by Jenny Hill Executive Director ARMS at Willis Corroon
The eighties and early nineties saw the establishment and development of the major captive movement in Europe. Home for these captives was almost exclusively Guernsey, Luxembourg and the Isle of Man.
Luxembourg developed on the back of an active captive market in Sweden and it is no surprise that the other two successful domiciles are situated close to the UK mainland. By far the greatest number of captives in Europe are set up by UK parents. At the last count there were 115 in the Isle of Man and 251 in Guernsey, representing around 45% of all European domiciled captives.
The last few years have seen two developments. One is the emergence of new domiciles - Dublin, Gibraltar, Malta, Jersey, Madeira, Switzerland and Cyprus. They obviously think that this is an attractive and growing area to be in, but are they justified? Is the growth a reality and will new owners go to the new domiciles or will they follow the herd?
The second development has been the changing legislation in the major domiciles to counteract the dual threats of competition from other domiciles and attempts by tax authorities to erode the fiscal benefits of low or nil taxation in the offshore centres. Legislation is also emerging to allow co-operation between domiciles when a parent company wishes to move its captive from one location to another. This cooperative stance is unexpected in an area of hitherto strong competition and we await developments with interest.
CAPTIVE GROWTH
It is easy to see why potential captive domiciles might be attracted into the market. The rate of growth in Guernsey has been phenomenal. The number of captives has grown from 189 in 1990 to 312 in 1995 an increase of 165%, or 12% (compound) per year. Not many industries have matched that in the last 5 years. Gross premiums have risen even faster, indicating perhaps that growth is due not just to additional captives, but to the fact that existing captives are getting larger.
The big question is "Is this growth rate sustainable?" The UK has certainly been an engine of growth for the industry but it is often quoted now as being a mature or "saturated" market. 96% of the top UK companies (measured by turnover) have at least one captive. This doesn't apparently leave much room for expansion, but is size everything?
It's a commonly held belief in the captive industry that insurance subsidiaries are set up by the larger companies. This is based on the realistic assumption that a minimum level of premium spend is required to justify the costs of running a captive. Research shows however that while 195 of the top 250 UK companies (measured by turnover), do indeed have captives there are 374 UK owned captives in Europe alone, indicating that size is by no means the only criterion.
This doesn't mean that the UK market isn't saturated. What it may mean is that the captive as a risk financing tool is adopted by companies much further down the scale than the top 250, or that companies often have more than one captive. This in turn means that the market in Europe is much larger than was originally supposed even given that some companies have multiple captives.
In France the situation is similar. Of the 69 European registered captives only 15 come from the top 50 companies. It is interesting to note further that Credit Lyonnais, while not in the top 50 owns 3 captives. In the Benelux countries only 10 of 99 captives are owned by the top 46 companies.
If the potential market is so large, can the new domiciles simply open these doors and let the new owners rush in? Not quite. Their experience to date has shown that life may be a bit more difficult.
The successful European domiciles have worked hard over the years to project an image of responsible regulation and an accomodating understanding of fiscal planning problems. Flexibility and adaptability have been key.
Competition has been fierce between Guernsey and the Isle of Man as they have struggled to keep a level playing field for UK parented captives. Both have now realised that future growth may come from further afield and both are prepared to lobby their Governments for changes in legislation and to take their message round the world, to South Africa, Russia or mainland Europe. The proliferation of European domiciles makes it even more important to get the public relations right. Domiciles cannot sit back and expect others to "sell" their wares. They must open up their shopfronts and actively sell themselves.
Dublin IFSC promotes itself vociferously - it was established as an international financial services centre and captive domicile primarily to encourage employment in Ireland and to take advantages of the freedom of services within the EU from 1992. Its primary market was not to be the UK but mainland Europe and the European operations of US multinationals. It would be in direct competition with Luxembourg - but with an edge. Where Luxembourg allowed only reinsurance captives, companies registered in the IFSC could write directly into any other EU country. Indeed, if the Pan European policy ever became a reality they could write that too! For two decades Dublin captives would enjoy low taxation under a special derrogation from the EU so everything was set to be above board with no hint of "tax haven" status.
