Persistent soft market conditions and frequent catastrophic events should spell uncertainty for captive insurers, but they are proving far more resilient than many expected.
Persistent soft market conditions and frequent catastrophic events should spell uncertainty for captive insurers, but they are proving far more resilient than many expected.
It’s widely held that the traditional captive insurance market has peaked, with most Fortune 500 companies already owning one or more of their own insurers. Yet small and medium-sized entities are enjoying something of a boom. This is true in Guernsey, where six new captives were created last year, of which four were protected cell companies, while 76 new cells were created. In total, Guernsey is now home to 837 captive insurance entities.
Even though captive growth as a whole has become “static” in Guernsey, Dominic Wheatley, CEO of Guernsey Finance, maintains that captives are still the bedrock of the insurance industry on the island.
Wheatley explains: “I don’t subscribe to the theory that captives require a hard market in which to flourish because surely constructing a business plan on a set of market circumstances over which you have no control is not an optimal approach.”
“So, even if a captive is established in a hard market cycle, it is unlikely to be abandoned when the market softens, because the real benefits of the structure lie in its governance, management, control and proper pricing of retained risk.”
“Therefore, when there has been a sustained softness in the conventional markets you can only assume that people have captives for permanent or long-term strategic reasons, not short-term tactical reasons,” Wheatley adds.
Richard Searle, partner at BDO, suggests that there is confidence in Guernsey, alongside a healthy amount of caution.
Amid unquantifiable variables such as Brexit, Searle points out that Guernsey has traditionally been good at is managing its own destiny. He says: “As long as we don’t just sit back and leave our destiny in the hands of others, but take control of it and manage it, I think we will be okay.”
According to Jeremy Quick, director of the banking and insurance supervision and policy division at the Guernsey Financial Services Commission (GFSC), the captive industry is faring “reasonably well”. He revealed that year-end premium in 2015 stood at £5.46 billion, compared to £4.94 billion in 2014, while licence numbers were in the 830s in 2016 compared to the early 800s in 2015.
Quick comments: “The global economy is back on track and Guernsey, as an international finance centre, should benefit from that in the long term.”
The GFSC has noticed an uptick in activity in a number of sectors. Insurance-linked securities (ILS) and pension longevity swaps have been two of the biggest. Quick suggests that the pension longevity swaps sector will continue to grow, given the challenges that pension funds face with life expectancy increasing.
Although the reinsurance industry has seen a surge in figures, Guernsey remains a big captive domicile, which is an area that is stable in net terms.
Quick reveals that Guernsey has seen companies both leave the island due to mergers and acquisitions and enter the market anew, suggesting there is still a commercial appeal to the captive, despite strains on traditional business such as low insurance rates, increasing insurance premium tax in the UK and the crackdown on base erosion and profit shifting (BEPS).
Peter Miller, executive director at EY, also suggests that the captive industry remains “relatively safe” because insurance is always needed. Miller adds: “The only risk in Guernsey is that it becomes futile to have a captive because you can get it cheaper elsewhere.”
Although as a whole Guernsey’s captive figures are somewhat static, the same does not apply for Artex, which has seen success in bringing on new business, according to Peter Child, managing director for Artex’s Guernsey office.
Child explains that currently in Guernsey there is more of a focus on reinsurance and if Guernsey wants to grow as a whole then it has to focus in that area.
He comments: “For Artex as a business, this year there is still a lot of strength out there and you never know when the market changes, it might not be as dramatic as the way it has changed in the past, but there will be change and there will always be little areas where there will be a disconnect between what underwriters are willing to write risks at and what the insureds think their risks are worth, and when that happens we can provide some kind of value.”
Paul Sykes, managing director at Aon Guernsey, suggests that Guernsey is “nimble and innovative” and can move quickly as and when it is hit with fresh challenges.
Sykes says: “There are always challenges but Guernsey’s advantage is that we can move and navigate challenges to the benefit of our clients.”
“We have a very close relationship with the regulator and the local government, and if the business environment isn’t quite right we can move quickly to ensure it is optimally fit for purpose.”
