SPICING UP: WHY VANILLA CAPTIVES ARE HISTORY

“We have seen an upsurge in demand for a mix of onshore and offshore, brother-sister entities, and a variety of clusters.” ALICIA GREEN, BVI ASSOCIATION OF INSURANCE MANAGERS

The British Virgin Islands (BVI) remains a hive of innovation across all facets of financial services—including the ever-evolving world of captive insurance. If we take a look at historic captive structures, they were mainly created by large corporations to offer coverage where insurance was unavailable or priced out of budget.

The main purpose is to pay losses and to afford the owners more control over the risk and any losses incurred, and as a consequence, captives are basically an alternative risk mechanism used to finance risk.

Within recent years, especially since the arrival of COVID19, we see diversification, increased scope and an opportunity to create an era of “flavored” captives.

Forming a captive

Once the main purpose is identified, a decision is sought to register the company in a domicile that offers great regulatory flexibility and support with a range of licenses tailor-made to the type of captive. There are many captive domiciles globally, with the terms onshore or offshore usually used to determine whether the captive will be established locally or in a different jurisdiction.

Factors that will be taken into consideration in the captive feasibility study are tax implications and corporate and regulatory governance. Shall we set up at home or away? This for obvious reasons determines the level of tax implications and governance on the company. Offshore wins in many cases, especially for flexible regulation, proven reputation, minimum capital requirements and an environment offering excellent support services and relationships.

With a high level of sophistication at professional and governmental levels for all jurisdictions, onshore vs offshore seems to be an even mixture, making the decision-making process engaging for both owners and advisors.

Captives offer a wide variety of benefits which are becoming more attractive to potential owners although they may not be touted in the domestic insurance world.

• One of the determining factors is premium. The captive’s owners over time, due to the stability of its premiums, can set their own rates and customize coverage and policy language.
• Captive owners, because they have a direct interest, make an big effort to improve their own risk practices as it impacts the amount of premium and profitability for investments. Risk committees are established to control the risk rather than simply let the market take care of it. Through these, as the underlying business improves, the captive’s risk profile and claims-handling processes also improve.
• In contrast to commercial markets, captives and their insureds receive economic rewards for controlling losses.
• As the captive has reduced costs, policyholders can enjoy lower premiums and increased profits result for the owners. There are cost-savings derived from lower operating expenses, which result from the profit element built into premiums of commercial insurers. There are also savings in expenses on high sales, marketing and administration costs.
• Captives provide a significant cash flow advantage, not available in the conventional space, through underwriting stability, the ability to reduce costs and manage claims, and with the flexibility of due dates for premium payments by the owners.
• The industry is well regulated with minimum capital and surplus requirements, solvency margins, specific ratios of premiums written to net assets and in some cases, restrictions on investments. Captives are generally subject to more simplified regulation than conventional insurance companies.

Popular offshore jurisdictions such as BVI have become very attractive to register these types of captives. As time moved forward, domiciles began legislative reform to adapt to the self-insurance climate of the day for nuance, or what I refer to as flavor.

With the COVID-19 pandemic, captive professionals have been advising on creating more value and benefits to help captive owners across industries and secured good working relationships with affiliates in the onshore environment to provide add-on solutions to captive insurance entities.

The original concept of owning a captive spurred the use of the pure vanilla constructs, but we have seen an upsurge in demand for a mix of onshore and offshore, brother-sister entities, and a variety of clusters coming together to take advantage of the flavored approach to forming a captive.

Large and medium-sized industries have an enhanced appetite for insuring their own risks for strategic growth and development and seeking risk alternatives to stimulate economic development through their investments. This craving makes it an exciting time for brokers, independents, banks, accounting firms, claims adjusters, and in-house claims managers.

Who says captive management is a boring task? Captive managers are the sight and sound of the regulator while safeguarding owners, with the BVI being at the epicenter of this change.

“While the basic ingredient is vanilla, I believe that adding flavor adds value to the long-term strategy goals and benefits.”

Adding flavor to a captive structure

Party mix captives—here you would find multiple, non-related organizations setting up to insure the risks of their owners. They provide coverage for risks of the owners and affiliations relative in nature. There are different types in this mix:

• R & B is where cost, claim management and premium payments provide consistent flow of cash which is not available in common market.
• Deep house is where premiums paid can stimulate investment income. It is common for captives to earn investment income by investing net premiums retained because the savings allow the owners to set the amount of premium to be paid by the related parties.
• The Alternative provides coverage for risks that are uninsurable by the common market, providing a wide scope and favorable terms not available in the domestic insurance market.

Rental captives—these are proposed by a broker, reinsurer, or a fronting company. They offer lower fees with purpose-driven guidelines on flexibility for coverage, risks and construct of the insureds.

Cluster captives—created for a special purpose for the insurance of risk for its owner or economic relative.

Among the many benefits of forming a captive, most owners would be attracted to the saving on operating costs, flexibility, cash flow, investment opportunity, access to diversification and control over claims.

Captive owners seek to domicile their risk solutions in jurisdictions in which it is far less onerous to set up and manage the legislative requirements. An interesting fact according to the Insurance Institute was the recent finding that the alternative market features a host of innovative products, including:

• Catastrophe bonds, which package catastrophe risk as securities that are bought and sold in the capital markets;
• Weather-based derivatives, financial tools that let businesses hedge their risk of losses from weather; and
• Sidecars—reinsurance companies that contain a specific portfolio of risks financially supported by a sophisticated non-insurance investor, such as a hedge fund.

Captive companies purpose their energies and funding to global projects and help to fund major projects. As the industry evolves to incorporate more purpose-driven structures and incorporate diversity, while the basic ingredient is vanilla, I believe that adding flavor adds value to the long-term strategy goals and benefits of having a captive.

A captive is a useful vehicle to self-insure for cost and tax efficiency, and industry professionals have long claimed that captive insurance companies are the greatest thing since sliced bread. Depending on who is purchasing, even a slice of bread is infinitely better with some flavor.

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Alicia Green ACI is a consultant and captive insurance adviser to Integral Professional Services, and to the BVI Association of Insurance Managers and BVI Finance. Contact the association at: info@bvifinance.vg