Dublin does have one disadvantage. Luxembourg requires generous reserves to be set aside pre tax. In Dublin this is not the case but there is now finally the ability to defer dividends for five years. The uncertainty however of the past five or six years over the matter of catastrophic reserves has not helped Dublin in its quest for growth.
Having said that, it has not done badly. From a standing start in 1987 it now boasts 105 "pure" captives (excluding agency reinsurers and captive brokers). Its primary markets were expected to be Sweden, France and Benelux with Germany, Italy and Spain emerging in the future.
The first half of the equation proved correct, though limited. Nordic and Benelux countries account for 54 captives - a little over 50% of the total. The biggest disappointment has been Germany with only 7 captives and the biggest surprise the USA, which has produced four times that number. This reflects the affinity of USA corporations with Ireland - many of them have manufacturing and treasury operations located there.
So what are the trends and forces which have affected the development of European captive domiciles?
1992 AND ALL THAT
1992 was seen by some as the launch of a new era for the provision of services within the EU. Dublin was there to provide direct writing facilities and Pan European policies if required. In fact, of the 105 captives established, 63% are reinsurance vehicles.
This is partly due to the fact that reinsurance companies can be set up relatively easily and quickly. In addition they are less rigorously regulated. Owners can get the programme established in time for a particular renewal and convert to direct status, if required, at some less stressful point in the future.
Dublin has also proved fertile ground for owners of captives in Luxembourg which, while rich in reserves, provide no income stream to the parent. Setting up a second captive in Dublin to reinsure the portfolio of risk and enable the parent to receive a dividend has been a way round this problem. Luxembourg has responded with legislation (Reglement Grand-ducal du 20 Decembre 1991) that will allow reduction of the reserve and distribution of dividends. Nevertheless tax rates remain high at around 39% leaving Dublin with its edge intact.
The USA has seen "Fortress Europe" as a commercial threat and owners have been eager to set up captives in Dublin to service their growing European operations. Even so only 60% are direct writers.
Gibraltar now also offers direct writing capabilties within the EU and a flexible tax regime including a nil option. So far however growth has been limited, with European owners preferring to go to the longer established domiciles.
ECONOMIC DOWNTERM
Although total captive growth for European domiciles has been impressive the rate at which Europeans have entered the market has been levelling off.
The reduction in economic activity in Europe generally has changed the way parent companies make decisions - while they may wish to plan long term, the exigencies of the current commercial climate dictate otherwise. Capital is more difficult to find while cash flow is king. Some companies see the captive as an immediate cost saving device but the majority are likely to defer the decision, especially when insurance markets are soft.
INDUSTRY ATTITUDES
The captive idea has not proved to be as transportable as expected. The attitude to risk management in Germany, Italy and Spain is different from that in the UK and Sweden. Andreas Poss in "The Future Development of Captives in Europe" (published by RIRG, 1995) finds that only 16% of all companies in Germany employ professional risk managers, the application of technology to risk management is not common and the number of strategic plans few.
Paola Tegliavini, researcher with Security and Protection against Crime and Emergencies (Space) finds Italian companies to have an average to low awareness of the seriousness of risk, poor positioning of the risk management function within the organisation and a lack of awareness in the main of the benefits of efficient risk management.
Companies without a risk management strategy are likely to find themselves uncompetitive in the long run but it will be a major accomplishment to get some of these companies to think "captive" in the short term. Nevertheless the educative process has begun and while the rate of captive establishment may be slower than hoped the potential remains.
INSURER ATTITUDES
In the UK and Sweden insurers have learnt to live with and even support captives. Indeed Skandia used the idea to good effect and their offshoot, Sinser, now an independent company, has dominated the Swedish captive market for the past decade. It is a truism that captive business is good business even though captives may represent loss of premium income in the short term.
In Germany and other mainland continental countries such as Spain and Italy the tendency has been for long term relationships with insureds, stable prices, and governments willing to protect the industry. This has mitigated against product innovation including captives. Ireland's IDA estimated that in 1994 there were a total of 22 German captives worldwide. Given the size profile of companies in Germany and the fact that they exist in the largest insurance industry in Europe, the potential for captives should be a minimum of 1,200.
PRIVATISATION
The sell-off of government owned utilities and other industries has provided a boost for the captive industry. Companies of sufficient size, familiar with self insurance have been sold off - often with self insurance funds which have provided the basis for quite large captives.
