Malaysia: Adding Confidence To Captives

Last Updated: 23 August 2019
Article by Labuan IBFC Inc.

When it comes to risk management, the adage "Failing to plan is planning to fail", rings truer than most. Risk management is vital in any business, and when a more cost-efficient and customisable alternative to outright insurance purchase is sought, captive insurance ticks all the right boxes.

Globally, captives are the most prominent instrument for Alternative Risk Transfer (ART) market. The ART market allows companies to procure coverage and transfer risk mechanism without resorting to commercial insurance purchase.

The rise of captives

As described by the Insurance Information Institute, a captive is a special type of insurance company set up by a parent company, trade association or group of companies to insure the risks of its owner or owners. Starting with captives, the alternative risk transfer market later included risk retention groups (RRGs) and insurance pools. The number of captives has doubled in the last 20 years with recent figures by rating agency, AM Best, estimating at least 6500 active captives globally.

While there has been some flattening due to increasing regulatory pressure and consolidation activities, overall the captives market does not show any signs of coming to a standstill any time soon. With 40% of all Fortune 500 headquartered in Asia, in theory one would assume Asia would have a large number of captives as well.

However only 6% of the parent captives are from Asia. Overall, Asian domiciles have less than 200 captives, with Labuan IBFC being the fastest growing domiciles for captives. Labuan IBFC has progressively shown an upwards trend in captive formation with six captive formations in the first half of 2019, whereas last year it reported the same number of formations for the whole year. The jurisdiction saw a year-on-year increase by 12.8%, from US$288 million in gross written premiums in June 2019, compared with US$255 million in the same period last year.

Why so few captives in Asia though? For one, not many may actually know of captives as a viable risk management tool. The misconception that "It's only tax" is still prevalent. Other reasons include the possibility of the large conglomerates that make up most of the businesses in the region owning commercial insurance companies, hence not considering captives. Also as Asian companies begin to go global and get acquired through mergers, the acquiring companies may already have captives and have no need to set up new ones. Another is complex regulatory issues with the highly diverse regulatory parameters in Asia, compared to the more homogenised Western hemisphere with a more standardised regulatory framework.

Education and raising awareness on captives are key and still much needed in the region, in addition to increased efforts by regional hubs to attract and facilitate captives. In that regard, Labuan IBFC has stepped up in recent years, with events such as masterclasses around the region, and the Annual Captive Conference, and more recently its collaboration with Swiss Re Corporate Solutions, which served to highlight the feasibility of using captives on managing risks during a volatile time.

Why set up a captive?

But first, why consider captives? The hardening market, especially post hurricanes and wildfires of the 2017 and 2018, has been a painful one for the insurance industry. The rapidly changing business landscape due to disruptions from advancing digital technologies, has additionally seen the overall move from physical to intangible assets, resulting in new esoteric risk exposures such as cyber or reputational risks that are more expensive to insure via commercial insurance.

Such changes have sent insureds to look for other alternatives to fill in the gaps as traditional insurance pulls back. With current trends indicating progressively hardening market conditions in addition of the growing need for incubators of emerging risks, captives have begun to be seen as a noteworthy alternative.

Captives are able to act as incubators of risks through aggregation and "warehousing", allowing them to be vehicles to diversify the risk portfolio of businesses, especially for emerging or "uninsurable" risks. Diversification brought about by utilising captives reduces the cost of capital and ultimately total cost of risk.

Other financial benefits include realisation of tax benefits, in addition to having underwriting profit and investment gains remaining inhouse. Captives also have organisational benefits such as enabling a formal and centralised risk retention vehicle, which enables risk data sharing across the organisation. Captives can also provide for related third party business that may generate additional revenue streams.

Factors to consider when setting up a captive

However increased interest in the business world typically also mean increased scrutiny. Captives are not immune to such trends, having the added administrative burden to demonstrate that it is a genuine risk management tool based on the Organisation for Economic Co-operation and Development's (OECD) Base Erosion Profit Shifting (BEPS) guidelines.

Other considerations that need to be factored in when it comes to captives are also the capital commitment and the risks of adverse results. The current low interest rate environment, and the lack of more efficient capital utilisation means businesses should seriously think through the additional benefits of considering a captive formation. Key to this though is vision and support from senior management along with a robust roadmap laying out the development of the captive proposition. Another crucial consideration is a potential exit strategy of the captive, which often times a vital aspect that is overlooked when planning to set up a captive.

Other challenges include differing regulations from one jurisdiction to the other, although the OECD's BEPS guidelines is the industry benchmark in most cases. The Federation of European Risk Management Associations (FERMA) had recently provided recommendations to the OECD with regards to captives, with three key dimensions identified: commercial rationale, substance and governance, and ensuring transfer pricing requirements are met.

Captive as an integrated risk management strategy

Clearly there are benefits to considering a captive solution towards mitigating corporate risk, and if managed efficiently there can even be additional benefits to be derived from the management of retained profit within the captive structure.

In addition, the growing importance of risk management, further stimulated by regulators and shareholders in relation to corporate governance, and the pressure of earnings and capital management from shareholders, all render the need for flexibility, which captives offer.

Overall, even in these times of change, the benefits of captives as a risk management tool still outweighs its perceived challenges. For more information on captive formation at Labuan IBFC, write in to

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.

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