Elizabeth Carbonaro of WTW, Andy Hulme of SRS, and James Portelli of CWC discuss trends in the captive market of Malta, as well as the island’s regulatory environment and unique PCC legislation
Spanning just 121 square miles of sunny coastline, Malta can boast its capital Valletta as one of the most concentrated historic areas in the world, ranging the prehistoric architecture of the Megalithic Temples, capture by the Roman Republic, rebellion against French rule, as well as the island’s time as an important British naval base in the Second World War before becoming an independent republic in 1974.
With crystal clear lagoons and some of the best diving spots in the Mediterranean, Malta is a popular tourist destination. However, an A.M. Best country risk report in August last year determined that Malta’s gross domestic product (GDP) contracted 7 per cent in 2020 owing to the island’s dependency on tourism, which greatly suffered throughout the COVID-19 pandemic.
Despite this, the GDP was projected to grow by 4.7 per cent in 2021, with further accelerated growth anticipated in 2022, providing vaccination rates increase and summer tourism recovers.
Established in 2003, the captive insurance market brings a needed diversity and competitiveness to the Maltese economy. Following Brexit, Malta’s position as a ‘top three’ European captive domicile alongside Luxembourg and Ireland was further consolidated as more traditional captive jurisdictions that were included in the scope of the UK (such as Gibraltar) are now excluded from EU risks.
As an EU member, Malta is entitled to the EU single passport right, which means that any captives based on the island can provide insurance in other EU and European Economic Area member states using their Maltese license without having to apply for a separate license in each of their chosen jurisdictions.
Finance Malta reports the island is home to 72 insurance companies, including professional reinsurers, captive insurers and insurance managers, as well as four recognised incorporated cell companies.
Elizabeth Carbonaro, regional managing director, Western Europe at WTW’s global captive practice, comments: “We are seeing a reasonable amount of interest for captives including cells. In fact, we currently have a couple going through approvals at the moment and I understand that there are a number of other applications with the Malta Financial Services Authority (MFSA) at the moment.”
Carbonaro adds that this interest mirrors trends in the wider captive market, which has seen many companies seeking feasibility studies to assess the viability of establishing a captive. She notes that the COVID-19 pandemic has not deterred new captive formations, nor the expansion of existing captives.
Andy Hulme, director of underwriting at Strategic Risk Solutions, notes that as market terms continue to harshen and capacity decreases, risk management approaches become more sophisticated, with an increased focus on risks which were historically ‘uninsured’, such as non-damage business interruption, cyber, reputation, and other pandemic-related risks.
He adds that the COVID-19 pandemic has seen heightened focus on alternative risk financin both in Europe and in Malta, as existing captives evaluate their structure and capital base to mitigate commercial market challenges, while the middle-market is seeing wider opportunities as risk spending increases to be viable for a captive.
“The demand for fronting capacity is growing across Europe as risk pricing forces companies to look further than their own retentions. Malta has the regulatory headroom combined with the legislative provisions to support a variety of risk management solutions for sophisticated risk financiers,” Hulme explains.
The increase in captive formations globally is affirmed by James Portelli, consultant at Cutts-Watson Consulting. He notes that this is attributable to prevailing negative interest rates, wider economic uncertainty and regulatory developments, which have combined to perpetuate the hard market and its emphasis on solvency requirements and technical profitability.
Looking at the impact of the COVID-19 pandemic on alternative risk financing, Portelli remarks: “The captive industry is intrinsically business-to-business in its entirety and is accustomed to operating remotely. Therefore, it has been relatively ringfenced from the ravages experienced by some of the other industries in Malta, such as tourism and hospitality.”
In terms of Malta as a captive domicile specifically, Portelli adds: “Locally, the market is well-served in terms of insurance talent as well as the ancillary actuarial, accounting, auditing, loss adjusting, legal, compliance, investment management and other corporate services providers that work hand in hand with the industry.”
Regulation
The captive market was established in Malta with the Insurance Business Act of 2003. The subsidiary legislation of this Act outlines insurance and reinsurance undertakings within the Solvency II directive, including anti-money laundering guidelines, solvency capital requirements and reporting requirements, among others.
As an EU member, Malta must follow the collective guidelines of the Union, such as Solvency II, which requires captives to have appropriate capital and governance. Malta stands out in the competitive European captive market owing to its unique PCC legislation, passed in 2004, which attracts interest from smaller books of EU-based business and from the intermediary market.
Carbonaro explains: “Malta remains an attractive domicile, given that it is part of the EU but also has PCC legislation in place. The advantage of a cell is an overall lower cost base, and in certain cases that also translates into a lower capital base because the minimum capital requirement is already in position via the core.”
“The governance also sits within the core; therefore cell owners can benefit from the overall control framework at the level of the PCC, which tends to be very robust and at the same time requires less management input and time by the cell owner,” she continues.
In 2020, Malta saw a 5 per cent increase in the number of licensed insurance-carrying cells to 63, while insurance broker cells grew by net 20 per cent to 12 structures, making a total of 60 standalone non-domestic insurance and reinsurance companies. In addition, Malta saw the first insurance-linked securities (ILS) structure set up in 2020. The ILS market is able to explore the opportunities that Malta can offer (such as catastrophe bonds, reinsurance special purpose vehicles, securitisation cell companies, reinsurance and capital markets) rather than Malta exploring the ILS market because the legislation is already in place.
