Cayman captives: Past, present and future

Although insurance companies owned by parent companies or groups of clients for which they provided risk coverage dates back to the 1950s, captives didn’t make an appearance in the Cayman Islands until the 1970s. 

Fred Reiss, who is known as the ‘father of captives’ and whose Bermuda company International Risk Management Limited was the first to specialise in captive insurance management, also formed Transnational Limited in the Cayman Islands in the early 1970s.

Ian Kilpatrick, who started working with Transnational Limited in 1974, said Cayman benefitted when captives moved away from the Bahamas, a major off-shore captive domicile at the time.

“They moved from the Bahamas because they imposed a one-per cent tax on premiums received, which made them uncompetitive,” he said.

While the re-domestication of captives from the Bahamas gave the industry sector a foothold in Cayman, it was something else that sent the jurisdiction on its way to becoming a major player in the captive industry.

Early in his career at Maples and Calder, attorney Timothy Ridley set up a medical malpractice captive insurance company that gave the Cayman Islands instant credibility in the industry. CRICO, as it is called, was formed for the Harvard Medical School.

Tim

Peter Mackay, who founded Global Captive Management Ltd. in Cayman in 1982, said the fact that Harvard established a captive insurance company helped Cayman tremendously. “Clients would think, ‘if it’s good enough for Harvard, it’s good enough for us’,” he said.

After Harvard established its captive here, Mackay said Cayman became known as the medical malpractice – or med mal as it’s called in the industry – domicile of choice. “By far the majority of med mal is down here,” said Mackay. “That’s one of our areas of expertise.”

Peter

Although captive insurance management companies began setting up in Cayman from the early 1970s, they weren’t regulated. Recognising the need to have some oversight on the insurance industry, the Cayman Islands Government enacted the Insurance Law requiring the licensing of domestic and offshore insurance companies in 1979.

The hard market for insurance in the United States in the mid-to-late 1980s also provided a springboard for growth in Cayman’s captive insurance sector. “When it becomes a hard market, [insurance] rates go up, capacity goes down, it’s harder to find it, so you set up captives,” Mackay said.

Beating the competition

Cayman enjoyed a long run with little real domicile competition for the overall captive insurance market. Eventually, other jurisdictions – even onshore – realised they could compete in the same market.

“There’s a lot more competition that there was,” said Mackay. “Even back in the early 80s… there were no real US onshore captive domiciles; that’s not to say there weren’t some captives there – there were – but no real captive domiciles. Basically you had Bermuda, you had Cayman…and you had Jersey in Europe, and Luxembourg… it was a small business. It has since grown and continues to grow.”

In addition to new offshore jurisdictions like Anguilla, Belize, the British Virgin Islands and Singapore offering captive insurance company formation and management, many US states such as Utah, Delaware and Vermont now are major captive domiciles, with the latter trailing only Bermuda and Cayman in terms of licensed captives.

Fiona Moseley, president of Crusader International Management (Cayman) Ltd., said she believes the competition has evened out the playing field. #

Fiona
 

“Many jurisdictions have the same as what we have,” she said, adding, however, that there’s still a reason for businesses to choose Cayman. “I think where we differ and where we are still a leader is our regulation,” she said, noting that captive managers and their clients here have access to and can talk frankly with representatives of the Cayman Islands Monetary Authority.

“We can set up a meeting tomorrow, if it’s necessary,” she said. “New people coming into the industry have an opportunity to talk and say ‘this our thought, can we do it’?”

Moseley said one of the things that brings clients to Cayman is that CIMA takes a business approach to regulation. “It makes a huge difference,” she said.

“I have offices in the US, so I’m used to dealing with the US regulators and it’s a huge difference. You can only call [the US regulator] on a Tuesday afternoon between 2.00 and 3.00 and the chances of you getting a meeting within the next two months are slim.

“So those are the types of things you’re up against. US regulation is driven by government, so they’re elected officers. So if that state has budgetary issues, they’re going to cut… and the first place they’re cutting is the insurance departments, so you’ve no bodies to actually talk to, which is a completely different scenario than what we’ve got here.”

Challenges

In addition to increased competition, Cayman’s captive insurance industry has faced other challenges over the years, some from abroad, some originating locally.

The industry has had to evolve after legislation was passed in the US, from where Cayman gets about 90 per cent of its captive business. For example, Mackay said the US Tax Reform Act of 1986 seriously hindered the market in Cayman for group captives, which were a key aspect of his company’s business at the time.

