China to lead Asia captive growth despite sluggish 2017

China will lead strong growth in captive formation in Asia during the next ten years, despite another sluggish year in 2017 that saw the creation of only eight new captives across the entire region, according to Malcolm Cutts-Watson, industry veteran and a member of Labuan Financial Service Authority’s International Advisory Panel. Mr Cutts-Watson published his views on how the market developed in 2017 and what he expects looking ahead, on the Labuan International Business and Financial Centre website. He says that the captive market clearly faces challenges in the form of regulatory efforts such as the OECD’s BEPS initiative and of course the prolonged global soft insurance market conditions. Yet, he remains confident that the true risk management value of captives will ensure that the sector continues to grow and that the concept will finally take off in Asia over the coming years and in China in particular. “I still stand by my prediction regarding Chinese captives; 200 captives generating $20bn premium in ten years’ time,” he writes. Mr Cutts-Watson adds that 2017 year-end captive statistics were not available at the time he wrote his review, but he predicts that the trends of 2016 will have continued into 2017. This means that new captive formations will be roughly level with 2016’s number of 616. “Disappointingly”, only eight of which were formed by Asian owners. This, he says, will bring the total number of captive vehicles worldwide to around 6,750. Many of the entities contain cells (effectively mini captives) so the true number will be closer to 7,500. “So, there is continued steady growth despite the insurance market remaining soft (which anecdotally is an inhibitor to captive formations),” states Mr Cutts-Watson. “Interestingly, the majority of owners of newly-formed captives fall outside the Fortune 1000 and [that] is dispelling the myth that captives are only for large corporations. My assessment is that captives are formed for strategic reasons rather than purely arbitraging the insurance market,” he adds. The number of territories that offer bespoke captive legislation (including Labuan, of course) continued to increase, with more than 70 domiciles now in play. Mr Cutts-Watson says that this obviously represents more choices for the consumer, but warns that this increased competition could lead to a risk of lowering regulatory standards and inadequate local business infrastructure. The captive expert, who runs his own Guernsey-based consulting firm Cutts-Watson Consulting, says that off(and mid)shore jurisdictions continue to demonstrate greater innovation and flexibility to deliver new products and services. He also points out that the role of captive technology in the insurance-linked securities (ILS) and longevity risk space continues to grow and the evolution of captives beyond simple risk retention continues. Currently, ILS structures provide 10% of the global reinsurance capacity, and this is expected to reach 15% in 2018, he states. The captive agenda was again dominated by regulatory and fiscal developments in 2017 and this is likely to continue into 2018, says Mr Cutts-Watson. “Globally there is a shift to risk-based regulatory regimes and captives have not been immune. The upside is increased confidence in the resilience of the captive model through improved solvency (ie capital) and an enhanced governance and management of business risk. The downside has been additional capital commitments, increased running costs and additional bureaucracy,” he states. “Given [that] consumer protection and the collapse of financial markets are perils that rarely apply to the regulation of captives, the secret appears to be applying a regulatory regime that is proportionate to the risks captives pose. In the case of the EU, the Solvency II regulation applied to captives appears to be overkill and the supposed proportionality to be applied by regulators, illusionary. The end result has been a number of captive exits,” adds Mr Cutts-Watson. Another potentially significant challenge to the captive sector is the OECD's BEPS initiative on transfer pricing and this is beginning to “reverberate around the globe”, says the captive expert. Mr Cutts-Watson says there is clearly now a recognition that this measure will not go away quietly, and territories and corporations are having to review their business models and adapt where needed to achieve compliance. This initiative and other related global efforts on transfer pricing and tax avoidance may be behind the recent announcement by the governor of the Central Bank of Malaysia and the chairman of Labuan Financial Services Authority (Labuan FSA), Datuk Seri Muhammad Ibrahim, by which Labuan IBFC was advised that it needed to reinvent itself. “The secret seems to be to effect sufficient change to achieve compliance without impairing the nimbleness and innovative thinking of the finance centre,” says Mr Cutts-Watson. Looking ahead to 2018 and beyond, Mr Cutts-Watson says the evidence from 1 January renewals suggests there will not be a dramatic hardening in commercial insurance terms and conditions as a result of the string of major catastrophes in the US and Caribbean last year. “There is still plenty of capital to support risk takers, and improved penetration rates in emerging markets are generating profitable business. Expect to see a better understanding, and improved modelling of risks. With this information, insurance buyers will be able to determine the optimum balance of risk to be transferred or retained. Increased retentions will drive captive growth,” he points out. The captive expert says that he expects growth of US captives to slow in 2018 because of tax challenges over the pricing and coverage offered by smaller captives, but continued use of cells in protected cell captives will drive growth in the SME sector. Mr Cutts-Watson remains bullish about the prospects for the Asian captive market, despite disappointing numbers so far. “I expect to see more Asian-owned captives incorporated. Growth will be driven primarily by China, and in particular investment in non-Chinese located assets. I still stand by my prediction regarding Chinese captives; 200 captives generating $20bn premium in ten years’ time. But other countries in the region are also demonstrating an