Brexit
With 70 percent of Guernsey’s financial services business coming from or via London, Wheatley says Brexit will affect the island “profoundly”.
According to Wheatley, London’s position as a major centre for insurance and financial services makes it vitally important to the island. Unfortunately, uncertainty has reigned in London.
The UK officially pulled the trigger on Article 50 of the Treaty of Lisbon in March and commenced the two-year negotiation process that will end in its exit from the EU.
The activation of Article 50 allowed EU legislators to convene to decide what positions they will take on a range of issues, from the rights of EU citizens in the UK to financial services passporting.
Official negotiations between the European Commission and the UK’s Brexit team were expected to commence on 29 April, however, they were put on hold when UK Prime Minister Theresa May called a snap general election to take place on 8 June.
To the shock of almost everyone, the election resulted in a hung parliament after the Conservative Party fell short of a majority, but May has vowed to carry on as prime minister and has since secured the necessary votes to continue in government.
Her position, however, is far more precarious than anyone expected before 8 June and although Brexit negotiations have kicked off in Brussels, there is yet to be any certainty or clarity around how they will play out.
Wheatley suggests that London’s position as the centre of insurance will not change a great deal, despite moves from giants such as Lloyds of London, which announced the launch of its new EU insurance company in Brussels so that it can continue to be able to write risks from all 27 EU member states and three European economic area states after the UK has left the EU.
Wheatley comments: “There’s no reason to think that Brexit will affect London’s position in the insurance world, while it presents further opportunity for Guernsey which sees itself as a natural extension or support to City services.”
“We have the relationships, expertise, geographic and legal closeness that positions us as ‘London offshore’—we don’t see ourselves in competition with the city.”
According to Wheatley, Guernsey will have to take a ‘wait and see’ approach, but for now is getting on with business as usual, very much offering an island of certainty amid the political upheaval elsewhere.
Wheatley explains: “Our island’s political stability and economic security throws it into sharp contrast with a number of international finance centres which are being tossed about by the waves of change on both sides of the Atlantic. We invite you to explore the Guernsey advantage.”
Solvency II
The Solvency II directive came into full effect on 1 January 2016 with requirements for EU insurers to comply with its three pillars on capital and solvency, governance and supervision, and disclosure and transparency of information.
Guernsey took an early stance in 2011 not to seek equivalence under Solvency II because the directive does not distinguish between different types of insurer and the levels of capital they have to hold, and would therefore place an “inappropriately large capital burden on captives”, which constitute the major part of Guernsey’s insurance industry.
It was also suggested that the regime would be unsuitable for the large numbers of special purpose insurers in Guernsey in the alternative risk transfer space, including issuers of ILS.
Guernsey instead committed to complying with the insurance core principles of the International Association of Insurance Supervisors in the areas of solvency, corporate governance and public disclosure.
The introduction of a new solvency regime under the Insurance Business (Solvency) Rules 2015 set this compliance in law.
The general rule is that a Guernsey-licensed insurer and reinsurer must hold capital resources in accordance with three levels: the minimum capital requirement, the prescribed capital requirement and the capital floor.
These rules have recently been updated by the GFSC to include a new class of insurer and scrap the requirement of special purpose insurers to maintain minimum or prescribed capital requirements.
Although a decision was made in 2011, the island is again considering whether it is appropriate to pursue equivalence with Solvency II.
Stakeholders are currently discussing the cost and implications of equivalence to figure out how realistic it would be to achieve.
Once the decision has been made, dialogue with the Guernsey regulator and government would need to be started. It is understood they would support the industry consensus.
Potential advantages for Guernsey being put forward include simplified access to a wider range of reinsurance buyers and increased attractiveness as a home for reinsurance capital.
Bermuda is an example of a jurisdiction that has achieved equivalence with Solvency II.
When implementing the directive, Bermuda decided on a bifurcated approach to Solvency II, whereby only commercial insurers would qualify as Solvency II-equivalent, leaving captives out of its scope.
John Rowson, CEO at Kelvin Re, suggests that equivalence should be given “deep consideration”.
