“Captives that are already established will start doing more, different and interesting things.”
Peter Child, GIIA

2020 was a challenging but extremely fruitful year for captives in Guernsey.

Guernsey largely overcame one massive challenge in 2020, effectively eliminating COVID-19 from the island within a couple of months of initial lockdown. As a global industry we still have huge COVID-19 uncertainty, but one thing we can be sure of is that the use of captives is on the rise, and is going to become increasingly sophisticated in the future.

We have seen a big increase in interest for captive formations in Guernsey over the past 15 months or so, driven initially by escalating costs of professional indemnity cover in the construction industry, which then spread to other sectors.

We know that captive insurance interest and activity as a whole has grown in 2020 and will continue into 2021. There was a lot of interest during first half of 2020—the volume of enquiries was actually a challenge for us as an industry to handle—which led to a large number of feasibility studies being commissioned. There were, however, relatively few conversions of that interest into new licences, certainly in Guernsey.

In the run up to the end of the year that picture changed—new business really started to flow into Guernsey.

By 2025, when we look back, I think we will regard 2021 and 2022 as being the peak years for new formations and licences.

There was also an uptick in the number of clients with existing captives increasing use of their structures in 2020, as they considered the application of optimal risk-financing strategies.

Expediting applications

Towards the end of the year, the Guernsey Financial Services Commission introduced a fast-track pre-authorisation licensing scheme for new captives using the protected cell structure.

This was introduced, in part, as a way of accelerating the licence application process as demand and interest rose. In previous years we have found that new interest in establishing a captive becomes a fairly complex learning process. And as this goes on, in the run up to renewal, sometimes it runs too long, and the deal is put off by 12 months, or often never goes through at all.

The pilot scheme helps to overcome this, by enabling captive formation within 48 hours. It allows the captive option to remain a viable part of a renewal consideration or negotiation right up to the renewal date.

At present the scheme is limited to protected cells hosted by a protected cell company, owned by a licensed insurance manager. It is restricted to captive insurance business, and only a single line of business, although clients are not precluded from adding additional line in due course.

Over this busy period we have consistently stressed that captives should not be seen as a ‘magic bullet’ in risk management. Lots of people have heard something about captives, and when they see their premiums rise by a multiple of five or six, they might start to think about whether forming one could provide a short-term benefit to allow them to cope with the vagaries of the insurance market.

That has never been the case. A captive has always been a medium to long-term strategic investment of both time and money. For those after a quick fix, captives will sometimes not be the required panacea.

Guernsey recorded a rise in captive formations in 2019 of 11, more than double the figure recorded in 2018. The island has more than one-third of all captive insurance business in Europe, with more than 300 structures active in the island.

When pandemic uncertainty reduces, we expect people to make the longer-term investment decisions they need to make when setting up a captive.

We are certainly moving to a place where new captives will be comparatively sophisticated compared to their predecessors from the 1980s and 1990s. Those captives that are already established will start doing more, different and interesting things, and the captive insurance industry is going to turn into a much more sophisticated financial services offering than it ever has been before.

A survey of Airmic members, taken before autumn 2020’s Airmic virtual conference, revealed that two-thirds of risk managers and insurance buyers are now considering captives in response to the hardening market.

As Europe’s leading centre for captives, Guernsey faced the challenge in 2020 of addressing economic substance requirements in a COVID-19 environment.

That has largely been managed by pragmatism and the use of technology. Given international tax scrutiny of captives, all captive operators and owners have to be fully aware of economic substance issues, and while technology may continue to be used, the demand for physical board meetings is unlikely to decline.

Peter Child is chairman of the Market Development Committee at the Guernsey International Insurance Association. He can be contacted at: peter_child@artexrisk.com

A centre for longevity

Christopher Anderson of Carey Olsen explores a growth option for captives in Guernsey: addressing issues of longevity risk.

In the last five years, a number of well-known pension funds have completed transactions worth in excess of £30 billion through captive insurers based in Guernsey.

The most high-profile deal was for the BT pension scheme, valued at some £16 billion. That deal was conducted in 2014, but since then there has been a steady stream of arrangements made, with a surge in activity since the turn of the decade.

The end of 2020 was the busiest period so far. My firm, Carey Olsen, has advised on all these transactions over the years.

