge more.” He continues: “Of course, the insurers don’t want to lose competitive position, so none of them are willing to commit at the moment.” Cronje does not think a rise in fronting costs is likely to drive captives to redomicile from Bermuda into Europe, noting that this would probably increase the capital requirements for captives that fall under the scope of Solvency II (those with gross premium income exceeding €5m or gross technical provisions in excess of €25m). But it is likely to affect the amount of capital that parent companies will have to set aside for fronting costs. So far, the signs for Bermuda achieving recognition by European regulators are positive, with Ceiops recommending that the British overseas territory, along with Switzerland and the USA, be considered for a first-wave equivalence assessment. It is the first time Ceiops has set out the countries it considers important.

A STRATEGIC PRIORITY For its part, Bermuda has recently issued two consultation papers on solvency self-assessment and disclosure and transparency that outline the BMA’s proposals on establishing a Bermuda-specific Orsa (own risk and solvency assessment) regime and improving disclosure requirements for the largest re/insurers on the island. Bermuda’s commercial insurer’s solvency self-assessment is comparable to Solvency II’s Orsa requirement but has been adapted to the needs of the Bermuda market. “Achieving regulatory equivalence for our insurance framework with major international markets has been a strategic priority for the BMA for some time now,” BMA chief executive Jeremy Cox says. “Our latest developments cover two key priorities from a global regulatory perspective: the quality of risk and solvency assessments in the market and ensuring firms make appropriate disclosures. Starting consultation on these key elements of our proposed enhanced framework clearly demonstrates the progress we are making towards equivalency.” ■

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29/10/2010 09:55


PEOPLE & OPINION | market voices

IN MY OPINION

Solvency II: will it be a blessing or a curse? Solvency II will severely restrict the commercial insurance market. It is time Europe listened to the concerns of risk managers, says Carl Leeman (above)

Two key figures in risk management go head to head to debate the new solvency regime that is set to have a huge effect on the insurance market. Will it be good or bad? Hear what the experts have to say

Leeman: Over the last few years, nobody outside the insurance industry has shown much interest in Solvency II – the new EU (re)insurer solvency regime – except captive insurer owners. Captive groups have lobbied the European Commission to avoid the additional administrative tasks that Solvency II will introduce, which will generate significant costs, and also to resist the requirement to make a large increase in capital of the captives. As far as I’m aware, the captive owners are having some success. However, Solvency II presents another issue separate from that of captives, and I find it surprising that this has not been given the attention it deserves. The basic concept behind Solvency II is to protect consumers. It is a noble ambition – but I don’t believe that we actually need additional protection. The regulations we have seem to work well. In the recent financial crisis, the insurance industry came through relatively unscathed. Even the problems that arose in the case of AIG were not a result of the company’s underwriting activities. Most insurers have done a decent job in protecting themselves and having enough capital reserves to pay claims. What regulators don’t seem to realise is that claims are different from investments. In the insurance industry, there is no possibility of the kind of emotive panic reaction that we saw in the banking sector, when people were frantically withdrawing their money from the banks. The risk of an insurer becoming insolvent is much smaller.

recently expanded EU. The existing Solvency I regulations represent no more than a glorified rule of thumb as far as capital requirements are concerned and are clearly no longer appropriate or adequate. It is a bold person who states categorically that the insurance industry has no exposure to systemic risk. While such risk exposure is significantly less than that of banks, the insurance industry is exposed on the asset management side. An increasingly connected world can also lead to unexpected claim ripple effects on the liability side.

Lajtha: I am not convinced that consumer protection is the primary driver behind Solvency II. The overarching motivations for the Solvency II initiative are efficiency, resilience and the creation of a competitive, level playing field in a

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Leeman: I believe that Solvency II is not justified (or is at least misled) and will miss its noble objective. I also think it will have a hugely negative effect for insurance buyers. The feedback I’ve received from several insurers suggests that they’re already cutting back in some areas. They’re going to need more capital and there will be less capacity, and they’re going to devote more time and resources to administration. At the end of the day, this means that buyers will have to pay more for the same coverage. There are some insurers who may not be too concerned about this. They have been trying to increase premiums for years but have not succeeded so far, apart from in some specialist sectors. They may use Solvency II as an excuse to make the increase that they have been waiting for. Technically speaking, too, insurers are going to struggle when it comes to long-tail liability coverage – workers’ compensation for industrial diseases, product liabilities or professional liabilities – where it is not always easy to determine the exact financial reserves need to be established. With the additional rules imposed by Solvency II, all these types of cover will become much more expensive, even supposing that insurers are prepared to underwrite them at all.

Lajtha: No doubt there will be additional costs involved in such a radical initiative as Solvency II. However, the move to a risk-adjusted solvency calculation will inevitably lead to a more resilient and capital-efficient insurance industry. The availability and price of some commercial insurance may well become less accessible. However, this will tend to affect the more problematic or marginal areas of commercial insurance that are known to be difficult to underwrite and price. This will be felt by commercial insurance purchasers at the boundaries of insurability rather than most of the mainstream. There is little evidence that the material overcapacity in the mainstream market will evaporate. It may well be that some of the more complex liability exposures are underpriced and should be reappraised on the basis of the risk-adjusted capital required to underwrite them. Overcapacity in the insurance industry often leads to irresponsible pricing. This may be acceptable in the area of short-tail commodity purchases, but is not a recommended approach to more complex, bespoke, long-tail exposures. There is a price for sound technical underwriting that Solvency II will encourage. Leeman: The outcome of Solvency II is likely to be the opposite of the initial aim but few people seem to be prepared to resist it. Despite the fact that higher premiums are hardly in the best interests of their clients, the broking community has remained pretty much silent on Solvency II. Could this be because higher premiums will mean bigger commission payments? The European Commission doesn’t seem to listen to the point of view of insurance buyers. They don’t give satisfactory answers to the questions we ask, but stick to the mantra that Solvency II will give better protection for the consumer. My feeling is that the regulators are being driven

www.strategicrisk.co.uk

29/10/2010 10:39


PEOPLE & OPINION | market voices

T H E S OA P B OX Why we must curb climate change

Solvency II will benefit the whole insurance industry and it’s worth the effort, rebuts Chris Lajtha (above)

by a kind of pride. They consider that they are developing a unique regime for Europe which will gain attention worldwide and will probably be adopted elsewhere. If the rest of the world has no option but to adopt Solvency II (or something equivalent) then risk managers everywhere will see their insurance spending rise and coverage decline. Lajtha: Risk managers who focus on short-term premium expenditure as a primary performance metric are misguided. Most corporate risk managers I have met are much more concerned by the quality of cover, the stability of the capacity commitment, and the dependability of the claim management and settlement process. Any initiative that purports to increase the robustness of the capital base underwriting the risk should be viewed as a positive development in an industry that is selling a promise to make contingent payments some time in the future. European regulators are listening to many different stakeholders, including insurance buyers and captive owners, and the Solvency II discussions have been the subject of a host of public debates of all kinds. Fundamentally, with the enlargement of the EU from 14 to 27 countries, there is a clear necessity to address the business of insurance within the economic community. Solvency II represents a significant step in ensuring a competitive and robust insurance industry. This can only be beneficial to the insurance buyer (large or small) over the medium to long term. Carl Leeman is president of the International Federation of Risk and Insurance Management Associations (Ifrima) and chief risk officer of Katoen Natie Chris Lajtha is the owner of ADAGEO, a Paris-based risk and insurance management consulting company

