GLOBAL CAPTIVE PRACTICE (EUROPE) NEWSLETTER June 2014 www.williscaptives.com THE ANALYTICAL CAPTIVE MANAGER These are interesting times for captives interesting and challenging. This reflects the evolving risk and business environment of captive owners and their captives. It is essential that captives change and evolve to keep pace with the developing demands made of them, that they continue to create value, and that they meet the increasingly exacting demands of their parent group, board and regulators. Captive management has never been more challenging or more interesting! money laundering, terrorism funding, sanctions, and tax avoidance. Once again reputational risks are to the fore, alongside others such as both corporate and personal prosecution. These are not risks to be taken lightly.to meet these challenges requires a greater range of skills, more access to expertise and higher levels of quality in service delivery, something we are calling the Analytical Captive Manager. Companies today face a much wider range of risks that ever before, and in a governance environment that no longer allows them to turn a blind eye. Even if there is little that can be done to mitigate a risk, its acknowledgement and financing is the minimum required of directors. Market responses to emerging risks such as cyber have been cautious and limited in scope and limits. This leaves companies with significant additional financing requirements to be met. This is where your captive plays a key role in providing formalised governance and capital allocation, backed up by regulatory oversight, to clearly demonstrate the effective management of the risk. However, this must be achieved in an increasingly scrutinised world where the demands of regulatory and tax authorities must be fully met. Given modern communications you can no longer rely on restrictive authorities in distant parts of the world not scrutinising the compliance of your London market global programme under their own regulations. This exposes companies potentially to a range of risks, not least being reputational risks in key markets. Similar issues surround the operations of captives where increasing regulatory burdens driven by global drivers and increasing international scrutiny are placing more and more emphasis on the needs for traditional captive jurisdictions to conform with global standards in areas such as regulatory standards, Of course, the foundation of any effective captive management service lies in reliable, timely and accurate administration and reporting. This is a given and, like a referee in a football match, you only notice it when it goes wrong. However, it is not here that value is created even if poor administration can undermine it. Value creation lies in optimising the captive business plan and integrating it effectively with group risk management and financial strategies, and delivering it seamlessly alongside other aspects of the insurance programme. To do this requires bringing together analytics, wholesale broking, local service broking and captive expertise to maximise captive value creation whilst maintaining high standards of global compliance, simplifying the complexity of the many competing factors, and delivering full transparency and effective governance. This is the outcome of what we call the Analytical Captive Manager. Paul Owens, CEO, Willis Global Captive Practice Contact: +442031246556, owensp@willis.com ADAPTING TO CLIMATE CHANGE: CAPTIVE INSURANCE We have been talking about climate change for what seems like forever; debating the causes and arguing over the consequences. The new report from the Intergovernmental Panel on Climate Change (IPCC) urges that we respond now to the risks posed by climate change. Willis Global Captive Practice - International - Newsletter - June 2014 1
Insurance is the business of managing risk, and the industry has built up detailed knowledge of the losses associated with some of the risks identified by the IPCC. Increased frequency of flood and storms have already led to a shortage in insurance and reinsurance capacity in this sector. WHY WOULD A CHARITY USE A CAPTIVE INSURER? INSURANCE-LINKED SECURITIES In a sense the industry has already responded. Insurance-linked securities (ILS) have been the insurance industry s response to this lack of capacity since 1994. This enabled insurers to access the then alternative capital markets. Approximately 15% of global catastrophe reinsurance capacity is now provided through ILS. If natural catastrophes are becoming more frequent and severe then ILS will continue to grow. SEGREGATED ACCOUNTS The insurance industry has also found the most efficient mechanism for bridging the gap between the markets in the form of segregated accounts or cells. The climate change challenge is obviously enormous, but the convergence of the insurance and capital markets is surely a small part of the solution. Necessity is the mother of invention. ILS is no longer a risk specialty but a new normal. It is time to demystify and improve our understanding of this growing market