Rowson says: “I think a major advantage for Guernsey is that Bermuda has invested a lot of time and money implementing Solvency II equivalence.”
“Reinsurance is Bermuda’s principal industry, whereas for Guernsey it is a major industry, simply because we have a very diversified financial services sector.”
He adds: “The diversification in our financial sector is a strength to the island and supports the insurance and reinsurance offering for major banks and consulting firms with large local offices.”
Bermuda could be a useful test case for Guernsey. Rowson says: “This allows a detailed assessment as to whether it is going to add value or not.”
Rowson added: “I am very open minded to it and I am very pleased with the work that is being done and will support it, whatever the outcome.”
According to Richard Searle, partner at BDO, there are certain cases in which Solvency II equivalence could be useful, particularly when looking at business trading with Europe.
However, he also notes that Guernsey has a lot of business for which Solvency II would be “over the top and completely irrelevant”.
Searle explains: “Any approach that Guernsey takes should follow the approach the island’s regulators have taken in the past—to work with industry to identify where would it be relevant and implement a two-track system.”
BEPS
In October 2015, the Organisation for Economic Co-operation and Development (OECD) released its BEPS action plan to renovate international taxation rules and combat tax strategies aimed at artificially shifting profits to low- or zero-tax jurisdictions.
It is also designed to promote fair and equitable tax treatments on an international basis.
The BEPS package aims to achieve this by taxing profits where value is added, improving substance arrangements, and improving tax strategy transparency globally.
In February this year, Guernsey said the island is “continuing to take steps to build on its position as a BEPS-compliant jurisdiction”.
According to Wheatley, BEPS is “significant”, but less of an issue for Guernsey than some other jurisdictions.
Wheatley says: “Our insurance industry is substantial. We have qualified, experienced professionals undertaking all significant insurance activities and decisions in Guernsey, under the direction of highly experienced directors and the supervision of one of the leading international insurance regulatory bodies.”
“Given this, we see no reason for BEPS concerns for owners of Guernsey captives.”
In 2016, Guernsey established a BEPS working party to assess the OECD’s action plan, as well as scrutinise the European Commission’s ‘BEPS directive’.
The working party is chaired by Guernsey’s chief minister, deputy Gavin St Pier, and includes Guernsey Finance chairman Lyndon Trott as well as tax professionals and representatives of the Guernsey Institute of Directors and the Guernsey Society of Certified and Chartered Accountants.
According to Guernsey Finance, discussions between the working party and local business bodies have demonstrated that Guernsey is already largely compatible with the BEPS actions.
Guernsey Finance revealed that the island has taken five significant steps following discussions over BEPS.
These include taking up membership of the BEPS Inclusive Framework and accepting an invitation from the OECD to join the Ad Hoc Group on the Multilateral Instrument (Action 15), where the government committed in June to signing the BEPS Multilateral Instrument.
The island has also signed up to the Multilateral Competent Authority Agreement to assist with the sharing of relevant information in relation to country-by-country reporting (CbCR) (Action 13), as well as broadly adopting the OECD’s CbCR implementation package, to facilitate its implementation of this BEPS minimum standard.
Finally, it has put in place the relevant implementing regulations for CbCR.
Commenting on BEPS in February, St Pier said: “Guernsey is already in a leadership position on tax transparency, and we are also now very well-placed on the evolving BEPS international standards.”
“Over the past 12 months we have taken significant steps to demonstrate our commitment to this agenda, and we will continue to do so.”
“Our position as a ‘BEPS-compliant’ jurisdiction is important for the global tax transparency agenda and provides stability, competitiveness and opportunities for our finance sector.”
Although the foreseeable challenges in the industry are technical, including common reporting standards and Brexit, both present opportunity as much as challenge for Guernsey.
Wheatley says: “We are living in a period of unprecedented turmoil and disruption, so the stability and predictability of a financial jurisdiction like Guernsey does present as a reassuring option to many.”
He adds: “Challenges such as increasing insurance premium tax rates are an unfortunate policy choice as they are proven disincentive to the governance of retained risk by incorporations, but there is not much we can do about that.”
