Domiciles and captive managers are wise to explore the business potential emerging from frontier markets such as Asia and Latin America, says Guernsey Finance's Fiona Le Poidevin.
This year's Marsh captive benchmarking report highlighted that the most common form of new formations in the US are from midsize companies establishing small captives writing $1.2bn in premium or less.
Indeed, in recent issues of Captive Review there has been an increased focus on 'micro-captives' and in particular, Ross Elliot, captive director at the Utah Insurance Department (UID), was quoted as saying that around 85% of its licensed entities are micro-captives. These examples highlight the maturity of the captive insurance market in the US and it is a similar picture on the other side of the Atlantic in Europe.
With many of the larger organisations already having captives (or deciding that one does not form part of their risk management strategy), captive managers are seeking out new business from small and medium sized enterprises.
Of course, this in itself has been made more viable by the innovation of the cell company concept, which was pioneered in Guernsey in 1997.
Marsh's report also highlighted that captives are increasingly writing a wider range of risks. However, while diversification in terms of types of companies and types of risks might provide some short term business opportunities, if the captive industry really wants to grow over the long term then it needs to look beyond the traditional geographic markets of the US and Europe and more towards the emerging markets which are becoming increasingly aware of the captive concept.
This is something which we are already embracing in Guernsey to ensure that our business base is truly diversified on a global basis. Yet, I will not pretend that it is always going to be a 'quick win' and in fact, our experience is that the ease with which it will be possible to attract captive insurance business from an emerging market will be largely dictated by the stage of its economic maturity.
We have been researching a number of different jurisdictions to assess where there is a potential demand for services from Guernsey's finance industry, which is broadly based on the four key pillars of banking, wealth management, investment funds and insurance. What we have found is that emerging economies tend to go through stages of development which are related to a demand for particular services. For example, an initial surge in wealth creation brings with it a need for asset protection and management and therefore, as well as traditional banking services, there is increased demand for more sophisticated tools such as trusts and foundations.
As a country becomes wealthier and more mature so there is increased realisation of the importance of planning for the future, especially saving and this drives forward the development of domestic pensions and insurance industries which, in turn, help grow an investment sector.
This is looking for ways to deploy capital which will produce a return and a major opportunity is to invest in domestic businesses and make them more efficient, which is in effect the private equity model.
So we can see how economies develop in stages and, depending on the level of maturity, then there will be a range of services which Guernsey as an international finance centre can offer either individuals or organisations from those countries. In a sense, captive insurance is like the icing on the cake because it requires the economy to be at a reasonably well-developed level of maturity and sophistication for the concept to be viable.
Challenges and opportunities
This is not just due to the need for key decision makers within businesses to have sufficient levels of knowledge and understanding about the concept but also government and regulatory officials who set policy. For example, insurance legislation is some emerging markets, such as Brazil, is still very domestically focused such that it is not possible to insure risks within the country from an international insurance company.
In other countries, such as China, the insurance law doesn't differentiate between types of insurers and therefore the capital requirements are particularly onerous for even domestic captives. That is the major reason why it was only at the end of last year that the first Chinese onshore captive was formed (following one being established in Hong Kong in 2000 and where another was licensed last year).
In addition, it is also necessary to consider any other barriers to entry, for example black lists, and what might need to be done to overcome them, whether that is simply building better relationships between governments, regulators and tax authorities or entering into formal agreements such as a Memorandum of Understanding or a Tax Information Exchange Agreement.
It might also be considered whether a Double Taxation Agreement will help facilitate business between two jurisdictions. The point is that there are emerging market jurisdictions which are more sophisticated and more open in allowing risks to be written internationally and clearly these present the most obvious opportunities in the short term. For example, Guernsey already plays host to captives from parent firms based in the Middle East (e.g. Saudi Arabia), Africa (e.g. South Africa), Latin America (e.g. Colombia) and Asia (e.g. Singapore).
However, there are also those opportunities which are less immediate and will require a longer term commitment, especially in terms of education. Indeed, it is likely that captive managers seeking business from these markets may need to work closely with their home government, regulatory, tax and industry officials as a way to educate not just businesses within emerging economies but also their equivalent domestic authorities.
Long term game
It is critically important to research the different markets so that at least an educated decision can be made about the challenges that need to be overcome and the opportunities that exist within each emerging economy and as such, which offer the best prospects.
These should then be explored in a targeted manner to ensure that the best opportunities are prioritised and maximised rather than spreading efforts too thinly and not achieving results. There may be a long road ahead in some instances, but we are already seeing that Bermuda has specifically targeted Latin America, with some success and another Bermudian captive has recently been established to insure catastrophe risk in Africa.
Guernsey has also been active within emerging markets and we believe that the outlook is positive because our educational work is generating increased interest in the captive concept. For example, as part of the pilot Shanghai free trade zone, the China Insurance Regulatory Commission is now considering introducing more flexible regulation, including potentially lower capital requirements for companies in the zone.
If this is able to be applied to captives then it may be that in the future we will be able to work with the Chinese authorities to help them establish a sustainable regulatory regime.
On the one hand this would be a positive development in that it would signal a growing understanding of the captive concept in China, but having specific domestic captive legislation would theoretically provide a barrier to entry for the traditional captive domiciles.
However, what we envisage is that Chinese firms will insure their local risks in a domestic captive but then once they have become more comfortable with the concept, as they expand internationally and as they understand the need to manage risk effectively, then it would make sense to establish a vehicle in Guernsey to cover their global risk base (ex-Asia). This would be in a similar vein to the way large US multinationals often have a captive on that side of the Atlantic for their US risks and another in Europe for their rest-of world risks.
The point is that internationally expanding firms from emerging markets globally cannot just rely on a domestic captive regime (if it exists) to cover their global risks because there will simply not be the experience and expertise that is on offer from a jurisdiction such as Guernsey where the first captive was established in 1922.
As this year's Marsh captive benchmarking report also highlighted, captives are not established for tax reasons but because they form part of an effective risk management programme.
If firms from the emerging markets are to manage their global risks effectively then they need to ensure that they establish a captive which has sufficient substance to perform its true role and these vehicles are only going to be available from more established domiciles.
It is therefore down to captive managers to research and seek out business from these emerging markets, educating businesses from those regions as to the reasons to form a captive and it may also require local government involvement if reciprocal agreements would benefit such business flows.
Whilst some markets will take longer than others to convert, the ultimate benefits should more than justify the initial investment.
An original version of this article appeared in Captive Review, June 2014.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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