increased awareness of risk management and the total cost of risk, and this will lead to captive formations,” he states. The worldwide regulatory and fiscal initiatives mentioned above mean that domiciles need to up their game. Those that fail to respond to the changing governance landscape will lose business and ultimately become irrelevant, says Mr Cutts-Watson. “To be a successful and future-proofed financial centre, accreditation of global standards of conduct is essential. We have just seen the release of an EU blacklist of unacceptable financial jurisdictions and this will lead to diminished business from that region. Expect similar announcements from supranational organisations,” he adds. “Continued scrutiny as a result of the BEPS initiative will lead to pressure on finance centres to adopt improved transparency and eliminate carve-outs in fiscal policy. As discussed, Labuan IBFC has recognised the need to evolve. Paradoxically, more US states will pass captive specific legislation, offer light touch regulation and attract indigenous business as they appear immune from global scrutiny,” continues Mr Cutts-Watson. One barrier to the growth of off(or mid)shore captive jurisdictions, and more broadly global programmes, is territorial restrictions on the export of capital and premium. These measures have increased in recent times as emerging nations in regions such as ASEAN seek to protect their local insurance sectors and prevent exploitation of their markets by international insurers and reinsurers. But there is a growing recognition that such measures ultimately stifle the use of risk transfer and risk management in emerging countries and regions and so actually have a negative effect. Mr Cutts-Watson shares the hope of most in the international risk transfer and management community that such measures can be relaxed over time to the benefit of all, not least in Asia. “Should these trade embargos be lifted, possibly through some form of Asian regional trading and mutual tax agreements, then this would be a catalyst to new captive formations,” he states in his review. Mr Cutts-Watson also agrees with many that captives could be an important catalyst to bring the capital markets to play in the primary insurance market increasingly in future. “The importance of the capital markets to insurance risk will increase with the continued success of ILS issued out of a captive structure. The reinsurance market no longer views this as a threat but as a complementary offering, comparable to how insurance markets now view captives. To date, risk transferred to investors via [the ILS market] has been predominantly natural catastrophe cover. Look out for new risks being offered to the capital markets. The use of captives to remove longevity risk from pension and annuity providers will continue apace,” he says. This forms part of one very exciting area of potential development that is of particular significance for regions of the world – such as much of Asia – that are heavily exposed to natural catastrophes, according to Mr Cutts-Watson. “I see captives providing the perfect risk financing structure for territories facing similar natural perils. There are examples of this in the Caribbean, South Pacific islands and African nations. Risks are pooled into a captive vehicle and excessive risk cost efficiently transferred out to reinsurance or capital markets. The captive delivers a low-cost, robust operating platform and a solid governance framework (essential if a supranational organisation is financing the venture),” he says. Another development that excites the captive expert is the use of a captive vehicle to facilitate microinsurance. This makes insurance protection available for the first time to a large sector of the market that previously had not been in a position to buy cover, he points out. “Using mobile phone apps and blockchain technology, it is now possible to collect small value premiums on a weekly basis without incurring heavy distribution costs. In turn, a simple-to-understand insurance policy can be issued, with claims settled automatically using predetermined trigger points,” says Mr Cutts-Watson. “Again, the captive offers a low-cost operating platform and a strong governance framework. This type of product would be especially valuable for farmers and tradesmen in emerging territories and could form part of an impact investing offering, which is gaining increasing traction in the wealth management world,” he adds. In conclusion, Mr Cutts-Watson states that the global captive industry is “robust” and “healthy” and has many opportunities to expand. But the captive expert says the standard captive model may need “some changes” to enable it to face up to external scrutiny. He says the captive business plan needs to clearly state the rationale for, and strategy of, the captive and lay out a roadmap. It needs to demonstrate fair pricing of the risk and deliver substance. It also needs to provide proper governance and clearly assess the value the captive generates. “After four decades in the industry and business, I continue to be amazed at the resilience and creativeness shown by the captive community. I see no reason why this should change going forward” concludes Mr Cutts-Watson.

China to lead Asia captive growth despite sluggish 2017

Want to read this article?

Read Next

Global insurers’ market capitalisation grows as results improve

MNK Group acquires Costa Rican insurer Oceánica de Seguros

New chief underwriting officer for Markel’s Indian operations

Rates drive change in AM Best’s London market outlook to positive

North American broker M&As slow in first quarter to Covid-19 levels

Global insurers’ market capitalisation grows as results improve

MNK Group acquires Costa Rican insurer Oceánica de Seguros

New chief underwriting officer for Markel’s Indian operations

Rates drive change in AM Best’s London market outlook to positive

North American broker M&As slow in first quarter to Covid-19 levels

Want to read this article?

Read Next

Global insurers’ market capitalisation grows as results improve

MNK Group acquires Costa Rican insurer Oceánica de Seguros

New chief underwriting officer for Markel’s Indian operations

Rates drive change in AM Best’s London market outlook to positive

North American broker M&As slow in first quarter to Covid-19 levels

Related Articles