This year has been the warmest since records began more than 130 years ago and the warmer atmosphere and higher sea temperatures are having significant effects. It is as if the weather machine has moved up a gear. Future generations will bear the consequences unless binding carbon reduction targets stay on the agenda. Munich Re recorded a total of 725 weather-related natural hazard events with significant losses from January to September 2010, the second-highest figure for the first nine months of the year since 1980. Some 21,000 people lost their lives, 1,760 in Pakistan alone. Globally there has been at least a threefold increase in loss-related floods since 1980, and more than double the number of windstorm catastrophes, with particularly heavy losses as a result of Atlantic hurricanes. It would seem that the only plausible

Co-operate on global insurance standards I would like to see large insurers work more collaboratively to resolve compliance issues around the administration of global insurance programmes. It is time for the insurance industry to grow up. Compliance should not be an issue of competitiveness. In my view, we should all be able to interpret insurance regulations in the same way. I would like to sit down with the large global insurers, with the approval of the EU’s competition commission, and come up with an industry-wide solution. The problem is that each global insurer treats insurance rules and regulations differently, and according to their own interpretation, in each of the jurisdictions where they offer services. This can lead to a great deal of confusion over what the rules are and whether they are being followed correctly. A company, for example, could be found to be underinsured (or acting illegally) only

Professor Peter Höppe, head of Munich Re’s corporate climate centre

explanation for the rise in weather-related catastrophes is climate change. The view that weather extremes are more frequent and intense due to global warming coincides with the current state of scientific knowledge, as set out in the Fourth IPCC Assessment Report. Insufficient data exists to permit statistically backed assertions regarding the link with climate change. However, there is evidence that, as a result of warming, severe thunderstorms, hail and cloudbursts have become more frequent in parts of the USA, southwest Germany and other regions. The number of very severe tropical cyclones is also increasing. One direct result of warming is an increase in heatwaves such as that experienced in Russia this summer. Although climate change can no longer be halted, even with the help of very ambitious schemes, it can still be curbed.

Peter Den Dekker, president of Ferma

when it comes to making a claim in a particular region, simply because the rules have not been interpreted properly. The insured has an important role to play. If a risk manager does not educate their operations globally and line up the service providers for the local operations, then there will be delays and problems with compliance. This is a very complex area and a solution is needed. I would like the industry to come up with a more consistent interpretation of the various legal systems, rather than each global insurer competing for business based on its own understanding of the rules. We should all be willing to contribute to this process. • This column is a shortened version of comments made by Peter Den Dekker at the Ferma summit in London in October. Since taking the helm of Ferma, Den Dekker has spearheaded an ambitious lobbying campaign at a European level on issues such as Solvency II and broker remuneration.

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PEOPLE & OPINION | Eric Bloem

Insurance on tap For Heineken International’s group insurance manager, using a captive is not about tax, and it’s not about risk management – it’s about giving the commercial insurance market some serious competition, as Nathan Skinner discovers

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eineken is the largest brewer and cider producer in Europe. The group owns and sells more than 200 international beers and ciders, including Amstel, Foster’s, Murphy’s, Newcastle Brown Ale, Strongbow and Tiger. Last year, the company’s total revenue was over €14bn. But due to a slump in alcohol consumption, profits this year dropped over 70% to around €200m, from just over €1bn the previous year. Heineken International’s group insurance manager Eric Bloem runs Heineken’s Netherlands-based captive, Roeminck NV. He believes risk retention helps support Heineken’s internal risk management process and assists in negotiating with the market by making Heineken a more attractive risk. Where is your captive based? And why did you choose that domicile? Heineken’s captive is called Roeminck NV and it is based in the Netherlands, just like Heineken’s headquarters, which makes co-operation and contact between the two very quick and easy. How would you describe your captive insurance programme? What are its benefits? Roeminck is involved in property, marine and liability insurance programmes. The benefits that we realise are mainly to do with saving fronting cost and achieving faster processing in general – and claims in particular. With a captive, we can keep things simple and optimise our global programmes. The captive will never be able to carry all our risk entirely, but it is a powerful supporting tool. It can take care of the high-frequency losses. Is your board convinced of the benefits of a captive? The captive was a logical consequence of building a global insurance programme and the ongoing desire to aim for improvements. We did have to explain to the board about the strategic added value of a captive and the potential to

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resolve some flaws in the insurance market, such as the peaks and troughs of the market cycle. What do captives most look for in their insurance or reinsurance partners? A captive is part of a long-term strategy to finance risk efficiently, so the partners, consultants and suppliers preferably need to fit in with that strategy. Insurance partners must have endurance and be equally interested in long-term relationships. How have captives been affected by the financial crisis? The investment policy of Roeminck is prudent, which means pursuing security above profit. So the answer is no, we have not been affected by the financial crisis. The word investment, however, does not seem to be applicable in this near-zero interest rate period. But I assume that most captives weathered the storm as well. How has the prolonged soft market affected your insurance-buying decisions and captive strategy? What is soft? We actually increased our involvement in the insurance programmes in our continued efforts to optimise our insurance solutions. Perhaps the market has reached a new equilibrium, because the cost component – for administration, distribution, communication – has come down, thanks to the use of computers. I do not think that the market is hard or soft. Those are just relative terms. The priority is to deliver the best available solutions for the company in a hard or a soft market, with or without a captive. That is all part of the equation and it explains the solution and the result. How is Solvency II going to affect captives? Solvency II will hit captives like it will hit smaller insurance companies of a comparable size. The rules will be equal and so will the pain. So the answer is, it will decimate a number

of insurers and that will not be in favour of the insured. As a result, the need for captives will grow. A number of captives, however, will have to increase their capital. Realistically, this does not always fulfill a purpose other than to be compliant. The same will apply to some insurance companies and thus it will push pricing up as there will be more dead capital. The lower return on capital will not be appreciated by rating agencies, for example. I assume this could lead to downgrades. Also, the issue of the standard model and the room to develop your own model will affect the business and make a distinction between large insurers and small ones. Developing your own model is not cheap and will thus be something only for the large operations. Solvency II will not help to create a level playing field and it will not help transparency nor make the job of the regulator easier. To what extent is the decision to form a captive inspired by tax or risk management? A captive is a long-term solution and taxes can change fast. So tax does not play a role. Managing risk is something that comes with understanding the risk, and for that an insurance manager does not need a captive. So the inspiration to start a captive is not driven by these issues. It simply starts and ends with the desire to optimise the conventional insurance solutions that are not always cost efficient or at least need a bit of competition. How did you become involved in captives? I previously worked for a captive broker and it was there that I became involved in the captive instrument and learned the trade. How have you seen the industry evolve? It has moved back to the original objective, which is that a captive is an instrument to improve efficiencies in conventional insurance programmes and thus put pressure on the commercial insurance market. That is what a captive should be: competition for the market. Who do you most admire in the insurance world? The happy regulator who understands the business even after Solvency II implementation. Describe a typical day in the office. There is no typical day. Issues can pop up at any time and demand a realignment of your focus and priorities. The only guarantee in this job is change and that is what risk managers need to manage. ■

www.strategicrisk.co.uk

29/10/2010 14:15


PEOPLE & OPINION | Eric Bloem

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BRIEFING | Deepwater disaster

€15bn

The value of the fund set up by BP to cover all claims relating to the oil spill

53,000

barrels a day of oil flowed into the Gulf of Mexico at the height of the disaster

Not just a drop in the ocean

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29/10/2010 14:17


BRIEFING | Deepwater disaster BP spreads blame for Gulf disaster A report by BP into the cause of the Gulf oil spill disaster outlines eight reasons for the tragedy www.strategicrisk.co.uk