and innovate with new products. Stewart McLaughlin, Account Director, Willis Management (Guernsey) Limited Contact: +44 1481 735 632, stewart.mclaughlin@willis.com Recently a major international charity announced their captive will expand from writing UK-only business to play a key role in their international property programme. But with no tax drivers, and no shareholders demanding increased profits, or demonstrations of risk governance, why would a charity have a captive? It might seem a tricky question, but try turning it on its head, why would a charity buy insurance? Charities would rather be spending money achieving their core aims, and making the world a better place, than buying risk transfer they don t really need. Our usual methods of identifying risk tolerance need to be adapted here, as it s the ability to continue to deliver services, and run critically important projects that drives their level of risk appetite, not a need to protect their share price or satisfy a rating agency. For some global charities, the very nature of their operation makes them difficult to insure, pushing them to take more risk themselves, and rely less on commercial insurers. So why a captive over a contingency fund? A captive provides a formalized, regulated vehicle for risk retention, and can bring greater discipline to risk management and governance than, say, a balance sheet fund. As regulated entities themselves, charities understand the benefit of a transparent and rigorous approach to managing their risks, and their trustees and donors demand it. 2
KEY ISSUES WHEN SETTING UP A CHARITY CAPTIVE Firstly, all captives require some capital investment at formation. A case must be made to demonstrate that the captive is an appropriate investment for the charity, and is compliant with the Charity Commission (or local) regulations. IS THE CHINESE CAPTIVE DRAGON STIRRING? This is no barrier to the formation of charity captives but it is critical that the captive has a convincing business plan and projected returns, as well as plans in place for a major loss. Secondly, charity captives tend to be wholly-owned rather than facilities provided by a third party (for example, protected cell companies). This means that the full control of the captive sits with its board of directors and ensures perfect alignment of the captive s activities to the organization. This might include, for example, ethical investment policies. Finally, charities don t pay corporation tax (in most circumstances), and subsidiaries can claim relief on any profits donated to their parent. Although fiscal efficiency is rarely the primary driver for establishing a captive, it does impact on selection of domicile. Charities are less restricted in their selection of domicile, and able to select the most appropriate location for their needs, whether that s a direct writing vehicle in the EU, or a low cost offshore domicile. As you might expect, it s not just charities that have found ways to use a captive to support their activities, government and NGO s share many of the same characteristics, and are waking up to the benefits of building segregated internal risk capacity. So, captives can be a valuable tool for the third sector, and we expect their use will continue to grow. I know I would rather that my charity donations were used to support its work on the ground, and invested to protect it for the future, than went into the pockets of commercial insurers. Wouldn t you? Katherine Outhwaite, Captive Consultant, Willis Global Captive Practice - International Contact: +44 20 3124 8690, katherine.outhwaite@willis.com We have just returned from China where we jointly hosted with our Willis China colleagues a seminar focusing on captives. Our initial thoughts were that we may get 30 attendees. Imagine our surprise when 150 delegates attended. In addition, the event was covered by the press and local TV. There is huge interest from all sectors as the companies see a captive as a potential solution within an integrated risk management solution. These organisations, along with academics, are applying pressure on the authorities to try and ensure the regulatory framework is fit for purpose and market leading failure to do so will see other domiciles take market share. The potential to create a new global insurance centre is enormous. Remember both London and Bermuda can see their origins as captive (or similar) centres. Maybe the Chinese captive dragon has finally woken up; to us all the signs suggest so: 2nd Chinese owned captive set up in Hong Kong recently Changes in Chinese and Hong Kong legislation to facilitate creation of captives Growing interest by Chinese businesses Increased promotional activity by captive practitioners and governmental agencies BENEFITS TO THE REGION Hong Kong stands to benefit from this interest. Although it is the world s third-largest financial centre, 3
