Captivating insurance

Written by: Richard Willsher Posted: 29/06/2018

City_insuranceThe Channel Islands – most notably Guernsey – have planted a firm flag in the global insurance sector, and no one looks set to remove it any time soon

Both Guernsey and Jersey offer insurance products and structures with global appeal. Though the two islands use very similar models and both offer captive insurance as their lead structure, Guernsey is the more active. Indeed, it’s one of the world’s top captive jurisdictions and by far the leading centre for captive insurance in the European time zones.

Captives are insurance companies that are typically owned by corporates. In fact, most of the companies in the FTSE 100 index own a captive of some sort, and 40 per cent of these are domiciled in Guernsey. What they offer is self-insurance. 

Peter Miller, an Associate Partner at EY in Guernsey, succinctly describes the concept: “If you pay out £1 million in premium a year but only have claims of £100,000, then you’re losing £900,000. If you pay the £1 million to the captive and pay out the £100,000 of claims, you retain £900,000 and can invest the premium for a return.”

Captives have several other advantages. First and foremost, they’re established as properly constituted insurance companies for regulatory purposes. If they’re located in the Channel Islands they can be quickly and cheaply established and fall outside the scope of the European Union’s (EU) Solvency II regulatory regime. 

This means they can hold capital in proportion to the risks they actually write rather than in accordance with the overall industry template, which requires high levels of capital and solvency. In addition, the reporting and compliance requirements are considerably less.

One other advantage that captives offer is that they enable corporates to access the reinsurance market where premium rates are lower than they would be in the open market. All in all, they’re a keenly priced and flexible risk management tool, and it’s captive business that accounts for the lion’s share of insurance business in the islands.

Risk coverage

Often within the structure of protected cells or incorporated cells (see jargon buster), a captive can cover pretty much any risk its owners want it to cover, provided that it’s properly constituted, resourced and run. 

While lines of business have traditionally been dominated by property and liability classes, there’s now more variation. As Aon Guernsey Managing Director Paul Sykes explains: “In more recent years, we’ve seen increasing use of captives to write non-damage business interruption, cyber, employee benefits, trade credit and supply chain covers.” 

An Insurance Sector Strategic Review commissioned by the States of Guernsey and carried out by PwC in December 2016, highlighted seven key areas in which the successful Guernsey industry could continue to develop.

Captives was one of these – and while it’s been the bread-and-butter business of the industry for some time, it’s continuing to expand. Cyber and technology risk of various sorts formed another category of risk. Life business, retail insurance, reinsurance and alternative reinsurance were further ones. Pensions longevity de-risking was the seventh. 

Each of these is a specialist business in its own right, but they each point to some key features that the islands offer that remain consistent from one to the other.

So why are the islands so successful in insurance? And why does Guernsey have a leading position in the market? First and foremost is the proximity of the islands to the EU and particularly to London’s leading global insurance industry. The vast bulk of insurance business transacted in Guernsey and Jersey either derives from the requirements of businesses with a presence in London, or is placed with the insurance industry there.

Second, as Derek Maddison, Chairman of the Guernsey International Insurance Association, explains: “We have a very approachable regulator here. The speed of getting things done is good.”

Third is the industry expertise, especially in captives. To quote from the PwC Guernsey Strategic Review: ‘The sector is staffed by 775 skilled professionals including chartered insurers, actuaries, accountants and risk modellers, and is complimented by an extensive network of legal, accountancy, investment, compliance and advisory firms. An experienced group of non-executive directors adds a final layer of substance to the presence of the island’s international insurers.’

This matters, because a key competitive advantage is that the islands are experts in the relatively small but vital offshore insurance segment of the vast worldwide insurance business. It makes sense for those interested, and in a position to gain from the advantages, that the islands offer to speak to the experts rather than study what’s a pretty esoteric, specialist subject.

“We have local knowledge of the islands regulators’ codes of practice,” says John Lowery, Head of Corporate and Professional Risks at Rossborough, a Channel Island broker and part of US insurance brokerage group Arthur J Gallagher & Co. “We have wordings that insurers approve, so we help with claim servicing. These give comfort to those in London who are placing the business.” 

Lowery highlights the importance of the close relations the islands have with the City – it’s very much a two-way street. For example, he notes that a City investment manager may use a Channel Islands administrator for his or her funds. This will necessarily involve the use of island-based directors, non-execs and officers. They, in turn, will require directors’ and officers’ professional indemnity cover. Rossborough will arrange this and probably place the business with either Lloyds of London or directly with insurers in the City.

City_insuranceILS connection

In another example of the City connection, the GIIA’s Derek Maddison refers to the relatively new and rapidly developing insurance-linked securities (ILS) market. Institutional investors – some, though not necessarily all, of whom may be based in London – may wish to invest in structures that give them exposure to such risks as natural disasters. 

The institutions invest a premium against the risk that a particular catastrophe may occur, with claims being triggered by certain measurable events, such as a Richter scale measurement for an earthquake or a force level for a storm or hurricane. Should the risk come to pass, the premium will be used to meet claims. If it doesn’t, the premium and an investment return on it will be returned to the investor. 

“The driver is that the number of natural catastrophes for which people are seeking cover is growing,” Maddison explains. “Some of these risks can be difficult to place in conventional insurance markets. There may not be enough capacity or those insured may want a particular trigger to be used instead of proving an event in the conventional insurance sense.

"There’s also a growing appetite among the institutional investors to diversify into such risks.”

The importance of the relationship between the City institution, say, and a Channel Island structured and managed risk vehicle is easy to see. Aon’s Paul Sykes underscores the point.

“London is the insurance and reinsurance capital of the world, and also the headquarters of Aon plc. Our relationship with London is absolutely crucial, as we work on a daily basis with brokers and insurers [including Lloyds], many of whom are strong supporters of Guernsey, having transacted business here for many years.”

While the Brexit question hovers over the head of the relationship between the City and the Channel Islands – because no one yet knows how this will affect the City’s financial services markets – the islands know where they stand. They’re neither part of the UK, nor are they part of the EU, so they will still be in a position to operate as offshore insurance centres both with clients in the UK and in the single market.

In the meantime, new business trends such as the ILS market development, the attraction of niche reinsurance business and the ever-growing menace of cyber-risk, look likely to burgeon in the islands, according to market practitioners. 

The islands, and Guernsey in particular, are constantly examining and tweaking the regulatory environment to give themselves competitive advantages against both onshore and offshore rivals in the European and global insurance arena. At the same time, the specialist expertise in the islands is practised, honed and enhanced with each new transaction carried out. 

There’s every reason to expect, therefore, that the islands’ insurance sectors will continue to develop and prosper for the foreseeable future.

JARGON BUSTER

• Captive insurance: An insurance company owned and used by its own corporate to cover certain risks. 

• PCC – protected cell company: An overarching incorporated company with its own board of directors that houses individual segregated cell companies which are typically owned by corporates. These cells can write whatever insurance its owner needs it to write, within the regulatory limits, and its assets and liabilities are segregated from those of the other cells.

• ICC – incorporated cell company: A company that’s authorised to establish individually incorporated cell companies, with their own board of directors. Because of their individual incorporation, the cells are regarded as having a more legally solid segregation of assets and liabilities than the cells of a PCC. 

• ILS – insurance-linked securities: An investment instrument that enables institutional investors to gain exposure to particular risks for a defined period of time. Risks could include those of natural disasters, such as those linked, among other things, to weather or earthquakes. For those selling the risk, ILS represents the opportunity to gain risk coverage outside of traditional insurance.

• Reinsurance: Wholesale insurance that provides insurance to insurance companies.

 


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