With a reserve limit of $700m, BP’s captive insurer is unlikely to make much of a dent in covering the oil major’s losses from the Deepwater Horizon oil spill, but Jupiter has still proved its worth, reports Helen Yates

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hen an explosion on the Deepwater Horizon oil platform occurred on 20 April this year, killing 11 platform workers and injuring 17 others, it quickly became apparent that the ensuing oil spill had the potential to become a major environmental disaster. For nearly three months, an estimated 53,000 barrels of oil a day spewed into the Gulf of Mexico before the wellhead was finally capped on 15 July. The clean-up is expected to take months, if not years. BP is the energy company at the centre of the disaster. The clean-up costs, reputational damage and related litigation are expected to cost it billions of dollars in claims for years to come. Had BP purchased its insurance from the commercial market, it is likely that such a loss would have caused a sharp contraction of capacity in the energy markets and a resulting hike in rates. But BP has a Guernsey-based captive insurer called Jupiter, which has a policy limit of $700m and does not buy reinsurance protection. Instead, BP, with its deep pockets, is expected to shoulder the bulk of the loss, announcing in June that it was establishing a $20bn (€15.27bn) claims fund over the next three and a half years to “satisfy legitimate claims, including natural resource damages and state and local response costs”. But not all parent companies have such financial capabilities. So, in these circumstances, what is the role of the captive insurer, and is it compromised by the parent’s potential for loss on a catastrophic scale? The situation of BP and its captive insurer is fairly unique within the captive arena, explains Kane Global consultant Clive James. “As a

rule, the company buys very little insurance, as much of its cover goes through its captive Jupiter in Guernsey and they take very high limits within that captive. As a consequence of this, they don’t tend to access the reinsurance market an awful lot. The direct impact of the disaster on the captive will be fairly substantial, particularly as it will have to cover the costs of the massive clean-up operation. There will therefore be a relatively limited impact on the reinsurance market, as BP’s captive will take the majority of the hit.” “In general, most captives have fairly strong reinsurance programmes so that they limit their potential liabilities in the event of catastrophe losses,” he continues. “But BP is unique in terms of the size of the company, as it has enormous amounts of reserves. A lot of captives can take fairly big hits, but it would be unusual to see exposures greater than $100m in terms of aggregate losses and, in the vast majority of cases, the figure will be a lot less because they simply wouldn’t have the capabilities to cover such losses.”

DOWNGRADE WOES In June, AM Best and Standard & Poor’s downgraded Jupiter’s financial strength rating, citing concerns over the full potential impact of the oil spill on parent company BP. “Although BP has recently agreed to establish a $20bn claims fund, given the magnitude of this event it is currently impossible to assess the ultimate impact on BP, both in terms of financial liabilities and reputational damage,” AM Best wrote. To a certain extent, the rating of a captive insurer is dependent upon the rating of its parent. In the case of a catastrophic loss, which undermines the capital position of the parent, a captive will be more susceptible to a downgrade even if its financial position is not really in question. However, AM Best assistant vice-president Steven Chirico says: “Is it wholly reliant on the parent company? Absolutely not. If the parent company were to get dragged down to a BBB-, it wouldn’t necessarily be a stress on the captive’s A- rating. It would only be if we felt the parent company’s business profile is compromised.” One reason for the guarded attitude towards BP was the potential hit to its reputation risk – a difficult factor to quantify. The widespread media attention and political wrangling involved in what was the

worst US environmental catastrophe since the Exxon Valdez oil spill in Alaska in 1989 had a huge impact on BP’s share price, which had lost almost half its value by June. While Jupiter did not have a reinsurance layer to absorb losses above its reserve maximum of $700m, the additional liability was retained by the parent company. In such a situation, the captive is not intended to deal with catastrophic-scale losses, explains Chirico. “We are not necessarily experts in analysing the oil industry. We understand from dealings with oil industry captives that when you’re talking about the numbers from a surplus and capital perspective and the ability to obtain liquidity in the marketplace for large oil companies, it’s hard to imagine how big a loss needs to be for a company to become compromised. The oil companies are so large and have such large capital [cushions] they can withstand a very severe financial loss.”

TRANSFERRING THE RISK Typically, the captives of energy firms or large drug companies, for example, would look to transfer catastrophe risk beyond the first $100m or $200m to the reinsurance market. Here, the value of the captive is demonstrated by it taking a share in the loss, rather than being set up to shoulder the entire burden. By taking a material line, the captive demonstrates it has a vested interest in taking risk mitigation and control more seriously than if it were ceding 100% of the risk into the commercial (re)insurance market.

‘One of the reasons BP moved away from the insurance market was the capacity was not there for this type of environmental loss’ Alan Fleming, Airmic Captive RISK NOVEMBER 2010 |

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BRIEFING | Deepwater disaster

“When you have your own captive and you’re retaining risk, the bet is you’re not going to have a loss and, if you do, you’re going to pay for it severely,” Chirico says. “With commercial insurance, you’re betting that you are going to have a loss, so right from the get-go you’ve misaligned your interest – you’re paying money for a premium and if you don’t have a loss, all you’ve done is you’ve lost money.” Just because a captive is not set up to take the burden of catastrophe loss does not negate its value, argues former Airmic chief executive and chair of the Airmic captive interest group, Alan Fleming. He was risk manager at chemical giant ICI during the liability crisis of the mid-1980s when premium rates for covers like general liability and medical malpractice soared. “I don’t think a loss like this is necessarily bad news for captives – it is bad news for BP,” he explains. “Sometimes when something like this happens, the market reacts very defensively. That’s what happened in the 1980s with the liability crisis: everyone just shut

up shop. Because we had our own captive insurance company, we were able to continue to offer cover up to a demand that we could finance and then on the basis of that we could continue to try to buy reinsurance protection.” Similar-sized losses in the commercial insurance and reinsurance market have caused serious dislocations in the past. After Hurricane Katrina in 2005, which cost the industry in excess of $40bn, prices increased by 100% on some catastrophe-exposed lines, while capacity for retrocession was almost impossible to find. “One of the reasons BP moved away from the insurance market was the capacity was not there for this type of environmental loss,” Fleming continues. “When I was at ICI, the environmental exposures were not readily insurable either but there were enormous potentials in relation to a particular event.”

KEEPING YOUR INDEPENDENCE The key lesson for captives to take from the BP experience is to maintain their independence

from the parent company. As long as a captive is separately managed and does not expose all its capital to one event, in theory it should be able to absorb a loss on the scale of the Deepwater Horizon explosion and oil spill, regardless of whether the lion’s share of the loss is transferred to the reinsurance market or retained by the parent. “When you think back to the days of Maxwell, about the only solvent part of the business in the longer term was the captive insurance company,” Fleming says. If anything, he thinks the bigger risk is that of the counterparty. “Unless it’s a non-insurable event, I would imagine that the biggest risk to the captive would be counterparty risk, where they’ve taken on a fairly severe natural catastrophe type exposure and the reinsurance doesn’t perform. “The captive needs to be managed as an independent entity and it shouldn’t be exposing itself to catastrophe risk, even if the parent company is.” ■