until recently captives have not really figured in its vision of future business development. We see this as about to change as the captive concept gains momentum and new captive owners look to replicate recent formations in Hong Kong. Expect to see many job adverts for captive experts as the region looks to build the necessary support infrastructure. For me, I m expecting to log lots of frequent flyer miles. Whilst Hong Kong may be the obvious choice for Chinese captive owners, expect competition from Singapore, the largest Asian captive centre. And the dark horse in all of this? Watch out for the emergence of the Shanghai Free Trade Zone. Paul Owens, CEO, Willis Global Captive Practice Contact: +442031246556, owensp@willis.com Malcolm Cutts-Watson, Chairman, Willis Global Captive Practice International Contact: +44 1481 735 628, cuttswm@willis.com INDEPENDENT MANAGER VS BROKER MANAGER: AN OLD CHESTNUT REVISITED Ten years ago I concluded that it was more important to select the best manager for the job rather than worrying too much about their alignment or otherwise with your group broker. That still remains my position, but the range of skills you should be looking for is now presenting a substantial challenge to single-domicile independent managers. Perhaps that explains why there are a reducing number of these as they sell out to brokers, or establish multidomicile capabilities. This has driven significant consolidation in the industry over the last few years and will continue to do so there will be no let-up in the rate of change in the captive firmament. Crucially in those 10 years the key question has changed from Which manager delivers the range of services required by my captive? to Which captive manager offers the range of services required by the group? The range of services required of captive managers has also grown considerably as the expectations and demands of captives from an increasing number of stakeholders have grown. So here are three questions to ask about your captive: How are you dealing with issues of global compliance? How are you pricing your risk? How are you adapting the captive business model to meet the changing demands of your own dynamic business environment? HOW ARE YOU DEALING WITH ISSUES OF Ten years ago I wrote an article in which I commented on the debate (topical at that time) regarding the independence of brokers and captive managers. Ten years on the debate remains but the issues have moved on. Captive managers have never faced a more challenging environment than they do now; consequently captive boards have never been more reliant on their managers to provide effective responses to such a dynamic captive universe. GLOBAL COMPLIANCE? This encompasses traditional compliance requirements of the domicile but also takes in other regulatory compliance in operational jurisdictions, and international compliance such as Anti-money laundering and sanctions. This requires a comprehensive understanding of all compliance requirements, the various ways of achieving them, and how to properly monitor and control compliance across the programme to reassure the directors and owners that appropriate levels of compliance are being met. HOW ARE YOU PRICING YOUR RISK? Traditional captive underwriting practices such as broker s bench quotes, unadjusted averages claims bases, or simply defaulting to renewal as expiry are increasingly unsustainable. They are experiencing ever 4
more stringent scrutiny from auditors (both captive and group), regulators, business unit managers, tax authorities (Insurance premium tax and corporation tax), fronting insurers and captive non-executive directors. GROWING OLD GRACEFULLY What is needed is a defensible risk assessment process based on recognised modelling techniques and sound, comprehensive data. What is more, premiums must be robust at both the global and local (to the insured risks) levels. HOW ARE YOU ADAPTING THE CAPTIVE BUSINESS MODEL TO MEET THE CHANGING DEMANDS OF YOUR OWN DYNAMIC BUSINESS ENVIRONMENT? No captive programme can remain still for long and no captive strategy is likely to remain optimal for more than 2 or 3 years without some adjustment. This requires constant challenge and review, looking to match optimal captive structures and coverage with the changing needs of the group. To work properly this requires an understanding of the group s business and strategy, the captive, and a detailed understanding of the changing international insurance and risk environment. Periodically this review should set out to re-establish the economic value of the captive from scratch if you wouldn t set it up now, you probably shouldn t have it at all. Ten years on, independence of manager and broker remains an issue in some people s view in their selection of captive manager. However, in my view this ignores the increasing complexity of captive programmes and the increasing challenges of the world in which they operate. The key factor has to be whether your manager has the capabilities to meet these efficiently and effectively; open communications, cooperation and international bench-strength are far more important in achieving this must surely take precedence over the perceived advantages of independence between broker and