More recently, the US Foreign Account Tax Compliance Act – parts of which have already taken effect and parts of which are scheduled to take effect over the coming years – will impact Cayman’s captive industry, although Mackay said it was too early to say how much.

Captive insurance companies have bank accounts and if a signatory on one of those accounts is defined by the US tax laws as an American person, then the company must be FATCA compliant with various information or face a 30 per cent withholding tax on any funds transferred from the US.

“One way around that is doing everything onshore,” Mackay said. “FATCA doesn’t apply in that sense because all the transactions are on onshore. But that’s not what everyone wants to do. Some of them cannot do business onshore; they’d rather keep it and seem to be doing it from offshore. So you’ve got that issue.”

Mackay believes that if it makes sense for someone who needs a captive to come offshore, they will still come offshore, as long as the regulatory requirements don’t become overburdening. In addition, like other sectors of Cayman’s financial services industry, Mackay said the captive industry here has to fight the image that the jurisdiction isn’t above board and that captives are used for things like money laundering, even though the assets are probably in bank very close to the captive’s parent operations.

“The majority of the money is in the US – which it [always] was – anyway,” he said.

“The majority of the investments are all in the US anyway. This whole business of ‘it’s in the Cayman Islands’ is rubbish. The money is sitting in a bank in the USA for most of our clients. It’s managed by a US investment manager. Sure, it’s a Cayman Islands company, but saying the money is in the Cayman Islands is wrong.”

Moseley pointed out that another aspect of Cayman captives that could become overburdening relates to the rising costs in Cayman for attorneys, auditors, license fees and other bureaucratic expenses.

“Right now, I don’t think it’s playing a big part because in the grand scheme of a cost for a captive, that’s probably not at the forefront,” she said, noting however that clients will make periodic jurisdictional cost comparisons. “Previously we’ve been on a par – and have some pluses – with other jurisdictions,” she said.

“But it’s getting harder and harder to win that battle.” She said that it’s a big administration expense for a captive to relocate, but they will do it if they can find similar services and long-term cost savings.

Insurance Managers Association of Cayman Chairman Clayton Price, who also heads up Marsh Management Services Cayman Ltd. – Cayman’s largest captive insurance management company in terms of licensed insurers – said the global financial crisis was also a challenge for the captive insurance industry. 

Clayton

“During [the financial crisis] there was a lot of reevaluation of corporations and their deployment of capital,” he said. “Insurance companies are a big suction cup when it comes to capital requirements because there has to be a prescribed amount set aside in order to make good on future obligations that you don’t necessarily know about in today’s terms. Because of that I think there was a slowdown that was felt.”

That slowdown led to a decrease from 780 to 738 Class “B” insurance licenses – the kind that regulate captives and their derivatives – in Cayman between 2009 and 2010, a drop of more than 5.3 per cent. Price noted, however, that part of the decrease was due to CIMA “tidying up the registry” of inactive insurance companies.

Another potential threat to the captive industry comes from the US Affordable Care Act, often called Obamacare, Price said.

“Being in the early days… nobody really knows exactly how this thing is going to morph and what’s going to be the law of unintended consequences,” he said.

“Right now we’ve got 260 healthcare-type providers captive in the Cayman Islands. Are all of those parent entities going to be able to continue to be competitive and continue to exist themselves or is there going to be harmonisation within the healthcare industry? If that takes place individual captives may get bigger, but there may be fewer captives to manage. That would definitely be something we’ll have our eye on as being a potential threat.”

Mackay said another potential challenge comes from all of the newer captive jurisdictions which are trying to get a foothold in the industry by offering partially tax-free captives under a US law known as 831(b), which applies to captives which have less than US$1.2 million in premiums.

“I think a lot people are setting these up as a wealth transfer on lines of business that really shouldn’t be in a captive and they’re charging amounts that should be charged,” he said. “I think the IRS – and I hear this from US lawyers – are looking into that. It’s not what I would call a captive.”

Mackay thinks an IRS crackdown on these structures will hurt Cayman’s captive sector, even though the Cayman Islands Monetary Authority doesn’t approve them. “It will give the captive industry a bad name,” he said. “Even if we don’t have one, they’ll just say this is an abuse by the captive industry and we’re in the captive industry.”

Mackay also spoke about the possibility of a challenge that would be akin to nuclear assault on the industry.

“There’s always the concern that the US is going to keep trying to change the playing field,” he said. “They have talked in the past about a 4 per cent [federal excise tax]. No matter what, if they did that, we’d be finished – 4 per cent is a lot of money on $20 million when I could do it onshore.”