Reuters

WHAT CAUSED THE SPILL? “No single factor caused the Deepwater Horizon oil tragedy. Rather, a sequence of failures involving a number of different parties led to the explosion and fire that killed 11 people and caused widespread pollution in the Gulf of Mexico earlier this year.” That is the main finding of BP’s internal inquiry into the cause of the Gulf oil spill disaster. BP’s internal inquiry spreads the blame across “multiple companies and work teams” (including BP, Halliburton and Transocean) who contributed to the accident that it says arose from “a complex and interlinked series of mechanical failures, human judgments, engineering design, operational implementation and team interfaces”. Led by BP’s head of safety and operations, Mark Bly, the investigation uncovered several reasons for the explosion and disaster that ensued: • The cement and shoe-track barriers – and in particular, the cement slurry that was used – at the bottom of the Macondo well failed to contain hydrocarbons within the reservoir, as they were designed to do, and allowed gas and liquids to flow up the production casing. • The results of the negative pressure test were incorrectly accepted by BP and Transocean, although well integrity had not been established. • Over a 40-minute period, the Transocean rig crew failed to recognise and act on the influx of hydrocarbons into the well until the hydrocarbons were in the riser and rapidly flowing to the surface. • After the well-flow reached the rig, it was routed to a mud-gas separator, causing gas to be vented directly on to the rig rather than being diverted overboard. • The flow of gas into the engine rooms through the ventilation system created a potential for ignition, which the rig’s fire and gas system did not prevent. • Even after the explosion and fire had disabled its crew-operated controls, the rig’s blow-out preventer on the sea-bed should have activated automatically to seal the well. But it failed to operate, probably because critical components were not working.

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‘No single factor caused the Deepwater oil tragedy. Rather, a sequence of failures involving a number of different parties led to the explosion’ BP’s internal inquiry

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The 5th annual MultaQa Qatar conference will be held from

Monday 14 March to Tuesday 15 March 2011 in

Doha, Qatar at the

Sharq Village & Spa MultaQa Qatar offers a unique platform for senior (re)insurance and risk management executives from around the world to discuss regional and global industry issues of strategic importance. Turn boundless opportunities into profitable realities: •

Evaluate the regional (re)insurance landscape and discover new business opportunities •

Examine how global (re)insurers are taking advantage of regional growth in Qatar •

Keep up to date with the latest capital investment projects and understand their insurance requirements •

Understand the regulatory framework in the GCC •

Identify opportunities for captive insurance in Qatar Qatar ‘Case Study’ Clinics: Talent • Lifestyle • Takaful • Ratings

Join us at our next rendezvous in Doha and discover the perfect place to ‘do business’

“I do attend many conferences and MultaQa Qatar is extremely well organised, compared to others.” Yassir Albaharna, chief executive, Arig – Bahrain

“In comparison with other events I believe that MultaQa Qatar has positioned itself as one of the ‘serious’ forums.” Ian Sangster, chief executive, QIC International LLC

Attendance is by ‘invitation only’ and you can register your interest to attend @ www.globalreinsurance.com/qatar or by calling Debbie Kidman on 0044 [0]20 7618 3094 Hosted by

register your interest @ www.globalreinsurance.com/qatar

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RISKS | offshore

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The number of onshore captive insurance domiciles in the USA

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attling out of economic recession requires a careful balancing act by all governments. On the one hand, there is the need to generate income – usually by increasing taxation. On the other, there is no benefit in imposing further costs on businesses that can only have the effect of making them less competitive. In the UK, chancellor George Osborne took the business encouragement approach, with an emergency budget in June that introduced four annual reductions in the rate of corporation tax. These will eventually take the rate down to 24% from its current figure of 28%. Further, the anticipated increase in insurance premium tax, up just 1%, was considerably less than many had predicted. Jonathan Groves, who leads Marsh’s UK captive consulting practice, says that corporate tax rates have generally been falling across the board, and he estimates that the average rate in Europe has dropped in the last 10 years from around 33% to 25% – a significant

reduction. He believes that if the trend continues, it could have an influence on where businesses decide to locate their captives. Although governments frown upon companies using captives purely as tax avoidance vehicles and have taken steps to prevent this, there are still tax advantages to be gained by using captives, states Towers Perrin’s report Captives 101: Managing Cost and Risk, especially those with multiple owners or insureds and those where the insureds and the shareholders are not the same, “Deductibility of premiums and deferred taxation of insurance income are the two principal advantages,” the report says. But goes on to warn: “Tax issues can be a major driver, but they should not be the only reason for forming a captive. If they are, the captive might not stand up under the scrutiny of tax authorities and regulations.” Groves agrees that tax considerations have been an aspect of captive ownership. “Lower tax jurisdictions such as Ireland have always been attractive. And if you accept that tax rates are a factor, then countries that reduce their tax rates could have an influence on where captives are located in the future.” Executive chairman of JLT’s worldwide captive and insurance management operations (ex Americas), Nick Wild, is not convinced. “In the last 15 years – and particularly in the last five – tax has become much less of a driver in the decision as to where to put your captive. This is mainly because most of the countries from which captives emanate have amended their regimes to deal

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€900m

Captives with annual premiums lower than this tend to be formed offshore due to lower ownership costs

with the fact that the captives may be located in low-tax areas,” he explains. Although companies continue to locate their captives in low or no tax regimes, Wild believes that this is because of the expertise on running captives that has accumulated in such domiciles over the years. “The tax benefits have largely gone away but the knowledge and experience still reside mainly in those domiciles, so captives tend to gravitate there,” he comments.

IN MY BACKYARD But, Groves believes that implementation of Solvency II could reduce the competitive edge of some domiciles. “Although it’s been argued in the past that there has been a common EU regime relating to insurance regulation, that hasn’t totally been the case. There’s been some regulatory arbitrage where regulators have often interpreted rules and policies differently.” Groves thinks that Solvency II will create some consistency and uniformity in approach. He explains: “Some of the significant differences that might have existed with regard to insurance regulation may possibly become far less significant once Solvency II is introduced. And, provided Solvency II and its framework does not kill captives off, the regulation should create a more competitive environment between European countries and offshore domiciles.” Groves also says that there are “good logistic reasons” why it is better to have a captive in the same country as its parent. And national preferences may play a part. Wild points out that some companies, notably those based in the USA, have strong preferences for locating their captives onshore. “They would rather be doing business in their own backyard than on some farflung island,” he says. As a result, the number of US onshore captive insurance domiciles has steadily

With many corporate tax rates falling, and Solvency II creating uniformity across domiciles, is offshoring captives becoming less attractive? Sue Copeman reports why some companies are sticking to their home turf

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RISKS | offshore

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increased over recent years. According to US consultants Wealth Management Solutions LLC (WMS), the number stands at around 24 states. WMS says that captives that are formed, licensed, managed and operated outside the USA or offshore can elect to be taxed as a domestic US corporation for US tax purposes. “This allows a foreign-based captive insurance company to receive the same US tax benefits and treatment as a captive insurance company formed in any of the 24 US states with captive insurance legislation. The big difference is that a foreign-based captive generally has a much lower costs of ownership and a far higher degree of flexibility for its US owners compared to a captive insurance company that is domiciled in the USA.” The result is that most small captives with annual premiums below $1.2m (€916m) are formed offshore. There can be some tax advantages besides a reduced corporate tax rate in locating onshore. For example, if a British company locates its captive in the UK, any losses that the captive makes can be offset against profits in the core business. But if a captive isn’t subject to UK tax, this is not an option. Groves explains: “It’s often overlooked when considering captives that results are consolidated for accounting purposes but not from a taxation perspective.” There are also fewer uncertainties when doing business in a familiar country. Over the years, tax authorities have sometimes legally challenged offshore captive owners, with varying degrees of success. Groves says that avoiding investigation and litigation can be a consideration where

any tax benefits are marginal. “It’s a risk/ reward trade off in the way you operate your business. You might save €1m but there’s a 50:50 chance that you won’t and it could cost €1.5m,” he adds.