manager. Dominic Wheatley, Chief marketing officer, Willis Global Captive Practice International Contact: +44 1481 735630, dominic.wheatley@willis.com At my age I feel entitled to look back in my dotage and remember what I see as the good ol days. Having got into the captive management arena by accident, as most in my day had seemed to do, I found it a diversified, and multi-faceted area of international finance. Full of exotic locations and travel (on expenses) and a place to meet some really interesting and great people. I started in the industry at a time when it was just beginning to be regulated. That was 35 years ago and the regulation was in my current view more akin to regularising rather than regulation. As I now face the prospect of entering into the lair of Solvency 2, I got to thinking of how much the term regulation has changed the captive world and what the future might hold for us both. I recently took 10 captive names in Ireland at random (only because that is where I am currently based) and did a search to establish when they were formed and therefore how old they are:. 0-5 years - 1 5-10 years - 2 10-15 years - 4 15-20 years - 2 Over 20 years - 1 So, 70% of random captives looked at in this very unscientific analysis were formed over 10 years ago and 1 in 3 was formed over 15 years ago. Let us look at the environment in Ireland in which captives operated over 10 years ago. 5
If I recall correctly these captives would have been established when the minimum capital for a reinsurer in Ireland was approx. 125k and for an insurer 635k. 10 years ago there was no EU wide reinsurance regulation (it came in in 2006), so reinsurers were subject to local regulation only. Corporation Tax rates in the IFSC in Ireland were 10%. VAT was lower than it is today and it is probably safe to say that insurance premium taxes in countries where captives wrote their risk were probably also lower. Captive transfer pricing guidelines and endless governance and compliance issues didn t appear on any board agendas 10 or more years ago. Fast forward to 2014 and looking towards 2016, an Irish reinsurer would need minimum capital of 1,200,000 (a 860% increase!) and a captive insurer requirement would need a minimum of 3,700,000 (a mere 483% increase). Reinsurers and Insurers today have the European Union to thank for the regulation of their captives and under Solvency II captives will likely receive little leeway under proportionality in their future regulatory treatment. Corporation tax in Ireland is currently 12.5%, VAT on certain non-insurance services is 23%. IPT in some countries is 23% and captives are being targeted under the OECD BEPS Action plan 2013 for transfer pricing examination. While Europe is perhaps an extreme example of how the regulatory, governance, compliance and tax regimes have changed significantly, Europe is not alone. The regulatory burden applying to captives is increasing everywhere in response to pressure from the IMF, OECD, G20 and other international organisations, as embodied in the revised core principles of the IAIS to which all reputable domiciles defer. So, are captives still as viable today (and from 2016 on) as they were 10, 15, 20 or more years ago? Who knows? It is unlikely any parent Group has remained static in the intervening years. Those involved in sponsoring the formation of the captive may have moved on or even retired. The tax environment has certainly changed globally as has the insurance marketplace. IT capabilities are worlds apart from what was available previously and inevitably regulation has wrapped itself around every aspect of our business world and personal life. ensure they are best positioned to take advantage of what the future (in all its many facets) holds in store and the challenges it will throw up. Maybe the good ol days are actually ahead of us, but I suspect only if we prepare properly.. Tim Byrne, Executive Director, Willis Management (Dublin) Limited Contact: +353 1 4074984, byrneti@willis.com CONTACTS FOR FURTHER DETAILS Seamus Gallagher, Captive Consultant, Willis Global Captive Practice - International Tel: +44 (0) 203 124 8777 Email: seamus.gallagher@willis.com Katie Outhwaite, Captive Consultant, Willis Global Captive Practice - International Tel: +44 (0) 203 124 8690 Email: katherine.outhwaite@willis.com Dominic Wheatley, Chief Marketing Officer, Willis Global Captive Practice - International Tel: +44 (0) 1481 735 630 Email: dominic.wheatley@willis.com We communicate with you to understand your business, providing the expertise and creativity to develop and deliver excellent captive solutions, and we do so with passion. Find more information at our website, www.williscaptives.com, or our up-to-the-minute blog, WillisWire. As I look back, and forward (to retirement), it is time for me to reassess my health and finances to ensure both take account of a changing world in which I hope to continue to thrive. I wonder how many captives, 10, 15, 20 or more years on since their establishment have had a similar independent health and financial check-up to 6