Cayman Islands: Captive Review

Corporate governance is very much a hot topic of discussion these days in the offshore world, particularly in relation to insurance. Why so? The increase in focus is due to the enhanced scrutiny of onshore regulators and tax authorities following the recent round of accounting debacles and corporate insolvencies. Shareholders are also viewing the issue with increased interest; recent studies reveal that in 2001 there were 327 federal securities class action lawsuits filed in the US which is 60 per cent. more than in 2000.

The increase in potential liability has resulted in corporate risk managers re-examining internal controls and their D&O liability exposure. The extra demand for D&O liability coverage coupled with a reassessment of the underwriting risk by insurers has led to skyrocketing premiums. Many companies are now self-insuring an increasingly large amount of this exposure by taking on higher deductibles and lower coverage levels. In addition, post-Enron the trend in the insurance market is to provide less favourable terms for D&O policies (for example, certain D&O policies in the US are now excluding coverage for the costs of defending legal proceedings where criminal charges are brought against a director or officer and other D&O policies are excluding rights of severance so that if one director is guilty of misfeasance the policy becomes null and void for all).

It is accepted wisdom that the captive product well serves an insured who has applied proper corporate governance and who has in place proper risk management procedures. An insured operating to the correct standard in both areas should benefit from using a captive as the premiums paid will more directly reflect the reduced risk profile of that insured. Furthermore D&O policies are often not well drafted resulting in uncertainty as to whether risks are covered and as to the extent of the coverage. These uncertainties can be removed when using a captive since the policy is not presented as a "standard form" but can be specifically tailored to meet the exact requirements of the insured. An additional advantage of using a captive is that it allows direct access to the reinsurance market. A captive that is providing coverage to an insured with exemplary claims experience (and moreover with demonstrable corporate governance procedures) should have no difficulty in obtaining competitively priced reinsurance coverage.

Recent interest in Cayman has been both with respect to the establishment of captives (or the use of existing captives) to write D&O liability cover and the use of segregated portfolio companies where D&O coverage can easily be introduced as an additional line through the use of a separate legally ring-fenced portfolio utilising a "rent-a-captive" type structure. In addition, established alternative risk transfer structures permit the ceding of risks from D&O fronting carriers.

The recent hardening in the insurance market thus continues to increase the number of captive insurance companies formed in Cayman. Since the end of 2002, an additional 27 insurance licences have been issued. In addition, Cayman now has 66 segregated portfolio companies licensed as insurers and within those companies there are 323 portfolios writing business. Always innovative legislatively, Cayman is set to continue providing legal solutions to risk managers in an increasingly difficult insurance market.