Originally published in Captive Review, Guernsey Report, 2009-10, October 2009

David Sheil of Alternative Risk Management tells Captive Review how Guernsey is prepared for the aftermath of the global economic crisis and the changes that Solvency II will bring to the industry

As Guernsey continues to establish its position as a leading insurance and captive centre, the residual effects of the economic crisis alongside the potential impact of Solvency II means that captive managers in the jurisdiction must be prepared to adapt to future changes as the insurance industry continues to evolve.

Drawing upon a wealth of experience, David Sheil, operations director at Alternative Risk Management (ARM), speaks to Captive Review about the current state of the Guernsey captive market and describes the opportunities and challenges that the jurisdiction will face going forward.

Captive Review (CR): What recent trends have you seen in new captive and cell formations?

David Sheil (DS): Despite a self-evidently poor economic backdrop, the number of cells being formed continues an upward trend. Equally, we are not seeing clients close down their existing captives or liquidate their cells, and organic growth within existing clients' structures continues to thrive.

The types of risk being placed into captives include professional indemnity, legal expenses, trade credit, marine cargo, international medical plans, new emerging technologies and unsurprisingly, banking and finance risks. We are also seeing an increasing interest in captives and cells coming out of Europe recently.

CR: There has been some consolidation recently in the captive manager market in Guernsey and Bermuda. Do you see a continuation of this?

DS: Captive managers buy and merge with other managers for a number of reasons. One of those reasons is to achieve scale in a particular domicile or perhaps a number of domiciles. There are also small niche captive managers who have found a ceiling to the level at which they can expand and are also finding the regulatory and technical burden significant enough to make it uneconomic to continue on their own. In the case of Guernsey, where once there were almost 15 managers 10-12 years ago, following mergers and acquisitions by the large brokers in the main, we now have about six that dominate the market, four broker-owned and two independents.

Large broker-owned managers have strong tie-ins, of course, to their broking counterparts, particularly in London where multinational captive programmes feature largely, whereas independents like ourselves also have clients of this type and a variety of owner-managed small- to medium-sized clients originating out of independent UK and European brokers.

CR: How do you think Guernsey is performing as a captive domicile?

DS: It remains a significant player across all aspects of the captive market. Guernsey has always had and continues to have strong links with London brokers, insurers and reinsurers – being physically and culturally so close to one of the world's leading insurance markets is key to our success. Also, as Guernsey and Jersey are major financial centres themselves, we continue to enjoy referrals from other financial and legal intermediaries across the Channel Islands as well.

Guernsey Finance, for example, is working very hard on its own to promote this island as a home for captives and as a reinsurance centre. A lot of our success is also a tribute to the confidence our clients have in the skill sets of people who work in the industry here. There will, however, always be politico-legal issues to address not only in our industry but across all aspects of offshore financial services, such as tax haven accusations when some comparative onshore jurisdictions have themselves more aggressive tax regimes, and the rising cost of compliance and regulation.

CR: What effect are increasing rates of insurance and reinsurance having on clients' costs and on their captives?

DS: It is not clear that rates are rising across all lines of insurance at the same level. Certain insurers have been hit hard by the financial crisis and are trying to repair their balance sheets, but customers have also been hit equally hard and are likely to have reduced capacity to pay premiums. Reinsurers, who will often be a major driver in rates, have experienced a relatively stable 2009 so far. However, they too have been hit by Hurricane Ike losses and the potential for further hurricane and storm losses in 2009. The insurance market in general is looking at the regulatory compliance ost of Solvency II and the probability of rising interest rates in 2010.

There has been a large influx of capacity into reinsurance casualty markets and it is expected that will maintain stable rates into 2010, although in professional indemnity (PI) and professional lines there have been some significant increases in rates and probably more to come for financial institutions' directors' and officers' (D&O) covers.

We may even experience more clients in that field looking for captive solutions for both their own balance sheets and also where they take on a combination of risks in certain transactions with customers.

We are also seeing increased interest in trade-credit solutions using captives. The trade credit market has been hit by large losses with some underwriters withdrawing from the market altogether. The reinsurance market in this line is beginning to stabilise, although certainty of that will depend on the loss development of claims arising from the past 12 months or so and the fact that there is reducing demand anyway due to prevailing economic circumstances.

CR: How important are taxation considerations for new and existing captive owners?

DS: It is rarely, if ever, a key driver. Clients are more focused on dealing with the risk they retain or developing a suitable captive retention structure or on an underwriting opportunity that complements their customer base, for example, in areas such as travel insurance or extended warranty. Controlled Foreign Companies (CFC) legislation and taxation on profits has always been there in the background, of course, and it is just something that has to be complied with. The focus is more on managing the risk rather than over-doing the tax aspect although there is some recent legislation in CFC regarding loss-reserve calculations that both clients and managers need to become familiar with.

On the Insurance Premium Tax (IPT) front, the Kvaerner case means there is more of a focus on premium allocations and a more in depth consideration of the way losses are paid and accounted for in overseas subsidiaries.

CR: What effect will Solvency II have on captives?

DS: Solvency II is at an advanced stage throughout European insurers under the three pillars that set out capital requirements and risk management standards.

The Financial Services Authority (FSA) will be publishing its Stage 1 Thematic review shortly with Stage 2 beginning in October 2009 and ending in late 2010. This will be the final discussion phase before actual dry runs of the implementation phase before going live in 2012. It is possible that some insurers may look for enhanced security or collateral where they front for captives if they are expected to meet certain regulatory capital requirements. In certain jurisdictions, the industry has sought a 'carve out' for captives. A question arises as to whether Guernsey with its system of Own Solvency Capital Assessment (OSCA) meets any kind of equivalence status which is very much the same situation under the Reinsurance Directive. Where there is considered to be equivalence in prudential regulation, the various directives allow the EC to initiate agreements with non-EU territories and provide for mutual recognition of supervisory roles and practices.

CR: What future does Guernsey have in captives?

DS: A very bright and positive one. I think insurance brokers and insurance carriers respect the industry's professionalism and capabilities to develop solutions to both recurring and sometimes novel problems.

As long as our local regulation, robust as it is, remains geared towards the kind of business that Guernsey attracts, then we have something to look forward to. It is also worth saying that Guernsey Finance has been working hard on promoting the island as a reinsurance centre and we already have some strong players set up down here.

Hopefully, it is the beginning of a trend given the island's proximity to London and European time zones, as we undoubtedly have the skill set here (as an industry, we interact with virtually every major insurer and reinsurer probably every day of the week) and the legislation to handle reinsurance operations.

For more information about Guernsey's finance industry please visit www.guernseyfinance.com.

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