This phenomenon has been common throughout Europe, including the former USSR, encouraging the demand for captives. The CIS has attracted interest from both new and existing domiciles but while the demand and the desire might be there on the part of the new companies, difficulties and uncertainties remain.
REDOMICILATION
Company structure is a fluid thing and the reasons for locating a captive in a particular domicile may change over time. In the past it has been difficult to redomicile captives in a financially efficient way. New capital had to be found and two sets of regulators satisfied - at least until run off was complete.
An emerging trend has been reciprocal legislation between two domiciles which allows the "migration" and regulation of a captive from one to the other. Bermuda and the Isle of Man have the legislation in place at both ends, facilitating the movement of captives between the two. Indeed some captives have already moved from Bermuda to the Isle of Man.
This is an enlightened stance for captive domiciles to adopt, taking it on faith that there will be two way traffic, or that potential owners will be more likely to choose a domicile that has this flexibility should they need to move in the future. In time, domiciles may be at a disadvantage if they do not have such legislation and the new countries like Malta and Madeira should bear this in mind.
CONCLUSION
The rate of growth in the captive industry has attracted many new domiciles. The economic conditions have not proved conducive to rapid growth from mainland European countries but the USA and other ex European countries have filled some of the "gap".
Existing domiciles have had to amend their legislation to remain competitive but are now entering a phase of co-operation. New domiciles are going to have to work hard to promote themselves in what has proved to be a more difficult environment than the statistics suggested. The potential for development in Europe remains vast but the timing depends upon economic conditions, and insurer attitudes.
In the meantime, the watchtower in Malta remains vigilant.
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.
For further information contact Jenny Hill tel: +44 (0) 171 488 8866, fax: +44 (0) 171 488 8968 or visit the Willis Corroon web site, at Click Contact Link
For additional information on Captive Insurance in Europe enter a text search 'Willis Corroon' and 'Business Monitor'.
The eighties and early nineties saw the establishment and development of the major captive movement in Europe. Home for these captives was almost exclusively Guernsey, Luxembourg and the Isle of Man.
Luxembourg developed on the back of an active captive market in Sweden and it is no surprise that the other two successful domiciles are situated close to the UK mainland. By far the greatest number of captives in Europe are set up by UK parents. At the last count there were 115 in the Isle of Man and 251 in Guernsey, representing around 45% of all European domiciled captives.
The last few years have seen two developments. One is the emergence of new domiciles - Dublin, Gibraltar, Malta, Jersey, Madeira, Switzerland and Cyprus. They obviously think that this is an attractive and growing area to be in, but are they justified? Is the growth a reality and will new owners go to the new domiciles or will they follow the herd?
The second development has been the changing legislation in the major domiciles to counteract the dual threats of competition from other domiciles and attempts by tax authorities to erode the fiscal benefits of low or nil taxation in the offshore centres. Legislation is also emerging to allow co-operation between domiciles when a parent company wishes to move its captive from one location to another. This cooperative stance is unexpected in an area of hitherto strong competition and we await developments with interest.
CAPTIVE GROWTH
It is easy to see why potential captive domiciles might be attracted into the market. The rate of growth in Guernsey has been phenomenal. The number of captives has grown from 189 in 1990 to 312 in 1995 an increase of 165%, or 12% (compound) per year. Not many industries have matched that in the last 5 years. Gross premiums have risen even faster, indicating perhaps that growth is due not just to additional captives, but to the fact that existing captives are getting larger.
The big question is "Is this growth rate sustainable?" The UK has certainly been an engine of growth for the industry but it is often quoted now as being a mature or "saturated" market. 96% of the top UK companies (measured by turnover) have at least one captive. This doesn't apparently leave much room for expansion, but is size everything?
It's a commonly held belief in the captive industry that insurance subsidiaries are set up by the larger companies. This is based on the realistic assumption that a minimum level of premium spend is required to justify the costs of running a captive. Research shows however that while 195 of the top 250 UK companies (measured by turnover), do indeed have captives there are 374 UK owned captives in Europe alone, indicating that size is by no means the only criterion.