WELL EQUIPPED But nationalistic and familiarity preferences aside, Wild does not believe that a European country such as France would automatically attract existing or new captive owners to locate there “even if it dropped its corporation tax rate to 5% overnight”. He stresses that it takes a long time to build up experience in running captives. “Even though knowledge and expertise can be relocated, having the right legislation and regulation is also key in enabling captives to operate efficiently,” Wild says. “Many of the countries around the world whose tax rates may be going down are not well equipped to accommodate captives. They’re not geared up, and I don’t think they want to gear up for it,” he adds, pointing out that they would need to rewrite their legislation to attract captives. Groves is not so sure that the established offshore domiciles have little to worry about, and believes that some may be reviewing their current tax regimes in the light of corporate tax trends. He sees the issues of tax rates and Solvency II as being very closely related in their effect on captive location. “Offshore jurisdictions have to manage the question of whether or not to be an equivalent jurisdiction. If they decide to be equivalent, this may make them less competitive and it could make long-term sense to locate your captive where your home company is based.” While attracting captives may not be at the top of the agenda for countries cutting their corporate tax rates, Groves believes that for some of them “it’s on the radar”.

‘Many of the countries whose tax rates may be going down are not well equipped to accommodate captives. They’re not geared up’ Nick Wild, JLT Wild concedes that some companies may find the ‘own backyard’ approach attractive. “But we won’t see another 20 captive domiciles suddenly emerging, trying to drum up business and proactively attract captives. “In fact,” he concludes, “I think there’s already a surfeit of captive domiciles – and there’s a danger that resources may get spread too thinly.” ■ Sue Copeman is editor-in-chief of StrategicRISK

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CAPTIVE BUSINESS | innovations

Rise and shine Risk managers must make their captives work harder in the current soft market. Nathan Skinner studies options including in-house employee benefits and traditionally uninsurable risks such as supply chain upheaval

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t first glance, there may not appear to be much incentive for using a captive right now. The insurance market is in the depths of a prolonged soft cycle without much sign of change, according to most commentators. The capital, often in the form of bank loans, needed to set up a captive could also be hard to come by. “Most companies that could have a captive have done it already or have looked at it and decided not to,” says head of JLT’s captive management arm in Guernsey, Nick Wild. These factors mean that the number of new captive formations has levelled off, after steady growth over the past two decades. New companies are emerging all the time and Wild believes that a moderate-sized company today could easily grow within three years into a size of business worthy of a captive. But he says: “The reality is that the large numbers of captive formations are not there at the moment because first, it is a saturated market and second, the insurance market is so cheap that frankly it’s

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difficult to make a new captive make sense.” He continues: “The captive market is in a state of equilibrium. There are just about as many captives going off the books as there are coming on. If you look at the major domiciles, they are losing about as many as they are gaining at the moment.” There is little doubt that interest in the captive solution will continue. But given the current tough climate, risk managers are looking for ways to make their captives work even harder for them. Aon Guernsey executive director Derek Millar thinks risk managers’ approaches to captives fall into two categories. “You have the very experienced risk managers, who have used captives for a long time, and risk managers who are new to the concept; the way they think is completely different. The new kids on the block will think: ‘If [premium] rates in the insurance market go up I’ll look at using my captive to keep the premiums down’ – whereas the more sophisticated risk manager is always

looking for new opportunities to use their captive.”

POOL POTENTIAL One area where it is widely recognised that a captive can save its parent significant sums is through the provision of employee benefits. “People are exploring employee benefits in quite a big way because that is still a relatively untapped area,” Wild says. “Some companies are spending more on their employee benefits than they spend on their conventional insurance programmes. So that’s an area that could be expanded.” But at present only relatively few captives write employee benefits business, he continues. “Most employee benefits business that I’ve seen people attempt to put in a captive is basically the captive taking a position behind a pooled programme.” Cost savings are the prime driver for captive pooled employee benefits. For most commercial risks the insurance market is highly competitive but there are only

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CAPTIVE BUSINESS | innovations

a limited number of carriers who write employee benefits well. It can be cheaper to pool the various programmes in a captive than to purchase individual solutions on the commercial market. “There’s nothing terribly innovative about having a pooled employee benefits programme but a lot of people don’t have one,” Wild says. “Quite often [various regions of] global operations are each doing their employee benefits in their own way. As part of pulling it all together, companies realise they have a big insurance premium spend and they think: ‘Surely there’s part of that risk that I’m passing to the insurance market that I could be keeping myself in the captive?’” But the risk manager needs to be aware of a number of major challenges attached to employee benefits. One big challenge is complying with local regulation. “In every operating environment you need a different solution,” says chief executive of Willis’ captive management arm, Dominic Wheatley.

“Every country has their own rules and laws about employee benefits, about the provision of life cover and health cover, and therefore you need local delivery of that.” Millar adds: “Employee benefits are the Holy Grail in some ways. If you have a global business and each region does its own thing it ends up being expensive. If you get a captive to front the whole thing then it can be really profitable. But the problem is getting each of the operations to buy into that.” In most global enterprises it is the human resources department that has responsibility for employee benefits, so the risk manager has to convince HR that using the captive is the best option. This might involve wresting the department away from a commercial employee benefits provider that they have a cosy relationship with. Generally, Millar says, the verdict on placing employee benefits in a captive tends to go like this: “Would it work? Absolutely. Is it profitable? Definitely. Is it practical? Generally not! I know a lot of clients that have looked at doing this but very few have been able to succeed at it.” More positively, chair of Willis’ international captive practice, Malcolm Cutts Watson, says: “Where we’ve found the most success with captive employee benefits programmes is where the chief financial officer or the group counsel is put in charge of both the general insurance buying and the HR. They can then transfer some of the disciplines over from one silo to the other. When they are kept quite separate it is generally difficult.”

INSURING THE UNINSURABLE “There’s not a great deal of new risks that are obvious candidates for captives,” Wild bemoans. “Captives have been around for some time so they have explored most lines of coverage and if it makes sense they are already in there.” But Millar is more optimistic. “Sophisticated risk managers are thinking about the traditionally uninsurable risks and whether there could be an insurance solution and, if so, whether it is possible to use a captive for that.” He highlights an interesting trend where captives look to tailor bespoke insurance solutions to cover traditional exclusions. He explains: “You insure something that was previously uninsurable within the captive on a net retained basis, with a fairly modest limit to begin with. When you get to the renewal, if you’ve had no claims or only small claims then

you’ve built up some underwriting experience. You may be able to tap into some of the reinsurance markets and they’ll take a small piece of the risk.” Cutts-Watson has noticed a similar trend, where captives look to insure risks that the market simply won’t insure. “Other areas are contingency-type risks that could be related to supply chain or business interruption. These are the things that the market may not be able to model that well and is therefore not that comfortable writing. So the captive is a good way of warehousing that risk until you’ve built up data about it and then you can decide whether to transfer it to the market or not. “We did a lot of work in the 1990s with banks when they were coming up with new financial products and looking for the market to provide credit insurance on those products. Because they didn’t have the track record the insurance market was unsure about underwriting the risk as they couldn’t model it. So the captives were used as an incubator to put the risk in and then subsequently the banks decided to transfer the risk into the market once they had a better handle on it.”