Pension funds which operate defined benefit schemes are exposed to longevity risk—the risk that their pensioners live longer than predicted. That exposure has been growing rapidly in recent years as life expectancy has increased—just one extra year of additional life expectancy can add 5 percent to a pension fund’s total liabilities. In today’s low interest rate environment, pension trustees are finding it difficult to earn sufficient returns to compensate.

To protect against this risk, pension funds have traditionally purchased a bulk annuity policy from a specialist insurer. These can be expensive and for some pension funds it can be more cost-effective to establish their own captive insurance company, which insures the fund’s longevity exposure and reinsures 100 percent of that risk into the life reinsurance market, where pricing may be lower.

The pension fund pays a fixed premium to the captive in return for payments from the captive sufficient to cover the fund’s liabilities to its pensioners. The captive pays a fixed premium to the reinsurer in return for reinsurance of the risk it has assumed to the pension fund.

These are long-running deals which can take years to finally run off, terminating the insurance contracts. So the transactions require security arrangements and collateral to ensure that the deal can be unwound if one of the parties fails.

A captive-based solution can also be a stepping stone on the path to the pension fund purchasing a bulk annuity at a later date. The insurance contract written by the captive can easily be novated to a bulk annuity provider, enabling it to step into the deal.

The fact that the transaction already has reinsurance protection ‘baked in’ makes these transactions attractive to bulk annuity providers. Carey Olsen has already advised on a number of novations out of captive longevity swaps.

Centre of excellence

There are a number of reasons Guernsey has been able to position itself as such a popular jurisdiction for longevity swaps. These range from its highly-regarded regulatory regime, through to its long history in cell company and captive insurance innovation, which has created a centre of excellence for handling these types of complex transactions.

Because the captive carries no underwriting risk and its credit risk is mitigated by the extensive collateral and security arrangements outlined, it is subject to a lighter touch regulatory regime and consequently lower operating costs, including:

  • No solvency requirements;
  • Low minimum share capital (often around £100,000);
  • No requirement to appoint a trustee to hold the captive’s assets; and
  • No requirement to appoint an actuary to annually report on its assets.

The captive is required to appoint a Guernsey auditor and provide to the Guernsey Financial Services Commission a copy of its audited accounts together with an annual return.

All of the longevity swaps completed to date, as well as those in progress, have used an incorporated cell (IC) of a Guernsey incorporated cell company (ICC). ICs are proving attractive in the context of longevity risk transfer for several reasons.

For a pension fund contemplating a number of swaps (perhaps for different schemes or different categories of pensioners), an ICC is a cost-effective way of establishing a group of special purpose insurers under common ownership. Once a pension fund has established an ICC and transacted a swap through its first IC, it can easily add additional cells to accommodate further transactions.

An IC offers a variety of restructuring options. It can be transferred between ICCs, converted into a standalone company, amalgamated or migrated to other jurisdictions. This flexibility is very attractive in the context of a transaction that can subsist for a very long time, perhaps longer than 60 years.

Several Guernsey insurance managers have established their own ICCs to facilitate longevity risk transfer transactions for their clients. Those managers can offer pension funds an IC in a ready-made and licensed ICC.

Those ICCs may comprise a number of ICs owned by different pension funds, each of which is established to operate a single longevity risk transfer transaction. This structure can be cost-effective for pension trustees who are contemplating one-off or smaller transactions; and who therefore do not wish to establish their own ICC.

Instead of employing staff, the captive, or cell, usually appoints an entirely non-executive board of directors (who will also direct the ICC) supported by a locally licensed insurance manager. The insurance manager provides administrative services, technical insurance support, a registered office address and acts as the IC’s general representative.

Board meetings are held in Guernsey and a majority of the directors are usually Guernsey residents in order to ensure that the mind, management and control of the IC remains at all times in Guernsey.

As the first jurisdiction in the world to introduce cell company legislation, Guernsey is home to a large number of cell companies. There is plenty of experience on-island in advising and managing these types of vehicles.

The ongoing impact of the coronavirus pandemic on longevity is uncertain, but despite this, Guernsey has seen, and is likely to continue to see, significant growth in longevity swap transactions structured through Guernsey cell companies.

Christopher Anderson is a partner at law firm Carey Olsen. He can be contacted at: christopher.anderson@careyolsen.com

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