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A point of difference.

The Isle of Man Captive Association is an organisation dedicated to the progression and development of insurance management companies on the Isle of Man. Its growing membership supports and advances a set of guiding principles that each member company can benefit from.

In particular, the Association's continual dialogue and support from Government ensures that the Island's unique offshore jurisdiction and quality of financial services is not only maintained but also enhanced.

Offshore Attraction

31 January 2013

Gaynor Brough, chairman, Isle of Man Captive Association

The future is bright for offshore domiciles seeking to attract business from African rent-a-captive users

The majority of captive formations by South African companies in recent years have been in the form of rent-a-captive structures onshore, mostly with one organisation. Furthermore, a small percentage of the number of South African companies with offshore captives have chosen to close them down and opted for an onshore solution.

If we look back to the 1980s, this was not the case and South African companies favoured offshore jurisdictions as the domicile of choice for their captives. Popular domiciles included the Isle of Man, Bermuda and Guernsey.

However, we are now witnessing a reversal of this trend and appear to have gone full circle with renewed interest now being demonstrated in offshore domiciles. Following the Isle of Man Captive Association’s recent visit to South Africa, where it conducted a series of exploratory interviews with figures including risk managers and risk consultants, the following reasons for the spike in interest were determined: (i) cost efficiencies; (ii) capital management; (iii) good governance; (iv) credit risk.

In January 2015, the South African Financial Supervision Board is due to introduce its Solvency Asset and Management (SAM) regime. This is similar in nature to Solvency II, which will likely be implemented in the EU in 2016. Essentially, SAM is a risk-based approach to capital and takes into account all risks when assessing the amount of capital required to support the underwriting of insurable risk; SAM applies to both life and short-term insurance industries.

Similar to the probable impact of Solvency II on EU-based insurers including captive insurance companies, the introduction of a risk-based capital approach will have the following adverse effect on insurance pricing:

• There will be some consolidation of insurers as smaller companies merge or are acquired by the larger players due to the increased regulatory and cost burden. This consolidation will lead to reduced competition and inevitable prices increases as supply contracts, thereby spelling the end of the current soft market.

• The cost of compliance with Pillar II, which forms part of SAM, will translate to an increase in the cost base of insurers and the promoters of rent-a-captive structures. It would be natural to conclude that these costs will be passed on to the insurance buyer in the form of higher premiums or facility/administration fees in the case of rent-a-captives. Certainly, in the case of Solvency II it is fully anticipated that the costs of administering captive insurance companies will increase by approximately 50% and the same can be assumed for rent-a-captive facilities.

• Currently, a number of forms of capital are utilised. However, in the new environment such flexibility will not exist, certainly contingent types of capital such as guarantees and LOC’s (letter of credit) are unlikely to be allowed and there will be onerous capital charges relating to some types of investment.

PCCs and ICCs

In South Africa, there is the notable absence of Protected Cell Company (PCC) legislation. Currently, the majority of alternative risk finance structures in South Africa are limited to rent-a-captive facilities, often provided by very few suppliers, leading to market concentration.

Since the financial crisis in 2008, boards of directors and their audit committees have become increasingly concerned with good governance and the identification, documentation and mitigation of business risks. One area of concern is counter-party exposure. This risk is present in the use of rent-a-captive structures given the risk of contagion arising from the liabilities of other cell owners and also the credit risk to the promoter of the rent-a-captive facility. The segregation of assets and liabilities in such structures relies on shareholders’ agreements and these are yet to be tested in court.

Within a PCC structure, there is legal segregation of assets and liabilities thereby providing directors with comfort that their assets are completely ring-fenced from their fellow cell-owners and the promoter of the PCC.

Countries such as the Isle of Man, Gibraltar and Malta have PCC legislation and recently the Isle of Man and Malta passed Incorporated Cell Company (ICC) legislation. An ICC differs from a PCC in that each incorporated cell is a separate legal entity and the cells are able to trade with each other, therefore providing increased flexibility. Both PCCs and ICCs still provide the benefits of rent-a-captives, while providing a more legally robust structure.

Captive insurance domiciles that are outside the EU and are not seeking Solvency II equivalence have seen unprecedented levels of new enquiries in the past 18 months as captive owners and potential captive owners seek jurisdictions where the legislation/regulation recognises the low risk that is inherent in pure captives and provides regulatory frameworks, which are robust, yet tailored to the size and complexity of the risks underwritten.

For clarity, a pure captive is deemed to be an insurance company that is established to insure the risks of its parent or organisations affiliated with its parent.

From a capital efficiency perspective, there are distinct advantages to being in a non-Solvency II equivalent jurisdiction as the capital and solvency requirements in the majority of offshore domiciles are designed specifically for captives and domiciled captives, as such, are proportionate to the risk profiles of captives and allow flexibility in the forms of capital which can be utilised, for example [by] partly paid up shares, letters of credit and subordinated debt.

This is not to say that the captive domiciles in offshore Europe are a regulatory light touch, as they have a strong proven track record spanning more than 30 years and their regulatory frameworks are designed to follow the global regulatory prescribed by the International Association of Insurance Supervisors (IAIS).

The insurance core principles of the IAIS is the means by which the IMF judges compliance with international law and regulation, making this a truly global standard rather than restricted to a particular region as in the case of Solvency II or SAM.

SAM and Solvency II have the primary objective of protecting the policyholder, which is the ultimate purpose of the regulatory regimes in all reputable jurisdictions. However, there are few similarities between a pure captive insurance company and more general or life insurance products. Offshore domiciles are highly versed in the differences and their regulation reflects this.

It is fully anticipated that the number of captives globally will continue to grow, especially within offshore domiciles, as insurance buyers seek to remove themselves from the vagaries of the insurance market with the aim of stabilising and controlling their insurance premiums, thus removing volatility.

From an African perspective, the interest to date is predominantly from large multinationals and other companies expanding through Africa. Industry types vary – from financial services to resolving the challenges faced by the African mining sector. It is predicted that offshore domiciles will be attractive to African rent-a-captive users as they seek to use more robust and cost-effective solutions for managing their risks, such as PCC or ICC arrangements. Not being part of the EU, the Isle of Man is not required to apply the Solvency II regulatory framework, but conforms to the insurance core principles of the IAIS, as recognised in the review by the IMF.

This article originally appeared in the January 2013 issue of Africa Insurance Review.