EXTENDED WARRANTY Third-party insurance is another area that captives have looked at to add value to their business. Extended warranty insurance on electrical goods, cars and mobile phones is big business for captives. “There are quite a lot of people out there using captives for customer insurances,” Wild says. “The reason the big players in extended warranty for electrical goods, cars and mobile phones are putting this business into their captives is because it is highly profitable. The customer pays a fairly modest amount on top of their original purchase and normally that’s got a decent profit margin.” Risk managers interested in going down the captive route should pay close attention to the innovative ways in which these vehicles are used to add value to their parent business. If risk managers want to continue to leverage a captive solution for the benefit of their business, they’ll have to think creatively about new areas that they could expand into, or re-examine traditional risks that the wider market might be excluding. This will require a deep understanding of the business that the captive is serving so that risk managers know what the priorities are and how a captive solution could help. ■

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CAPTIVE BUSINESS | mergers

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When become Following a merger between parent companies, combining their captives can free up much-needed capital. But, as Neil Hodge reports, when you’re talking two captives in two different locations, the process can be far from simple

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he financial crisis has given companies a renewed need to focus on how they can be more profitable and where they can cut costs. As a result, it was only a matter of time before boards started looking at their captive insurance companies – set up to self-insure their risks – to see if they were all necessary and if any could be divested or merged. Some companies have already begun that process. Last year, Sweden’s Electrolux divested itself of two of its captive subsidiaries in a bid to save around SEK3.5m (€380,000) in administrative costs. The company’s Luxembourg captive Electrolux Reinsurance was acquired by Swedish municipal insurance company Svenska Kommun Försäkrings, while it liquidated its Irish captive Alfar Insurance Company. However, Electrolux retained its other captives, Electrolux Försäkrings and Vermontdomiciled Equinox Insurance Company. Corporate insurance partner at law firm Holman Fenwick Willan, Kapil Dhir, believes merging captives can be the best way to go.

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“Merging captives reduces management and administration costs. Companies can also reduce the amount of regulatory capital that is required to maintain the captive and so free up some cash to invest elsewhere in the business,” he says. But experts warn that companies need to take a number of issues into consideration when they decide to merge their captives. Chair of Airmic’s captive interest group, Alan Fleming, says that the key issues that determine where to retain a merged captive are premium volume, and the regulatory and legislative environment of the domicile. “Companies want to operate their captives as easily and cost effectively as possible,” Fleming says. “If companies are planning to consolidate them following a merger or acquisition between parent companies, those captives located in the most corporate-friendly environments are the ones that are going to survive. Geography also has a role to play – if a UK company wants to have its captive close by, Guernsey, the Isle of Man and Ireland are going to look more

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attractive than Bermuda, for example,” he adds. But Dhir says companies must also be aware of the regulatory issues surrounding captives, particularly if they are in different jurisdictions. “Merging operations across jurisdictions can present real problems, however slight the differences in law might appear. This may slow the process down and there may also be a fee involved in moving funds from that captive.”

TWO’S A CROWD There are typically two main ways to merge captives. The first, and the most widely used, is to carry out a transfer of assets and liabilities from one captive to the other that the company wishes to retain. The unused captive can then be liquidated, its insurance licence surrendered, and any remaining assets distributed to its shareholders. But such a move needs the approval of all policyholders, which can be time

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CAPTIVE BUSINESS | mergers

consuming, and poses the risk that a refusal from any one policyholder will prevent the merger. The second way – amalgamation – is limited to particular domiciles, such as the Cayman Islands and Guernsey. Essentially, the legislation in both these jurisdictions allows companies to merge all their captives registered in these domiciles without the administrative burden of having to negotiate each and every policy, reinsurance contract and fronting agreement. In other words, the merger can go ahead with court approval and is not reliant on policyholder consent.

MERGING CELLS In March this year, Heritage Insurance Management Ltd in Guernsey achieved a worldwide first by amalgamating two protected cell companies (PCCs) into one. The companies, Harlequin Insurance PCC Ltd and Friary Court Insurance PCC Ltd, were both insurance PCCs with 17 independently owned cells between them. The combined company has retained the name Harlequin Insurance PCC Ltd. Managing director at JLT Insurance Management in Guernsey, Nick Wild, says some domiciles – such as Guernsey, Bermuda, Malta and the Isle of Man – have legislation that allows companies to migrate their captives into one entity so long as the regulators from both jurisdictions are satisfied that the single captive has sufficient assets to cover all potential liabilities. “Guernsey’s regulatory framework makes it very easy for companies to merge their captives, particularly if more than one is based in the jurisdiction,” he says. “The ability for companies to migrate their captives to Guernsey from other domiciles and to amalgamate those already present here without the need to consult policyholders is particularly welcome as companies try to reduce their captives.” Vermont in the USA has also recently passed a law that enables companies to migrate captives and then merge them. The process is relatively straightforward – taking between six weeks and three months on average – and is inexpensive to process. Not all jurisdictions allow this, however, with Ireland being one example. Experts warn that there is a risk that companies will underestimate the costs associated with merging two or more captives. “Companies need to carry out appropriate due diligence and they need to check how effectively the captive to be acquired has been managed,

what its running costs are, and how effectively the risks have been underwritten and provided for. Merging any entity has associated costs before it produces savings,” Dhir says. “I suspect captives are not really at the forefront of executives’ minds when they are looking to merge companies,” Wild says. “But proper due diligence of the kinds of liabilities that these captives are providing cover for is essential. The last thing a company wants is to find that the captive it has just acquired might have long-term asbestos liabilities attached to it.” Wild also says that companies must consider the tax implications surrounding captives. “The differing tax rates of various domiciles may play a part in the decision as to where the company’s sole captive should be located. Also, companies need to find out if there might be any tax issues that could arise when a captive is closed.” Indeed, companies can have a nasty surprise when trying to wind up a captive and move the assets. Dhir says Luxembourg is a case in point. “If you close down a captive registered in Luxembourg and try to repatriate the funds in another jurisdiction, you will face a tax exit charge based on the fund’s total value. This is the reason there are so many zombie captives in Luxembourg – companies prefer to leave them as they are rather than close them down because doing so is just not financially viable,” he says. Yet merging captives may not suit everyone and companies should consider other possibilities rather than simply opting for merging captives, says Dhir. For example, they could consider a portfolio transfer of the underlying business. This involves a company transferring the insurance business to a different company and having it approved by a court order. This works well in the case of a multi-line, multi-party captive that has multiple policyholders, as there is no need to consult with them once the court order is in effect. Another option is simply to reinsure out into the market, instead of selling all the business and its risks. This means they limit their marginal earnings but they also limit their exposure to losses. “Companies need to look at all the options very carefully,” Dhir says. “Merging captives may be a sensible approach, but they should not assume that it is automatically the right course of action to take.” ■

KEY POINTS • Merging captives across two or more jurisdictions can present real problems, however slight the differences in law might appear. This may slow the process down and there may also be a fee involved in moving funds between captives. • To do a transfer of assets and liabilities from one captive to another needs the approval of all policyholders, which can be time consuming. There’s also a risk that if any one policyholder refuses to agree, the merger is stopped from going ahead. • Some domiciles – such as Guernsey, Bermuda, Malta and the Isle of Man – have legislation in place that allows companies to migrate their captives into one entity. Not all jurisdictions allow this, however. • Companies need to carry out appropriate due diligence and they need to check how effectively the captive that is going to be acquired has been managed, what its running costs are, and how effectively the risks have been underwritten. • It is important to consider the tax implications surrounding captives. Companies need to find out if there might be any tax issues that could arise when a captive is closed. For example, if you close down a captive registered in Luxembourg and try to repatriate the funds in another jurisdiction, you will face a tax exit charge. • Merging captives may not suit everyone and companies should consider other possibilities. For example, they could consider a portfolio transfer of the underlying business. Instead of selling all the business and its risks, another option is for companies to simply reinsure out into the market.

