Originally Published in Post Magazines SMEs Supplement, July 2007
There was a time when it would have been safe to assume that captive insurance was the preserve of large international organisations. However, innovation in the sector has meant that the advantages it offers have become more accessible and therefore relevant for small to medium sized enterprises (SMEs).
A captive, in its purest form, is a company set up by its owners primarily to insure the risks of its parent (and/or subsidiaries). This can offer several advantages in comparison with insuring through the commercial market:
- The insuring of unusual or catastrophic risks or multiple small risks
- Avoid subsidising large overheads and profit margins of commercial underwriters
- Premiums that relate to the insured’s previous claims record
- Direct access to the wholesale reinsurance market
- Benefit from the investment return on retained premiums
- The retention within the group of the excess of net premiums over claims
- Taxation efficiencies – the payment of insurance premium is deductible in arriving at profits and receipt is at the group’s offshore captive
- Improved risk management and understanding of the cost of risk
However, SMEs have found that the benefits of a captive, given the likely volume of business, can be outweighed by the start-up and on-going costs.
Participating in a rent-a-captive scheme offers the advantage of sharing such expenses. Firms are cautious about using a conventional company, where all of the assets and liabilities are linked and thereby risk that the failure of one insurance programme will lead to the loss of assets relating to another.
In 1997, Guernsey pioneered the Protected Cell Company (PCC) – a company made up of a core and individual cells, where the legal segregation ensures that no claim against one cell will be covered by the funds within another.
Several jurisdictions, including Guernsey, have now introduced the Incorporated Cell Company (ICC). An ICC, like a PCC, has cells but they are separately incorporated and distinct legal entities, offering an added layer of protection in the separation of assets and liabilities.
The use of a third-party cell company rather than a full-blown captive has distinct benefits which for SMEs, in particular, makes captive insurance more viable:
- Lower Operating Costs – Savings from reduced reporting requirements and shared costs
- Less Management Time – Reduction in the amount of executive time required by the cell owner, primarily because attendance is not required at quarterly PCC Board meetings
- Quicker And Cheaper To Set Up And Exit – Setting up and closing down a PCC cell does not require the same legal processes required to incorporate or wind up a company
- No Minimum Capital – Need to cover the minimum margin of solvency and the risk gap but this may be less than the £100,000 minimum required for a separate captive
- Less Tax – Using a PCC can avoid being subject to Controlled Foreign Company legislation
Captive insurance – even with the option of using a third party cell company – may still not prove to be the most attractive option for some firms, (for example those smaller businesses where the level of premium is less than £250,000).
However, such are the potential benefits of captive insurance for all sizes of company that an insured’s risk management strategy could be considered somewhat deficient in scope and responsibility if it does not involve the use (or at least consideration) of some form of captive insurance.
Growing recognition of this, including from increasing numbers of SMEs and brokers with such clients, means that the number of captive, PCC/ICC and cell formations is continuing to rise. Guernsey, for example, while a mature jurisdiction in terms of captive insurance, still retains the accolade of being the leading domicile in Europe, with captive entities rising again in 2006 to 624 at the end of the year.
Increasingly therefore those SMEs and brokers who are unable to explain and analyse the full range of options, including captive insurance, will find themselves at a disadvantage.
Guernsey is already engaging with the SME community through a series of initiatives with the British Insurance Brokers Association (BIBA). They can of course obtain information from the many other jurisdictions around the world who have introduced the cell company. However, their implementation of the concept has been on the back of Guernsey’s pioneering work and the considerable success it has enjoyed during the past decade. Indeed, at the end of 1997 there were six PCCs and 14 cells domiciled in the Island but by the end of last year this had risen to 68 PCCs and 243 cells. In addition, there had been the formation of the Island’s first insurance-writing ICC.
The fact that Guernsey can boast a rich heritage in captive insurance and the cell company concept means that the Island has also accumulated a wealth of related expertise. Guernsey now plays host to 27 captive managers, ranging from small boutique operations to large international players and independent captive managers through to broker-tied managers, where there is extensive experience, expertise and professionalism.
Guernsey would also be a natural choice for UK SMEs because the Island is a British Crown Dependency with legislative and fiscal independence from the UK and outside of the EU; English speaking; uses the British pound; and is located within easy reach and with regular links to both the UK and also continental Europe.
The way ahead
SMEs and their brokers need to be aware that developments in captive insurance mean that the benefits offered are now more accessible and therefore relevant to these businesses – it is time to re-examine the insured’s policy to see if this option delivers a saving.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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.