Malaysia: Managing Corporate Risks Via Captives

Last Updated: 8 June 2016
Article by Labuan IBFC Inc.

Aricle by Anthony Egerton

At the Jakarta chapter of Labuan IBFC's 25th Anniversary ASEAN Roadshow, Anthony Egerton, Principal Officer at Huntington Underwriting Limited, discussed the benefits of managing corporate risk via a captive. Below is a summation of his presentation.

Introduction

Globally, a captive insurer, or captive for short, has become a mainstream risk management tool for many large organisations. In fact, more than 75% of Fortune 500 companies worldwide operate with established captives today. This translates into billions of dollars' worth of premium flowing through close to 7,000 captives worldwide.

According to Anthony Egerton, Huntington Underwriting Limited's Principal Officer, Labuan IBFC has become an attractive destination for these organisations to set up a captive because of its tax efficiency. However, he strongly advises against organisations starting a captive solely for tax reasons.

The former Asia-Pacific President of specialist insurance market, Lloyd's of London, shared his experience with a presentation on 'Managing Corporate Risks via Captives' at Labuan IBFC's 25th Anniversary ASEAN Roadshow in Jakarta.

He explained: "You have to identify and understand what risks are exposed to your organisations, entities and associations. Think about the risks you're happy to incur, and the ones you want to transfer, mitigate or manage in a different way. Once a thorough enterprise risk management assessment is done, you can think about using a risk management tool like a captive."

So what is a captive insurer?

A captive insurer is an insurance or reinsurance entity wholly-owned directly or indirectly by an industrial, commercial or financial entity. It provides insurance or reinsurance coverage for the risks, assets and liabilities of its parent company.

While the parent company determines the amount of risk that its captive assumes and how much it transfers to other parties via reinsurance, it will often appoint a specialist, manager, accountant or administrator to manage the affairs of the captive.

Types of captives

There are four types of captives:

  1. Pure captives
    These are single parent companies that underwrite the risks of their owner, which is either a single owner or an affiliate, exclusively.
  2. Group and/or association captives
    Insurance companies or risk-bearing entities owned by a group or association. For example, in the marine insurance business, P&I (protection & indemnity) clubs gather ship owners to mutualise certain liability risks together. They collectively own the insurance entity.
  3. Rental captives
    These captives are facility structures established by a manager or a third party, which are then rented to third party organisations. For example, there are Labuan protective cell captives where an administrator establishes a master cell and allows access for external parties to its subsidiary cells or "mini captives".
  4. Diversified captives
    This refers to captives writing third-party business. As insurance is about the diversification of risks, a captive not only assumes its owner's risks, it also becomes a small risk base that the owner can diversify from by writing other non-related business. Historically, many captives who wrote unfamiliar businesses for other parties have suffered significant financial losses. This captive is not recommended and is also not permitted in Labuan IBFC.

Direct dealings with global reinsurers improve risk management

One main benefit for large organisations setting up a captive is the ability to deal directly with the large global reinsurers like Munich Re, Swiss Re or Hannover Re, instead of being restricted to the domestic market that may only have smaller insurance companies. The ability to tap directly into these larger balance sheets also increases the access to more sophisticated risk management tools.

Depending on the risks to which an organisation is exposed, captives may be used to finance certain more challenging risks. Though the risks may be traditionally uninsurable, it may still make sense to pre-fund them should they materialise through some insurance mechanism.

"If they are uninsurable in a conventional sense, the only way to insure the risks is to put them into your own insurance company and manage them within the captive," said Egerton.

He added that customisation allows organisations to control the coverage and manage multinational programs efficiently across many different territories.

Captive licence required for set-up

Before starting a captive, an organisation needs to first determine if such an approach is suitable and if the cost-benefit analysis makes financial sense.

"Fundamentally, it comes down to the amount of losses and claims; things that go wrong within your business on a regular basis on a year-to-year basis, rather than paying premium to the conventional insurance market and collecting claims annually. The traditional insurance process can be very expensive and inefficient. It's better to pool premiums into your own insurance entity, and pay losses as and when they arrive. The volatility in this pool of losses on a year-to-year basis can be protected through reinsurance," he said.

Setting up a captive requires organisations to seek out a regulator like the Labuan Financial Service Authority (Labuan FSA) to apply for a captive licence. For all domiciles, insurance and reinsurance activities are regulated and require licences to carry out such activities.

Obtaining a licence may not always be straightforward, depending on the kind of risks the captive is planning to hold. Ultimately, the process of handling the risks is key. This needs to be done properly and professionally by registering a company with either a trust company or a company registrar, and then appointing a manager, an underwriting manager, directors and company secretaries before the captive can start writing business.

Rating adds value to a captive

An internationally recognised financial rating for a captive can boost its credibility. It is a technical detail often overlooked but worth exploring when setting up a captive.