Neil Hodge is a contributor to CaptiveRISK

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REGIONAL REVIEW

Captives in the Gulf

Abu Dhabi-based development firm Mubadala owns Masdar, a future energy firm that is developing the world’s first carbon-free residential city in Abu Dhabi (pictured). Mubadala has set up a captive insurance vehicle in the DIFC

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REGIONAL REVIEW

27%

The increase in insurance premiums in GCC member states in 2009

With proven financial resilience and impressive insurance growth, the Gulf states are now keen to attain captive domicile status. But, Liz Booth asks, can they prove they have something unique to offer?

T

he economic powerhouse that is the Middle East has emerged almost unscathed from the financial crisis that beset the rest of the world. High oil prices helped most Middle Eastern economies sail through the turbulence – and even the crisis in the Dubai’s construction sector has hardly dented the overall picture. This picture has been reflected in the insurance markets, with AM Best head of market analysis and author of a recent report on the region, Yvette Essen, agreeing that the insurance markets of the Gulf Co-operation Council (GCC) “have demonstrated a degree of resilience and are well placed to continue to grow”. Essen says that the United Arab Emirates (UAE), Bahrain, Saudi Arabia, Oman, Qatar and Kuwait have seen the take-up of insurance rise significantly, and while reduced spending on infrastructure may slow that rate of progress in the short term, she is convinced there are other opportunities for insurance growth. She says: “In particular, there is the prospect of an increase in personal lines business, flowing in part from the introduction of compulsory motor and health cover. Changing requirements are expected to drive premium volumes, and tougher rules will alter the insurance landscape. Local insurance regulation shows early signs of adopting global standards, and regulators are introducing higher capital requirements. “More foreign insurers and reinsurers are considering entering this region, which could lead to some takeover activity or the creation of joint ventures.

COMMON ATTRACTION Essen continues: “The GCC insurance markets are potentially among the world’s most dynamic, considering the low insurance penetration and high potential in each of these countries. However, as an increasing number of international

companies move into this territory, competition will intensify.” Putting the growth into perspective, Essen explains that although insurance grew 27% year on year in 2008 to $10.6bn (€7.76bn), the GCC’s total 2008 insurance premium volume was only slightly more than two-thirds Singapore’s total premium volume. With that background, it is no surprise that captive insurance is a relatively new concept for the region. However, in light of the competition between the Gulf states, captive insurance is developing fast, with Dubai, Qatar and Bahrain leading the way in terms of regulation and incentives to attract business. Unusually, the UAE and Qatar each have two regulatory regimes in place. As Essen explains, in the UAE, the ISA supervises all aspects of the domestic insurance industry. Meanwhile, the Dubai International Finance Centre offers a zero tax rate on profits, 100% foreign ownership and no restrictions on foreign exchange or repatriation of capital. Qatar’s original 1966 regulatory regime is administered by the ministry of business and trade, and its principal laws relate to the insurance operations of domestic and foreign companies, marine insurance and compulsory third-party liability motor insurance. In 2005, the Qatar Financial Centre (QFC) was established, and companies and individuals are authorised and supervise by the Qatar Financial Centre Regulatory Authority (QFCRA).

However, Essen warns: “The attraction of establishing itself as a captive domicile and offering opportunities to self-insure is not unique to Qatar. Nevertheless, there is still a lack of awareness and understanding surrounding captives, as they are a new offering. “A common attraction of the captive structure is the ability to lower premiums, but with GCC insurance prices already being generally low, there is little incentive to self-insure. Nevertheless, optimism

‘Captives managers are really trying to get out and talk to people. If people are not aware of the solutions available, then you will not get anything off the ground’ Peter Hodgins, Clyde & Co surrounds the prospects for captives.” So while the regulatory framework is being developed, the number of captives remains low. Dubai, for example, has just two in place, although two more

THE GULF

IRAQ IRAN

KUWAIT

TH

Bahrain

UL

Doha

OMAN F

Dubai

F OF

OM

AN

OMAN SAUDI ARABIA

SOUTHERN YEMEN

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GUL

UNITED ARAB EMIRATES

REGULATORY FRAMEWORK Both the Dubai and Qatar financial centres are in early phases of development and are trying to attract companies. Each centre has taken steps to become a key insurance market in its own right. The QFC, for example, in February unveiled intentions to become a captive, reinsurance and asset management centre.

EG

ARABIAN SEA

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REGIONAL REVIEW The growth each year of takaful business over the past 20 years. Insurance globally has grown an average of 5%

Shutterstock

10%-20%

should be operational by year end; Qatar has one; and Bahrain (the first in the region to embrace captives) has two. Saudi Arabia has yet to develop a regulatory framework for captives, although rumours abound about possible changes in the near future. Saudi is home to three major companies that operate captives elsewhere – one each in Bermuda, Guernsey and Qatar. It is the low numbers that occupy the minds of those involved in the sector. Senior regional adviser at Kane, Fetooh Al Zayani, and Marsh captive consulting leader Jonathan Groves both say the current focus is on raising awareness. Al Zayani has been quoted as saying: “The concept of retaining risk is already a well-established one in the Middle East. What now needs to happen is that we look to generate greater awareness that using self-retention vehicles is a much more efficient, cost-effective way of managing those risks.” Meanwhile, Groves says interest has picked up as the regulators have developed new frameworks. Marsh has spent a lot of time, he says, prospecting in the region and completing feasibility studies in countries such as the UAE and Saudi Arabia. The past year has brought results, with Abu Dhabi-based development firm Mubadala setting up a captive insurance vehicle in the Dubai International Finance Centre. Mubadala owns Masdar, a future energy firm that is developing the world’s first carbon-free residential city in Abu Dhabi. It is understood that the captive will be used to help manage risk management provision for those renewable and green energy development ventures. Meanwhile Dubai Holdings has set up a protected-cell captive in the Dubai International Finance Centre, and two more operations are under formation, expected to be licensed by the end of the year. Groves says: “Essentially, captives based in the region are used no differently to those in Europe or the USA. They are tools to manage risks in a cost-effective way and to provide access to the reinsurance markets.”

Clyde & Co partner Peter Hodgins agrees that the changing regulation is designed to bring more business into the region. “The establishment of captive managers also helps,” he says, “and overall the environment is more suitable, but it is still at a nascent stage. As a general rule, it is not a region filled with sophisticated insurance purchasers, so captives are not the first structure that they think of.” The advantages of using a captive based in the region for local businesses is that they are able to exploit their local environment. In terms of regulation, Groves says, supervisors “have tried to take the better regulation from elsewhere and bring it together in one place, which is a good thing”. Hodgins agrees that the regulators are moving “to facilitate captives and create awareness of what a captive can offer”. Because it is the Middle East, the captive

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CAPTIVE NUMBERS

Two captives are currently established (Dubai Holding Insurance Services PCC Ltd and MDC (Re) Insurance Ltd); two are in the process of being established

INSURANCE PREMIUM UAE $4.976bn (€3.59bn) CAPTIVE LEGISLATION

Dubai Financial Services Authority (DFSA) rulebook modules; Dubai International Financial Centre (DIFC) companies law (DIFC law number two of 2009); and DIFC companies regulations

LICENSING FEES

Captive normal application fee: $15,000. Annual fee: $15,000 plus $1,000 per $1m of gross premium income, capped at $150,000 annually. PCC normal application fee: $40,000. Annual fee: $40,000 plus $1,000 per $1m of gross premium income, capped at $150,000 yearly. A captive insurer of PCC will also need to register with the DIFC. Application for company name reservation is $800; incorporation of a company limited by shares is $8,000; and commercial licence fee is $12,000

