Well-run businesses must have a comprehensive 'insurance architecture' in place to deal with risk and increasingly 'captive insurance' is making headway in the Gulf region. michael pilkington, rajaee rouhani and sam wakerley report
Captive insurance arrangements form a continuing and noteworthy trend that is likely to gain momentum as the Gulf region's economy continues to develop.
Although captive insurance penetration in the Middle East has been low, there are signs that the region's insurance hubs are ready to take advantage of global and regional demand for captive arrangements.
It is not easy to provide a comprehensive definition of captive insurance. In essence, a captive insurance company is a subsidiary insurance company that provides insurance for all or part of the risks of its parent (and if required related companies within a group and even third parties) whose primary business is other than insurance.
Since the 1960s, captives have developed to meet the varying needs of a wide range of owners and users including single parent captives, multi-parent captives, association captives, group captives, diversified captives, agency captives, "rent-acaptive" and protected-cell companies.
Like a commercial insurer or reinsurer, once established a captive will be licensed as an insurance/ reinsurance company in its "domicile" state where it will operate.
Complex relationships
Modern captive structures can be complex with a multitude of contractual relationships.
Within a global captive programme there will be contracts of insurance and reinsurance on several levels, each with its particular obligations on the parties.
Captives may be established as a direct insurance company, issuing policies to and receiving premiums from their insured.
However, in certain jurisdictions, because of the local insurance regulations, it is necessary for captives to operate as a reinsurer and the primary policy being issued by a "fronting company", which then reinsures into the captive.
A typical global captive programme may include the following insurance contracts: Core wordings. These are often negotiated directly between the captive and reinsurers.
They form a master/core policy wording controlling the coverage the captive can ultimately provide the insured Local wordings. These are either in the form of policies directly issued by the captive or, if required by local regulations, fronting policies issued by local insurers which are reinsured back to the captive Reinsurance of fronted policies. These come into play where the captive has reinsured a local insurer who has fronted Inter-captive reinsurances. In a complex structure, the captive issues policies that are reinsured by another captive prior to reinsurance into the open market Reinsurance. The underlying policy is issued by the captive and then reinsured into the open market either by direct reinsurance or using a reinsurance broker.
Throughout this contractual chain there are a number of professional advisors involved, including local brokers, captive manager and reinsurance placing brokers.
There are several potential benefits of a captive programme: Reduced insurance costs. Premium paid to a commercial insurer generally includes a significant element of profit along with acquisition costs (including broker's commission), administration costs and overheads. A captive programme may reduce overall costs and allows its owner(s) to retain the profit within the group Cash flow/investment income. If risk is placed into the commercial insurance market, premium is paid in advance and claims are paid over a longer period.
The premium is available for investment income until such time that a claim is paid.
A captive programme allows a more flexible approach to the timing of premium collection and payment of claims, subjectalways to the regulatory regime in place. It also ensures that the retention of premium, and therefore the profit from investment income, remains within the group Coverage availability. In a hard reinsurance market, reinsurance capacity may be limited or too expensive for certain types of risks. The use of a captive in these circumstances may be a suitable alternative risk management strategy Access to reinsurance market. Reinsurers are the wholesale providers of insurance. They are able to provide coverage at lower rates since they have lower operation costs and fewer regulatory barriers.
A capt ive programme allows the owner(s) direct access to this reinsurance market without the need to go through a commercial insurer Risk management. Insurance rates in the commercial market often reflect broad industry standards and market conditions. This in turn leads to premium volatility. Many insureds feel they are not getting commercially attractive insurance which reflects their own risk management programme/ loss records. Use of a captive programme allows the captive to tailor the premium specifically to the owner(s) risk management profile/loss ratio. This stabilises pricing over time and allows greater financial control over insurance rates Risk retention. Self-insured retentions and large deductibles are often used by insureds as risk retention mechanisms.
However, many insureds consider that the rates offered by commercial insurers do not reflect the level of risk retention.
Under a captive programme, reserves can be built up within the group Profit centre. In addition to insuring the risks of its owner(s), a captive may also insure similar third-party risks and therefore earn profit as a commercial insurer would Tax benefits. Depending on the domicile of the captive, the captive programme may be part of an overall group tax planning strategy to allow profit to be made at zero or reduced tax levels Regulation. Captive insurance regulations, while providing a responsible regulatory framework, can operate in a less restrictive manner than apply to commercial insurance and reinsurance companies, given the "internal" risk management nature of the arrangement. (However, some regulators privately concede that captives are watched more closely for precisely that reason.)
Data collection/claims handling information/ risk modelling. Accurate historical claim information is essential for risk management planning and risk modelling.
It is reliant on the commercial insurer to retain these records where the insured places its risk in the commercial insurance market. A captive programme allows greater control and accessibility to these records and therefore more efficient risk management strategy
Likewise, there are disadvantages:
Cost. To set up a captive, its owner(s) will have to finance the set-up of the captive and provide the necessary regulatory capital as required by the domicile's regulatory body. Its owner(s) will also have to acquire the relevant expertise to run the captive, whether by contracting out to a third-party captive management company or hiring the expertise directly Administration. Captives will need to be maintained in the same way as a commercial insurance company. The captive's owner(s) will have to invest in additional systems, personnel and management, to run the captive. However, these may be contracted out to a third-party captive manager, although the costs will affect premium savings Change of corporate structure/business plan. Should there be corporate changes affecting the captive's owner(s), the existence of a captive may complicate matters. Changes in the business plan may require the captive to be put into run-of f during which it shall require continued operat ion without any economic benefit The Middle East 's rapid economic development and intense programme of spending across a number of sectors is laying a fertile bed for captive growth.
The region's domiciles look well placed to take advantage of this increased demand: Dubai International Financial Centre (DIFC), Qatar Financial Centre (QFC) and Bahrain, for example, each have flexible, robust regulatory regimes to challenge the traditional on and offshore markets.
Massive investment
As far as a DIFC-based captive is concerned, Ronny Vellekoop, the office head and senior executive officer of Marsh Management Services in Dubai, points out that the GCC has attracted massive levels of investments as a result of high oil prices. This "new money" is now invested locally and there is currently well in excess of US$2trn worth of projects either planned or under way in the region.
But he adds that the spike in investment opportunities has led to a proliferating number of corporate risks. Regional corporations are now calling for more options in relation to corporate risk financing mechanisms.
This is precisely why he considers that captive insurance is such an appealing proposition for regional corporations. With the gradual maturing of the region's financial services industry, captives are poised to make a considerable entry.
Stephen May, CEO Heritage London and Middle East, said: "We have spent the past 18 months discussing opportunities afforded by captives and other risk financing structures with firms in the region. With the development of a world-class regulatory framework in Bahrain and other states such as Dubai and Qatar, the benefits of domiciling these structures locally is attractive for many of our clients."
See comparison table below(source: Heritage).
© POLICY 2009