However, Mackay is optimistic that won’t happen, mainly because Cayman’s captives actually help the United States. He noted that despite the blustery rhetoric about the Cayman Islands from US President Barack Obama, the rules about captives haven’t been changed.

“There’s a lot of pontificating, but we are helping the US,” Mackay said. “Because the hospitals are saving so much money, we’re now giving grants back to buy simulation equipment, MRIs – things they couldn’t normally afford they’re now getting back as grants from here from the money they’re saving by watching their losses.”

Opportunities

While foreign regulation could hurt Cayman’s captive industry, it could also help it, particularly if key competing jurisdictions sign on to treaties that chase captives away.

Price said Bermuda’s captive sector has had some issues because they’ve had to embrace Solvency II, a European directive which is intended to reduce insurance companies’ risk of insolvency.

“They honestly really didn’t have a choice,” Price said.

“The commercial reinsurers demanded it due to the fact that they were looking for a regulatory equivalency for their platforms of writing directly into the EU market. So the 800-pound gorilla really drove that boat there, whereas in Cayman, captive is predominately the insurance sector at this point in time.

“Of course we’d like to grow some of the reinsurance business, but at this point in time, we have to pay attention to what the captives want and we had basically the freedom to make that choice of saying ‘well, we want to wait and see what this Solvency II means as opposed to a bunch of promises.”

Price said Cayman hasn’t totally rejected the idea of agreeing to Solvency II, but it’s taken a “wait-and-see attitude”.

However, the uncertainty around Solvency II’s potential ramifications has caused some captive owners in Bermuda to become jittery.

One consequence of the uncertainly in Bermuda is that some of their licensed captives are moving to Cayman. Price said Marsh is looking at three potential re-domestications from Bermuda this year, one of which has already taken place.

Another opportunity for Cayman’s captive market has come about as a result of a Tax Information Exchange Agreement the government signed with Canada in 2010, Moseley said. “I think we’ve got a tremendous opportunity now that we’ve signed the TIEA with Canada,” she said.

“We’re now on a level playing field with other jurisdictions that have a treaty with Canada. I think there’s a market in Canada for captives that previously went to Barbados because they had a tax treaty. The treaty that we’ve signed puts us on a similar footing.”

Moseley believes Cayman has clear advantages over Barbados.

“I think our regulatory system is far better than what there is – from what I’ve seen – in Barbados,” she said. “We’ve got the infrastructure, we’ve got the professionals that are here; we should be able to compete quite well for the Canadian business.”

Price was heading to Saskatoon, Canada in September to try and develop some Canadian captive business. “We already have a couple of Canadian captives on our books, so that’s a bit of a springboard to start with,” he said.

“There are some potential ones lurking out there that are considering Cayman captives so we’re hopeful we can share with them as to the rationale why.”

Moseley pointed out that if a particular risk can be defined, it’s probably possible to mitigate that risk using a captive insurance company. She said one big risk being discussed these days deals with the Internet and the potential for theft of personal information or intellectually property.

Price agreed that cyber liability was a new trend in captive insurance product lines.

“We’re seeing quite a bit of interest from entities that either already have captives or are considering them… to actually think more seriously about how they can use their captive for that type of risk,” he said.

“I think if you were to ask the CEO of a major corporation these days… cyber liability has to be somewhere on their conscious.”

Captive tourists

The importance of the captive insurance sector for the Cayman economy goes beyond just the people it employees and the fees it generates.

“No one else in the financial industry brings the kind of tourism captives do,” Mackay said.

Because captives are required by their license agreement to hold directors’ and shareholders’ meetings in the Cayman Islands, captive members are repeat visitors. “These are not people who use Burger King,” Moseley said.

“You’re talking top-end restaurant use, you’re talking rooms at the Ritz, or they’ll use a condo for the family for the week. So these are high-end people who are coming to the island and bringing their families and going on Stingray City tours, they’re doing their snorkeling, they’re doing their diving, so it’s not just the fees they’re paying.”

Some captive members even buy condominiums, which supports the local real estate industry and helps put more money in the government coffers in the form of stamp duty.

Price said using data predicated from an Oxford Economics’ Report done for the Cayman Islands in 2010, it was estimated that the captive insurance industry alone generates an economic impact of $80 million for the Islands.

In addition, at the end of November each year, IMAC hosts the Cayman Captive Forum, the largest annual conference in the Cayman Islands, attracting almost 1,300 people in 2011.

Moseley said The Ritz-Carlton, Grand Cayman sells out within minutes of the rooms becoming available to the attendees, and that other local hotels are totally booked as well. “And each year it gets bigger and bigger,” she said.

 

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