Paradigm shift – sector focus, captives

South Africa is Africa’s primary source of captive formations, with firms across all sectors owning captives in traditional offshore centres as well as on home soil. South African firms tend to have a strong understanding of risk financing and are well served by a developed financial services industry. However, the same cannot be said of the rest of the continent, particularly Sub Saharan Africa, where captives are tools employed by only the largest and most sophisticated corporations. Indeed, while captive insurance is a mainstream risk financing solution in Europe and the US and is rapidly gaining traction in Asian and Latin American emerging markets, Africa’s captive market is embryonic. “I would not expect a move of captives into the middle market in most African territories for some time yet—it will probably be a 10-year process before Africa gets to the sort of penetration levels we see in mainland Europe,” said Katherine Outhwaite, Willis Global Captives Practice’s Africa Representative.hideArguably the biggest barrier to entry is the fact that most African companies simply are not big enough to justify the expense and effort of running a captive. Captive uptake typically begins at the top end of the market—big, sophisticated corporations that understand risk financing and want to take their insurance destiny into their own hands—and slowly move down the food chain. This process has begun with the top tier of Africans firms, but captives may not be viable for the next tier down. Ms Outhwaite said a company needs to be paying at least US$0.5m in insurance market premiums before a captive can be cost effective. “Realistically it will be $1m upwards and the number of indigenous organisations paying that amount in premiums is limited,” said Ms Outhwaite. Kenya-based Johnny Evans, Deputy Chairman—East Africa of Gras Savoye, also put the figure at $1m and added that captives usually demand high deductibles, which could also put firms off. A captive owner must also possess a certain level of risk management sophistication—in Africa that typically means multinationals and major corporations in heavy industries such as mining, exploration, oil and gas, or in the financial services sector or telecommunications. “Companies involved in joint ventures or business relationships with major global corporates are going to be held to a standard and swept up into the risk management practices of their partners,” said Ms Outhwaite. “While their own local insurance markets may not be very developed, these companies will be expected to justify their risk management decisions to their global market.” But much depends on the regulatory characteristics of each of Africa’s diverse territories. “Regulators in Sub Saharan Africa are becoming stricter and wanting to retain more risk in-country, so they don’t particularly like captives,” said Mr Evans. “From an east African perspective, the law prohibits non-admitted insurance abroad—you have got to use local capacity first.” Ms Outhwaite further illustrated the issue: “You would expect somewhere like Nigeria, which has a big energy industry, broad geography and big physical risks, to see a lot of captives formed, but the Nigerian regime is such that it is actually very difficult to offshore risk or set up anything locally because of the capital requirements.” She expects the relatively developed north Africa region to be a source of captive growth, while Kenya and Ghana are the most likely of the Sub Saharan economies to drive captive formations in the next five to ten years. A third crucial barrier to entry is simply lack of awareness. “Outside South Africa, understanding of captives hasn’t evolved much in Africa,” said Mr Evans. As Ms Outhwaite explained: “The captive concept relies on a sophisticated risk management approach from the client, so in less developed insurance markets, the clients’ understanding of their insurance needs is also less developed. South Africa’s legislation has been in place for a decade or so, but in the rest of the marketplace I don’t think we can yet say that captive technology has been embraced.” An increase in captive expertise on the continent would help increase understanding of the concept, but while tangible demand in emerging markets like Latin America has led to an influx of expertise, the African continent is yet to lure the specialists, says Ms Outhwaite. “Once we have a critical mass of African companies that are of appropriate size to talk about risk financing and captives, the trick will then be to navigate the regulatory maze in each of these territories to make it work,” she said. Cell approach One type of structure that could help accelerate the uptake of captive insurance in Africa is the protected cell company (PCC)—an independently managed entity in which the risks of multiple companies are incubated in ring-fenced cells around a core of shared capital. PCCs, which are already well established globally and in South Africa, are popular with firms whose insurance premiums are not large enough to justify wholly-owned captives, or firms that simply want the ease of outsourcing their self-insurance, making them an ideal remedy for the African scenario. “PCCs are what the middle market uses in the rest of the world most frequently because they have a lower barrier to entry in terms of capital, but the same challenges to creating an offshore entity may still be present,” said Ms Outhwaite, adding that a lack of PCC legislation on the continent ‘limits access to this technology’. Guardrisk has been South Africa’s leading cell captive insurance operator since its formation in 1993 and the firm also manages protected cells in their Mauritius and Gibraltar offices for firms with African and European risks. According to Herman Schoeman, Guardrisk’s Managing Director, South African cell captive insurance business has grown firmly in the last two decades and continues to grow in terms of organic growth and new entities—in spite of a lack of formal PCC legislation (assets and liabilities are ring-fenced by way of stature rather than shareholders’ agreement). Mr Schoeman argued that specific legislation is not necessarily a prerequisite for PCC business, and sees plenty of potential elsewhere in Africa. “Any time we engage with partners or market participants in Sub Saharan Africa, there is a massive interest in cell captives. It just needs a shareholder with patience to put down the minimum regulatory capital and start building the business from there,” he said. As well as their primary use as self-insurance vehicles, PCCs can also be used to administer employee benefits programmes or generate revenue for retailers offering add-on insurance products to their customers. “I see a big opportunity in the retail space as well as the corporate self-insurance space,” said Mr Schoeman. But PCC revolution aside, the outlook for wholly-owned captive growth still remains positive—it is a matter of logic. As more of Africa’s leading companies form captives, the message will slowly filter down the food chain into a booming mid-market. African corporations are growing in size and sophistication every day, increasingly interacting with international markets and coming under constant pressure to adhere to global best practices. Africa is at least a decade behind the UK and US in its captive penetration, but the eventual adoption of captives as an alternative to traditional insurance is inevitable. Whether PCCs, or even the marketing efforts of Mauritius, can accelerate the process remains to be seen. Mauritius: The African domicile of choice? African captive owners have historically favoured traditional offshore captive domiciles such as Bermuda, Guernsey or the Isle of Man. However, this could change as Mauritius attempts to establish itself as the domicile of choice for African captives. Next year Mauritius will unveil an improved captive law to compete with established offshore rivals. The financial hub—conveniently located off Africa’s east coast—is already home to a modest number of South African captives and protected cells (though no figures are available for exactly how many). “The industry has been small to date because our legislative framework has been geared towards domestic insurers. We are developing legislation tailored towards captives that will reflect best practices and international supervisory standards,” said Max Fulton, Mauritius Financial Services Commission’s Director of Surveillance. He added that the island will tailor its captive provision to the needs of the African markets. “We are naturally going to focus our attention on Africa,” he said. Neil Mohindra, Head of Policy at the Mauritius Financial Services Commission, emphasised Mauritius’s proximity and strong business ties with Africa, as well as a relatively developed reinsurance market to serve its captive industry. “We have had approaches in the last few months from a number of insurers with captive management arms gearing up for the growth of captives in Mauritius through the formation of extra teams,” he said. However, Mauritius will face challenges, such as the trend across Africa of protectionist regulators trying to retain as much risk in-country as possible, said Gras Savoye’s Johnny Evans. Meanwhile, Willis’s Katherine Outhwaite said that while its status as a financial centre makes Mauritius an obvious candidate as a captive domicile, ‘people are always nervous about new domiciles and reputational issues are key’. However, she added: “Mauritius is certainly on our watch list and we have our fingers crossed.”

Paradigm shift – sector focus, captives

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