CAPTIVE REGULATOR

DFSA and DIFC Authority

BAHRAIN

MUCH TO OFFER

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DUBAI INTERNATIONAL FINANCIAL CENTRE

CAPTIVE NUMBERS

Two captives currently established (Tabreed Captive Insurance Company B.S.C and Masheed Captive Insurance Company B.S.C)

INSURANCE PREMIUM

$497m (€359m)

CAPTIVE LEGISLATION

Central Bank of Bahrain (CBB) rulebook volume three and commercial companies law 2001

LICENSING FEES*

CBB fees: application fee of BD100 (approximately $265) and annual licence fee of BD1,000 (approximately $2,650)

MINISTRY OF COMMERCE Application fee of BD20 (approximately $50) AND INDUSTRY CAPTIVE REGULATOR

Central Bank of Bahrain, and Ministry of Commerce and Industry

* Fees listed do not necessarily include all costs incurred in licensing a captive in Bahrain. The fee levied by the CBB and other local agencies can increase, without notice, and additional fees can be imposed at any time.

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REGIONAL REVIEW

Corbis

SPOTLIGHT ON DUBAI

On 31 August, Dubai International Financial Centre (DIFC), produced a report on its performance in 2010 to date. HIGHLIGHTS > The overall number of active registered companies operating from DIFC remains constant at 745. > New companies have registered from emerging markets such as China, Malaysia and the Indian subcontinent. > There has been continued development of internationally recognised regulations, with the introduction of new changes to DIFC’s collective investment funds. > The annualised growth rate is 20% in terms of additional office space leased in DIFC; occupancy of the DIFC’s Gate District remains high at 92%. > DIFC’s business strategy review has been completed in preparation for the next phase of the centre’s long-term growth. > The cost of doing business will be reduced to encourage the growth of businesses based in DIFC.

QATAR FINANCIAL CENTRE CAPTIVE NUMBERS

None, but Kane was awarded the first insurance management licence to establish captives in the QFC on 2 September 2010

CAPTIVE PREMIUM

None

CAPTIVE LEGISLATION

QFCRA Rulebook; QFCA Companies Rules; and QFC Companies Regulations

LICENSING FEES

QFCRA fees: application fee of $10,000 (€7,200) plus $500 for each individual for whom approved individual status is sought; annual licence fee of $10,000, plus $500 for each approved individual employed by the authorised firm at 30 September in the previous year

CAPTIVE REGULATOR

QFCRA and Qatar Financial Centre Authority

QATAR CAPTIVE NUMBERS

One captive established (Al Koot Insurance and Reinsurance)

INSURANCE PREMIUM

$1.01bn (€729m) (2008)

CAPTIVE LEGISLATION

Law number one of 1966 supervision and control over insurance companies, and agents and council of ministers’ resolution No 27 of 2003 confirming incorporation of Al Koot Insurance and Reinsurance

LICENSING FEES

Not available

CAPTIVE REGULATOR

Ministry of Business and Trade

Source: Clyde & Co LLP, Swiss Re and local sources

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SPONSORED COLUMN

Increasing prospects for growth for the captive risk market in the GCC

REGIONAL REVIEW

€14.4 trillion

Qatar’s proven energy resources expected to be monetised over the next 100 years

Corbis

Akshay Randeva, director, strategic development at Qatar Financial Centre Authority Traditionally, economic growth in the Middle East has primarily been driven by its vast reserves of oil and gas. However, in recent years many states in the Gulf Co-operation Council (GCC) have been using revenues from natural resources to diversify their economies. The vast natural resources wealth is a powerful driver. In Qatar, more than $20 trillion (€14.44 trillion) of proven energy resources are due to be monetised in the next century, according to a report by the Economist Intelligence Unit.

Taking market share This growth, past and projected, creates huge opportunities for the insurance sector among others. The insurance and reinsurance markets are being driven by infrastructure and investment projects, offering opportunities in a market where the necessary regulations and tax environment are in place. The GCC insurance market grew to $10.6bn last year, demonstrating the development of a strong risk management culture as larger and more complex projects have been undertaken across the region. This has not gone unnoticed by large multinational insurers, as companies including Heritage, Marsh, Aon and Willis have established themselves in the region. Kane, a leading captive manager, has recently entered the Akshay Randeva, QFCA Qatar Financial Centre. Captive insurance has been identified by the Qatar Financial Centre Authority (QFCA) as one of its three core financial services targets, alongside reinsurance and asset management, as areas with significant growth potential.

‘The large assets on the books of many companies has left corporates unable to secure the cover they require’

Adequate risk cover It is not just indigenous economic growth driving demand for insurance in the region; it is is expected that the insurance industry in the GCC will take market share from elsewhere in the world. Captive insurance, specifically, is becoming an attractive proposition to regional corporates. Many see adequate risk cover as increasingly important following the lessons of the 2008 global credit crunch. The large assets on the books of many companies, often as a result of their focus on business expansion during the past decade, has left many corporates unable to secure the cover they require. This trend, coupled with the capacity destruction in the international reinsurance market and the inability of local insurers to underwrite large complex facultative risks, forces corporates to look to solutions such as captive insurance.

Increasing sophistication While the effect of the EU Solvency II directive and its regulatory regime has yet to be fully examined, the possibility that EU-based captive insurers will face higher capital requirements and increased disclosure may lead them to rethink their business model. It is clear too that regulators, governments and market participants are supporting the expansion of this sector of the insurance market. The establishment of bodies such as the QFCA to promote the growth of financial services; the increasing sophistication of legislation and the regulatory framework, and the availability of specialist captive managers in the region all suggest that the captive insurance industry in the GCC is set to grow even more quickly, capitalising on an increasingly competitive edge.

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structures have been developed along takaful insurance lines to ensure they are shari’ah-compliant, and it is a requirement that each captive is approved under an Islamic religious approach. Needing an understanding of the specialised local requirements, as well as having an understanding of the captive and insurance markets, may suggest that recruitment could be difficult. Other captive jurisdictions make a virtue, for example, of being able to offer a range of experienced hands. Yet, Groves says, the Middle East does have an adequate talent pool; Dubai, for example, is home to a number of expatriates with significant regulatory experience. In fact, he says, the downturn in the property market has helped in a small way to make it easier for expats to move to the region. The challenge instead has been to weld those coming from elsewhere into local teams. “It can take time to orchestrate a good system if people don’t know each other and how they work together,” he says.

APPLAUDING EFFORTS And the ultimate challenge for the region, according to Groves, is how it can differentiate itself from existing captive domiciles – onshore or offshore. “I think they are struggling to differentiate themselves in the market and a lot of businesses are very hesitant about being the first into a new area,” he says. “Convincing your own management to set up a captive can be daunting at the best of times. Even the Saudi Arabian captives operating in Guernsey and Bermuda have not chosen to bring it closer to home because of the lack of differential.” However, now that captives are emerging, it may well become far easier for those overseeing risk management to convince their boards that it is a worthwhile move. Hodgins applauds the efforts being put in by the captive managers who, he says, “are really trying to get out and talk to people. You need businesses of a certain scale but if people have not been aware of the solutions available, then you will not get anything off the ground. Both Kane and Marsh have been putting time and effort into that education and I think that message is getting through.” He admits: “It is a little bit of a slow burn.” But with Qatar alone convinced it will have at least 15 operational captives in the near future, it looks like it is a concept that the market can expect to hear a lot more about. ■

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CaptiveRISK