This doesn't mean that the UK market isn't saturated. What it may mean is that the captive as a risk financing tool is adopted by companies much further down the scale than the top 250, or that companies often have more than one captive. This in turn means that the market in Europe is much larger than was originally supposed even given that some companies have multiple captives.
In France the situation is similar. Of the 69 European registered captives only 15 come from the top 50 companies. It is interesting to note further that Credit Lyonnais, while not in the top 50 owns 3 captives. In the Benelux countries only 10 of 99 captives are owned by the top 46 companies.
Country Top 50 or those No with Captives No of Captives
in FT500 Domiciled in
Europe
UK 50 48 385
Sweden/Nordic 49 28 110
Germany 50 9 15
France 50 15 69
Italy 29 3 3
Spain 29 0 2
Benelux 46 10 99
Switzerland 29 11 3
If the potential market is so large, can the new domiciles simply open these doors and let the new owners rush in? Not quite. Their experience to date has shown that life may be a bit more difficult.
The successful European domiciles have worked hard over the years to project an image of responsible regulation and an accomodating understanding of fiscal planning problems. Flexibility and adaptability have been key.
Competition has been fierce between Guernsey and the Isle of Man as they have struggled to keep a level playing field for UK parented captives. Both have now realised that future growth may come from further afield and both are prepared to lobby their Governments for changes in legislation and to take their message round the world, to South Africa, Russia or mainland Europe. The proliferation of European domiciles makes it even more important to get the public relations right. Domiciles cannot sit back and expect others to "sell" their wares. They must open up their shopfronts and actively sell themselves.
Dublin IFSC promotes itself vociferously - it was established as an international financial services centre and captive domicile primarily to encourage employment in Ireland and to take advantages of the freedom of services within the EU from 1992. Its primary market was not to be the UK but mainland Europe and the European operations of US multinationals. It would be in direct competition with Luxembourg - but with an edge. Where Luxembourg allowed only reinsurance captives, companies registered in the IFSC could write directly into any other EU country. Indeed, if the Pan European policy ever became a reality they could write that too! For two decades Dublin captives would enjoy low taxation under a special derrogation from the EU so everything was set to be above board with no hint of "tax haven" status.
Dublin does have one disadvantage. Luxembourg requires generous reserves to be set aside pre tax. In Dublin this is not the case but there is now finally the ability to defer dividends for five years. The uncertainty however of the past five or six years over the matter of catastrophic reserves has not helped Dublin in its quest for growth.
Having said that, it has not done badly. From a standing start in 1987 it now boasts 105 "pure" captives (excluding agency reinsurers and captive brokers). Its primary markets were expected to be Sweden, France and Benelux with Germany, Italy and Spain emerging in the future.
The first half of the equation proved correct, though limited. Nordic and Benelux countries account for 54 captives - a little over 50% of the total. The biggest disappointment has been Germany with only 7 captives and the biggest surprise the USA, which has produced four times that number. This reflects the affinity of USA corporations with Ireland - many of them have manufacturing and treasury operations located there.
So what are the trends and forces which have affected the development of European captive domiciles?
1992 AND ALL THAT
1992 was seen by some as the launch of a new era for the provision of services within the EU. Dublin was there to provide direct writing facilities and Pan European policies if required. In fact, of the 105 captives established, 63% are reinsurance vehicles.
This is partly due to the fact that reinsurance companies can be set up relatively easily and quickly. In addition they are less rigorously regulated. Owners can get the programme established in time for a particular renewal and convert to direct status, if required, at some less stressful point in the future.
Dublin has also proved fertile ground for owners of captives in Luxembourg which, while rich in reserves, provide no income stream to the parent. Setting up a second captive in Dublin to reinsure the portfolio of risk and enable the parent to receive a dividend has been a way round this problem. Luxembourg has responded with legislation (Reglement Grand-ducal du 20 Decembre 1991) that will allow reduction of the reserve and distribution of dividends. Nevertheless tax rates remain high at around 39% leaving Dublin with its edge intact.
The USA has seen "Fortress Europe" as a commercial threat and owners have been eager to set up captives in Dublin to service their growing European operations. Even so only 60% are direct writers.
Gibraltar now also offers direct writing capabilties within the EU and a flexible tax regime including a nil option. So far however growth has been limited, with European owners preferring to go to the longer established domiciles.