Hulme adds that the regulatory environment of Malta is beneficial for captive owners owing to the flexibility and engagement of the MFSA.
He says: “The Maltese regulator is an engaged regulator open to consider traditional and non-traditional risk alike, demonstrating a willingness to engage with prospective captive owners and to invest time to understand the risks and intention of coverage.”
“Obviously Malta operates within the Solvency II framework, which creates a consistency of approach, but within this framework the regulator is open to a range of risk financing solutions based upon their complexity and unique circumstances.”
Malta’s appeal as a captive market
CWC’s Portelli identifies two main reasons why the regulatory environment of Malta is beneficial to captive owners:
From a legislation perspective, captives can pursue various avenues in terms of formation. Insurance undertakings can establish as fully-fledged insurance or reinsurance companies, as captive insurance or reinsurance companies, as PCCs, or simply as a cell. They can also be either self-managed or outsource insurance management to one of the insurance management companies in Malta.
In parallel to insurance carrier legislation, Malta has also significantly developed its intermediary or distribution legislative framework and, as a result, also has protected cell insurance broking companies.
As a Solvency II jurisdiction, regulated insurance undertakings in Malta, including captives, provide thoroughness in their financial solvency assessments and greater transparency in their financial condition reporting.
Maltese regulators already take a somewhat more proportionate view in respect of their overall governance and reporting requirements — for some time, FERMA has been advocating to have captives classified as low-risk undertakings under the Solvency II revisions.
Historically, the captive insurance message in Malta may have been lost in translation. When the suite of legislation was first enacted almost two decades ago, legislators chose the word ‘affiliated’ over the word ‘captive’.
The result was that Malta reaped demand from parents that wrote mainly third-party business, but not from pure captive insurance business. ‘Captives’ subsequently found more of a home in cells with the enactment of protected cell legislation.
In the last five years or so, legislation was enacted with the word ‘affiliated’ replaced by ‘captive’ to better articulate the target market that it meant to attract. In the meantime, we have also continued to witness the formation by non-insurance parents of insurance companies with business plans one would traditionally associate with captives.
Challenges
However, CWC’s Portelli warns that the single most significant challenge for the captive industry in Malta is one that it may have unintentionally created itself.
He explains that when Malta introduced its high-standard captive legislation to compete with other leading domiciles, “the subliminal marketing messaging of double taxation treaties and shareholder rebates placed us not in the jurisdictional league of excellence in terms of our captive offering, but in the lower league of fiscal arbitrage”.
This means that many regard directives such as the common consolidated corporate tax base, the anti-base erosion and profit shifting action plan, and other tax harmonisation efforts by the Organisation of Economic Cooperation and Development to be a threat.
“It is more of a renewed opportunity to position Malta as a centre of excellence, but will require improved messaging,” Portelli recommends.
Hulme affirms that, similar to other EU onshore domiciles, MFSA must ensure that regulation is appropriately based on the nature, scale and complexity of the captive structures located there, which requires ongoing communication between industry groups, insurance managers, peer regulators and supervisory bodies.
He advises: “Malta, as with other EU domiciles, need to recognise the great need for proportionality in the application of the Solvency II framework. Offshore domiciles remain strong and the incentive for a pure captive to progress within a Solvency II framework is often difficult to justify unless admitted paper is a necessary requirement.”
WTW’s Carbonaro adds another significant challenge for both current and prospective captive owners in the industry as a whole is balancing the capital and governance requirements of having a captive with the inherent benefits, “coupled with recognising that a captive is a long-term benefit for the group, with the benefits not necessarily always being only financial benefits”, she explains.
Looking ahead
Noting that risk managers have faced “a tsunami of issues” over the last two years — including diminished capacities, severely impacted cashflows and the inability to have any realistic long-term vision — SRS’ Hulme expresses optimism that the need for captive consulting, company implementation and reviews will continue in 2022.
Examining pipeline developments for the captive industry in 2022, he observes an increasing focus on green issues as part of a wider ESG agenda. This focus by brokers and underwriters is exacerbating capacity issues in some markets — “we believe that captives can support and underline a progressive and leading ESG ethos for many corporates,” says Hulme.
This ‘green’ agenda is affirmed by Carbonaro: “We are seeing climate change, and its impact, being put on the agendas of companies, and this is slowly filtering down to discussions at the level of the captive.”
Carbonaro also observes a continued interest in firms looking to place their cyber risks, or at least portions of their cyber risks, as well as directors and officers liability, into captives in 2022 owing to capacity restrictions in the commercial insurance market.
In terms of the regulatory landscape, Portelli notes that the international tax harmonisation process has the potential to present a “significant risk” if mismanaged, while Russia’s blacklisting of Malta may bring further challenges.
“Despite these risks and challenges, the industry continues to grow organically. None appear to be insurmountable risks or challenges, and the opportunities far surpass both. Malta has a proud track record of identifying and responding to opportunities by leveraging any advantage it possesses — I expect it to continue to do so in respect of the hard insurance market,” Portelli concludes.
