The America middle-market has benefited from the plethora of captive solutions available to them including cell companies, the 831(b) tax election, and group and association captives. We asked two leading practitioners in Europe to debate the issues.
Are European companies missing a trick by ignoring the group captive solution?
Paul Eaton, New Business Director, Artex Risk Solutions: YES.
Group captives have been an important tool for the North American market for many years, but have not yet come of age in the European market and the question is why and whether now is the right time for the captive management fraternity to be promoting this product?
Group captives operate on the basis that once the entity has been formed by the founder members, new members are introduced as possible suitors by traditional distribution mechanisms, largely intermediaries, and once new members are accepted, the captive grows over time.
So how does the group captive operate? Often the facility is captive manager-led and selection criteria are defined to aim the product at a heterogeneous or homogeneous group of insurance buyers, usually in recognition of an industry segment or similar sized buyers.
The group will underwrite agreed lines of cover and there will be strict acceptance criteria for members in terms of risk management, loss history, ongoing loss control and financial stability.
It takes a group of founding members to provide the critical mass to form the group captive and the insurance programme can be fronted or underwritten directly, depending on regulatory requirements or if the insureds need appropriate paper for their business or lines of coverage.
While there can be different structures for group captives a typical approach will incorporate two self-insurance layers with set attachment, limits and aggregates: a frequency layer, designed to cover each members' attritional losses, and a severity layer in place for less frequent and larger losses.
The premium pricing in each self-insurance layer is actuarially calculated for each member, with the liability in the frequency layer for each member being covered solely by that member, whilst the severity layer is mutualised with all other members.
Above these layers there is reinsurance to the commercial insurance market which underwrites all losses in excess of the frequency and severity layers up to the agreed programme limit.
The total premium pricing to the member is built from the cost of each layer of risk plus the associated fees for loss control, fronting (if applicable), reinsurance and the management expenses.
The total premium pricing to the member is built from the cost of each layer of risk plus the associated fees for loss control, fronting (if applicable), reinsurance and the management expenses.
This approach presents an alternative to the conventional market, which may be welcome for some clients, but on its own is not remarkable.
The real benefits become apparent when you consider that group captives can reduce the premium threshold at which clients can access captive benefits.
Whilst the PCC model previously transformed the captive industry, opening up the market to companies with a premium spend in the region of £500,000 or more, this leaves a huge untapped market with individually lower but still substantial premium spend who could benefit from self-insurance.
In the US, Artex have designed group captives to operate for accounts with premiums from $100,000 upwards and for businesses with turnover of US$30 million all the way up to US$1 billion.
For the member there is the mecca of financial reward for good risk management practices and superior loss history delivered by very competitive premiums and the opportunity to receive performance-based dividends.
The ability to exert control over the insurance purchase is often missing for the buyer and the group captive delivers on this front.
Existing members are the owners and controllers of the group captive, each having contributed capital and holding a seat on the board, and on this basis it is their collective opinion that counts.
Working side by side with the insurance manager, they decide whether new members should join, they set the standards and they call the shots with the choice of fronting carrier, reinsurer and other service providers.
Are European companies missing a trick by ignoring the group captive solution?
Chris Le Conte, Managing Director, Robus Group: NO.
Group captives are very popular in the United States, but for various reasons have not taken off in Europe. I think there are a number of reasons for this:
Among these reasons, the following are most influential:
- Cultural differences between the variety of different countries and peoples we have in Europe
- Language differences
- Concerns over the mutualisation of risk
Group captives presume an element of trust between the various parties participating in them because they have to share each other's risk.
Also there are potential advantages of diversification of risk and the increased purchasing power with reinsurers as well as ensuring reinsurers are receiving sufficient volume of risk and premium to be interested in the arrangement.
Rent-a-captives are a variant of the form and were more successful in the past in Europe because at least contractually the parties could try and ring-fence their risks from each other.
When Steve Butterworth, ex-regulator of the Cayman Islands and then regulator of Guernsey, moved to Guernsey he told me that he had attended a number of board meetings of group captives in Cayman where there was more time spent arguing over risk sharing than there was over anything productive business-wise.
Companies would enter into group captive arrangements and then two years down the line would regret having done so because they weren't achieving the results that had been expected.
This conversation in Guernsey and others around it were how the concept of Protected Cell Companies (PCCs) was born where people could share a vehicle but ring-fence risks into separate pots.
Group captives can work in Europe in certain circumstances, and there is the example of the Catholic National Mutual in Guernsey, which is a shared vehicle for many dioceses of the Roman Catholic Church in the UK and has existed successfully for many years.
In my experience, despite the potential advantages of sharing and diversifying risk, and the potential advantages of 'bulk buying' reinsurance, in practice the concerns over the mutualisation of the risk and the politics of the boardroom would be a concern to me, and this is what I advise clients.
An original version of this article was published in Captive Review, April 2015.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