ECONOMIC DOWNTERM
Although total captive growth for European domiciles has been impressive the rate at which Europeans have entered the market has been levelling off.
The reduction in economic activity in Europe generally has changed the way parent companies make decisions - while they may wish to plan long term, the exigencies of the current commercial climate dictate otherwise. Capital is more difficult to find while cash flow is king. Some companies see the captive as an immediate cost saving device but the majority are likely to defer the decision, especially when insurance markets are soft.
INDUSTRY ATTITUDES
The captive idea has not proved to be as transportable as expected. The attitude to risk management in Germany, Italy and Spain is different from that in the UK and Sweden. Andreas Poss in "The Future Development of Captives in Europe" (published by RIRG, 1995) finds that only 16% of all companies in Germany employ professional risk managers, the application of technology to risk management is not common and the number of strategic plans few.
Paola Tegliavini, researcher with Security and Protection against Crime and Emergencies (Space) finds Italian companies to have an average to low awareness of the seriousness of risk, poor positioning of the risk management function within the organisation and a lack of awareness in the main of the benefits of efficient risk management.
Companies without a risk management strategy are likely to find themselves uncompetitive in the long run but it will be a major accomplishment to get some of these companies to think "captive" in the short term. Nevertheless the educative process has begun and while the rate of captive establishment may be slower than hoped the potential remains.
INSURER ATTITUDES
In the UK and Sweden insurers have learnt to live with and even support captives. Indeed Skandia used the idea to good effect and their offshoot, Sinser, now an independent company, has dominated the Swedish captive market for the past decade. It is a truism that captive business is good business even though captives may represent loss of premium income in the short term.
In Germany and other mainland continental countries such as Spain and Italy the tendency has been for long term relationships with insureds, stable prices, and governments willing to protect the industry. This has mitigated against product innovation including captives. Ireland's IDA estimated that in 1994 there were a total of 22 German captives worldwide. Given the size profile of companies in Germany and the fact that they exist in the largest insurance industry in Europe, the potential for captives should be a minimum of 1,200.
PRIVATISATION
The sell-off of government owned utilities and other industries has provided a boost for the captive industry. Companies of sufficient size, familiar with self insurance have been sold off - often with self insurance funds which have provided the basis for quite large captives.
This phenomenon has been common throughout Europe, including the former USSR, encouraging the demand for captives. The CIS has attracted interest from both new and existing domiciles but while the demand and the desire might be there on the part of the new companies, difficulties and uncertainties remain.
REDOMICILATION
Company structure is a fluid thing and the reasons for locating a captive in a particular domicile may change over time. In the past it has been difficult to redomicile captives in a financially efficient way. New capital had to be found and two sets of regulators satisfied - at least until run off was complete.
An emerging trend has been reciprocal legislation between two domiciles which allows the "migration" and regulation of a captive from one to the other. Bermuda and the Isle of Man have the legislation in place at both ends, facilitating the movement of captives between the two. Indeed some captives have already moved from Bermuda to the Isle of Man.
This is an enlightened stance for captive domiciles to adopt, taking it on faith that there will be two way traffic, or that potential owners will be more likely to choose a domicile that has this flexibility should they need to move in the future. In time, domiciles may be at a disadvantage if they do not have such legislation and the new countries like Malta and Madeira should bear this in mind.
CONCLUSION
The rate of growth in the captive industry has attracted many new domiciles. The economic conditions have not proved conducive to rapid growth from mainland European countries but the USA and other ex European countries have filled some of the "gap".
Existing domiciles have had to amend their legislation to remain competitive but are now entering a phase of co-operation. New domiciles are going to have to work hard to promote themselves in what has proved to be a more difficult environment than the statistics suggested. The potential for development in Europe remains vast but the timing depends upon economic conditions, and insurer attitudes.
In the meantime, the watchtower in Malta remains vigilant.
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.
For further information contact Jenny Hill tel: +44 (0) 171 488 8866, fax: +44 (0) 171 488 8968 or visit the Willis Corroon web site, at Click Contact Link
For additional information on Captive Insurance in Europe enter a text search 'Willis Corroon' and 'Business Monitor'.
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