Cayman Islands: The Risk Renaissance

The Cayman Islands captive insurance market has enjoyed two boom periods since the initial medical malpractice crisis of the Seventies put us on the map as a captive domicile. The first was in the mid 1980's, and the second, which for the reasons discussed below is more significant in the long term, began about 4 years ago and continues as I write.

In 1990, before the present boom, the Insurance Supervision Department of the Cayman Islands Government recorded the establishment of just 20 new licensees. Powered by the captive market, but assisted by the rise of catastrophe bonds and annuity products, discussed below, that figure has increased dramatically. In 1998 52 licences were issued, in 1999 37 and in 2000 another 46, to total 517 licensees at last year end.

What has caused this turnaround? Undoubtedly the main thrust has been establishment of captives, both wholly-owned and association, the reasons for which are as follows:

  1. Most immediately, the US insurance market has hardened over the past four or five months, particularly in the professional liability area. The recent significant decline in equity markets has resulted in investments alone being unable to support risk liabilities. This, combined with poor pricing of insurance products, has resulted in a surge in the establishment of professional captives.
  2. Captives have at last found their day. For too long they were regarded by the market as a good idea, but novel and untested. Historical inevitability has played its part here, and slowly but surely the image of the captive has altered in the mind of the insurance market so that at last it has become "respectable". Now captives are an accepted part of a risk manager's portfolio, as critical in their own way as commercial market policies. A manager's ability to provide captives is both accepted and expected in the current market. Further, greater ingenuity has been shown recently by providers with captives in moving away from traditional lines of risk and diversifying into new risk areas.
  3. The image of the Cayman Islands as a financial center has undergone a seismic shift in the past ten years. With a government dedicated to promoting a highly skilled and responsible market, respected worldwide, the Cayman Islands have become the first choice jurisdiction in which to establish an offshore captive. And onshore, particularly in the United States, another mindset has gradually altered: formerly, health-care institutions and care-givers, sensitive of their image, were wary of establishing captives offshore. Gradually, however, that has changed and it is perfectly normal now to see local health service providers, nursing homes, etc. from the United States establishing wholly-owned captives in the Cayman Islands.
  4. Every effort is made by the Cayman Islands to pass legislation that tracks the demands of the market. Recently our Companies Law was amended to provide for so-called "segregated portfolio companies", ideal for the rent-a-captive market by offering attractive isolated risk options to the insurance manager and its clients.
  5. Perhaps most important of all, the Cayman Islands Monetary Authority itself provides a practical but highly focused regulatory framework designed to allow the market to thrive subject to oversight that is every bit as exacting as that provided onshore. The main difference between onshore regulation and regulation here, however, is simply the "personal touch" of the Insurance Supervision Department, which managers and clients alike find attractive and helpful. Personal meetings with the regulators are encouraged. Thus, more likely than not, the directors of licensed insurers know their regulator here personally. And close contact is maintained between the regulators and the local insurance managers so that instant communication with the regulators may be achieved, through those managers, by every captive licensed in the Cayman Islands.

But the licensing of captives in Cayman tells only part of the story. In addition to captives, the Insurance Department has encouraged two further products to develop:

Catastrophe Bonds, pursuant to which insurers and insureds have used structured financial products to place cover by accessing the capital markets rather than through the traditional reinsurance or insurance markets. In the typical catastrophe bond transaction an "orphan" Cayman Islands special purpose company ("SPC") owned by a Cayman Islands trust company as trustee of a charitable trust is formed and licensed as a restricted insurance company. As a restricted insurance company no particular minimum net worth requirement is imposed which has the beneficial effect in keeping transaction costs low. The SPC enters into a reinsurance agreement, swap transaction or similar contract, typically with an insurance company, pursuant to which periodic payments are made by the counterparty and the SPC is obligated to pay a lump sum in certain eventualities (e.g. an earthquake of a particular magnitude in a particular location). The potential payment obligation of the SPC is secured by the deposit of collateral with a trustee. In order to fund its obligations the SPC issues notes in the capital markets, the terms of which pass through the periodic payments made to the SPC by the counterparty but whose principal amount is reduced in the event the SPC must make payments to the counterparty upon the happening of the relevant "catastrophe" event and the principal of the notes is therefore at risk.

The emergence of these new products often highlights difficult conceptual issues as to whether or not the particular transaction constitutes insurance business (and hence is subject to regulation) but the Insurance Department of the Cayman Islands Monetary Authority has proved responsive when considering the issues and the Cayman Islands, already one of the leading jurisdictions for capital markets transactions and structured financial products, is a natural domicile of choice for this new category of business.

Annuity And Life Products. Over recent years, a number of Cayman Islands structures have become well established for offering protected fixed or variable annuity and life products to both US and non-US individuals. These structures have been put together by not only the household-name life insurance companies but also by investment brokers (as another vehicle for their investment management services) and, increasingly, by specialist US tax lawyers with US and non-US high net worth private clients.

Typically, a Cayman Islands annuity insurance company is established. Many of these take advantage of the "segregated portfolio companies" provisions of the Cayman Islands companies’ legislation referred to above, so the company can divide its relationship with each customer or policy into statutorily protected "cells".

Fixed and variable annuity and life contracts with off-shore insurance companies are perhaps one of the few remaining legitimate tax planning uses of off-shore financial centres by US citizens and taxpayers. The lower running costs of a Cayman Islands insurance company (which is in turn reflected in the proceeds of the policies) offer a competitive advantage over on-shore products for US taxpayers.

As can be seen, the insurance industry in the Cayman Islands is flourishing. Captives continue to be established here for reasons mentioned above, and the nature of risk itself is that it continues to spawn new capital markets and other financial products. The regulators and managers here do everything they can to continue to attract both traditional and innovative risk business while, in the case of the Cayman Islands Monetary Authority, maintaining an effective and rigorous regulatory oversight.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances

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