A rating may be obtained from New Jersey-based AM Best, the only rating specialist agency in the world that focuses on the insurance and reinsurance industry. A rating from a rating agency such as AM Best will be highly beneficial to a captive and will allow it to demand preferential rates when negotiating with local insurers.

One example of an organisation with a successful rating is Energas Insurance (L) Limited, a captive insurer established by Malaysian oil and gas company, Petronas. In fact, Energas is the first Asian captive to receive a rating – an A (Excellent) - from AM Best (refer to the boxed section).

Petronas and Energas Insurance (L) Limited

Petronas, Malaysia's national integrated oil company, and its captive, Energas Insurance (L) Limited, make up one of Labuan IBFC's many success stories.

Between 1997 and 2004, it had paid RM1.3 billion in premium and received only RM460 million in claims from its insurers – an average long term loss ratio of claims/premium of 35%.

The level of premiums within the oil and gas insurance market can be incredibly volatile. Every time an oil company suffers a major loss on one of its offshore platforms, insurance premiums for the following year can increase exponentially. This affects all companies within the same industry worldwide irrespective of their own loss experience, which was what Petronas experienced.

Petronas' insurance challenges were further compounded because it was the only oil and gas company in Malaysia then and its risks were unique in the Malaysian insurance market. As a result, its insurance programme had to be heavily reinsured abroad as there was insufficient capacity and expertise within Malaysia to handle this type of risk. As a result, a significant amount of premium were remitted overseas from Malaysia.

In 2005, Petronas set up a wholly-owned subsidiary, Energas Insurance (L) Limited. It started underwriting in 2006 with a capital of US$10 million. It underwrote only the Group's own risks as a single-parent captive, but wrote a share of all Petronas' risks across the world.

Energas did not write any unrelated third-party businesses, nor did it get involved in some of the more complex risks to which its parent was exposed. Instead, it kept things simple by maintaining a low operational cost structure and generated stable investment profits.

Through a better understanding and management of its holistic risk profile, Petronas has been able to save the Group a significant amount of premiums.

As the captive has grown from strength to strength, Petronas also obtained a financial strength rating for Energas from AM Best; a rating that was at times even better than some of its reinsurers. AM Best affirmed the rating of Energas in March 2015 for its "strong risk-adjusted capitalisation and exceptional performance" as a captive insurance carrier.

Reinsurance via a structured programme may be best

Based on Egerton's experience, placing the captive's reinsurance programme on a structured basis can be more economical and efficient. In the insurance and reinsurance business, such multi-year relationships are preferred as they focus on building a deeper level of trust between the insurer/reinsurer and their clients. This then translates into a better understanding between the parties which leads to more tailored coverage at, generally, a lower effective premium level.

In contrast, most traditional (re)insurance is placed for one year with the option of an annual renewal. If the client has an unfortunate run of claims or if the international market suffers some major catastrophe losses, both parties may have to deal with difficult negotiations for renewal, which will almost always lead to more volatile premiums and retention levels.

Egerton prefers to write reinsurance on a multi-year basis for a minimum of three or even five years as it helps spread losses over time, but always includes significant risk transfer. "I've done deals for up to ten years where we commit to take a certain level of risk over a fixed period of time, irrespective of what happens to the losses or to the international reinsurance markets. So if there's a major disaster in California or Europe, it doesn't affect your programme."

Often, a term aggregate deductible cover can be incorporated over or above the amount of risk a client is happy to retain each year within the structured programme. This essentially helps clients reduce the cost further.

Such multi-year structures can act as a form of additional equity capital or substitute for the captive. He added: "Ultimately, you have to put some capital into your captive for the risks it is retaining. One of the challenges for most organisations is that capital is expensive. You want it for your core business. This captive after all is only a risk-pooling entity. It isn't your core business."

Labuan IBFC's cost-effective appeal to captives

Labuan IBFC is an ideal destination to establish new ventures, including captives. In Asia, it is only one of two financial centres that offer captives.

Labuan IBFC's modern and well-developed infrastructure allows companies to immediately start their operations and conduct business fuss-free. This is evidenced by more than 40 captives currently domiciled in the jurisdiction.

In fact, there are more than 230 licensed insurance entities registered in Labuan IBFC and this pool provides a ready network of insurers, reinsurers and brokers for a new captive to tap into. In addition, Labuan IBFC is also home to a substantial retrocession market.

Egerton went on to stress that apart from a healthy risk management industry, it is as important that the regulators not only understand the risk management business, but in fact, facilitate the setting up of entities as best they can.

He added: "A flexible but business-friendly environment is essential when you're starting a new business, be it your own business or your organisation's captive. You need to get on with the business you're there to do, rather than worry about a lot of paperwork with the regulator and all the other back-office administration."

"Labuan IBFC is also surprisingly inexpensive. I spend some of my time on other businesses in Singapore and Pakistan. Labuan IBFC is somewhere between the two as a cost destination, although much closer to Pakistan but with the benefit of Malaysia's stability and with a location at the heart of Asia."

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Mondaq Advice Centre (MACs)
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.