I am interested in exploring the opportunities presented by Captive or other Insurance Companies and Alternative Risk Transfer solutions

ART (Alternative Risk transfer) Solutions generally refer to the transfer or assumption of risk that does not fall within traditional insurance or reinsurance boundaries.

Risk Financing

Ensuring the provision of adequate funds to meet the financial implications resulting from future losses which could seriously impact the performance and/or the survival of businesses is an essential part of good corporate risk management. The financing of such risks can be achieved through risk transfer to third parties and/or risk retention (self funding). There are three main possibilities to finance risk although some or all of these can be combined depending upon the complexity of the business.

Risk Financing

Self Funding
In this case, a company decides to meet the cost of specific risks from current revenues or to create reserves to meet eventual losses. Both scenarios require an excellent understanding of the type, amount and likely timeframe of potential future losses preferably derived from solid data built up over several years. “Contingency” reserves are not tax deductible in most jurisdictions and run the risk of being used for “business needs” during difficult periods rather than being preserved for the purpose for which they were originally created.

Traditional Risk Transfer
This refers to the use of the commercial insurance and reinsurance markets to cover future losses through advance payment of premiums which are tax deductible as a normal business expense. The availability of the necessary funds is thereby guaranteed in accordance with the terms and conditions of the policies issued. However, there are certain constraints in using traditional insurance markets;

  • Insurance companies are dependent upon capital inflows to maintain capacity from year to year which in times of economic crises can give rise to reductions in availability of coverage and increased premiums.
  • Insureds which do not meet traditional insurance companies' profitability thresholds can also be confronted with limitation or withdrawal of coverage and/or premium increases.
  • Not all exposures to risk are necessarily insurable in the traditional markets.

Alternative Risk Transfer
Since the middle of the 20th century the boundaries of risk transfer have been extended beyond the realms of the more “traditional” options into a wide array of “alternatives” centred mainly on variations of the “captive” insurance company concept.

The "Captive" Concept

“Captives” can be defined as insurance subsidiaries of groups which are not themselves involved in the insurance business, created for the purpose of insuring some or all of the risks which would normally be placed in the traditional insurance markets and/or those risks which are difficult to place therin. of their group. This definition has been extended in several domiciles (including Malta) to include “associated” or “affiliated” business from members of professional associations, and the like.

The reasoning behind the creation of the first captives is still valid today and can be found in the constraints of the traditional insurance markets (see “Traditional Risk Transfer” above) and the desire of some groups to share in the technical profits generated by their good claims experience and to generate tax efficient technical reserves both of which are traditionally retained by insurers. It is also generally accepted that groups which create their own captives tend to be generally more alert to their risk exposure and maintain greater overall control of their risk financing strategy.

Captives can be incorporated in a number of different legal forms. Briefly, the principal forms are as follows;

Single Parent or Pure Captives whose sole purpose is to insure the designated risks of their parent companies, subsidiaries or affiliates.

Group Captives which are typically formed to insure the risks of a group of entities or individuals in the same field of interest. Frequently this form is chosen when the group participants are not large enough to warrant the creation of their own single parent captives. In this manner the individual members of the group benefit from greater leverage in the reinsurance market (for reinsurance of the captive)and spread the administration costs of running the captive across group participants.

Protected Cell Companies: A captive created as a Protected Cell Company benefits from substantial flexibility and added protection through its unique structure. A "PCC" is a single legal entity comprising a "core" which normally is non-risk bearing, and an unlimited number of "cells" each of which is statutorily distinct as regards assets and liabilities. This legal segregation lends itself to customisation of the PCC captive based upon e.g., the parent's organisational or geographical structure thereby enabling different operating units within a group to sponsor their own captive.

Individual Cell Captives: Smaller mid-sized entities may be unable to justify the investment necessary to create their own captive company. However, establishing a cell within an existing PCC obviates the need to create a Minimum Guarantee Fund which would be necessary for a stand-alone captive (or other insurance company) as this would have been created at the “core” of the Protected Cell Company. A captive cell within a PCC would only be required to meet the minimum solvency requirements based upon the E.U. rules thereby dramatically reducing the capital necessary to create a captive vehicle. The administrative costs of such an entity would also be substantially less than for a “full” captive and the flexibility to establish other cells to accommodate growth or alternatively close down a cell or cells should the experience prove unsuccessful, is greater than with other forms of captives.

Rent a Captive: In domiciles such as Malta which have Protected Cell Company legislation in place, “RACs” have been replaced to a large extent by PCCs or Captive Cells. With a RAC arrangement the necessary capital is provided by a sponsor such as an insurance broker the owner of the captive, which charges the “renting” entity a fee for the use of its capital. To ensure that this capital is not unduly exposed the sponsor would normally require some form of collateral security (bank guarantees or letters of credit etc.).

Direct and Reinsurance Captives The various forms of captives described above can be formed as either reinsurance or direct captives. Unlike other European domiciles such as Luxembourg and Ireland, Malta’s Affiliated Insurance Company (the Maltese term for captives) legislation is geared to the formation of direct captives rather than reinsurance captives (although these are permitted) with the following benefits;

  • Enables full advantage to be taken of EU “passporting” rights which allow direct captives and other insurance companies licensed in an EU country to issue insurance policies in any other EU jurisdiction upon the completion of a simple request process by the “Home” country Regulator (see fuller description below).
  • Avoids costly “fronting” fees which would be charged by an insurer in another jurisdiction for the privilege of issuing local policies
  • Avoids the expense and balance sheet implications of putting up collateral security in the form of letters of credit, bank or parental guarantees to satisfy the demands of “fronting” insurers.

Insuring "Non-Related" Risks Captives or “Affiliated Insurance Companies” as they are designated in Malta are not permitted to write non-related third party risks. The creation of a direct insurance company (which can also be in the form of a Protected Cell Company or as a protected cell) would be the logical way to accommodate such business.

Capital Market Solutions In recent years, several other decidedly more complex and possibly less secure risk transfer possibilities such as Finite Risk Solutions, the use of derivatives and other risk linked securities have been developed in the capital markets. However, these methods of hedging risks have all but disappeared given the current state of the financial markets and the uncertainty surrounding the tax treatment with such constructions.

However, “Catastrophe Bonds” issued by the major reinsurance groups are still available although their use is now limited to very large global companies, municipalities and even island communities to protect their balance sheets mainly against natural catastrophes.

How Abacus can assist: Abacus can assist the prospective captive or direct insurance company owner through a pre set-up analysis of the proposed business model and the choice of the optimal insurance vehicle. Thereafter, we can ensure the efficient establishment of the chosen entity and the provision of customised management services as described under “Our Dedicated Services”.