Contrary to what certain factions of the industry might lead you to believe, achieving growth in the modern-day insurance industry is not necessarily as complicated as it may seem. As is the case in most business sectors, the application of common-sense, intuition and experience generally provide the basis of opportunity.
There are, undoubtedly, many more complexities associated with the industry than there were in years past. However, today’s complications tend to be driven more by outside forces, such as politicians, regulators, and, more recently, the capital markets.
Converging Markets to Emerging Markets(header)
Basic economic principles and trends surrounding the commercial insurance industry are often inextricably linked to the reinsurance and captive industries and often indicate where future opportunities will arise.
For example, over the past decade, North America and many parts of Europe have rapidly matured to become what can be fairly described as a saturated market. Despite the participants being arguably some of the most innovative globally, the lack of natural consumer growth dictates that the commonly applied growth strategy is purely the acquisition of greater market share.
In a similar vein, the reinsurance industry in the West continues to stagnate. Due to falling insurance rates and an abundance of new capacity, many classes of reinsurance are increasingly being a commoditised product. In fact, it may not be too long before we see traditional reinsurers replaced by a dedicated derivatives market – particularly in the property catastrophe space.
As a consequence, reinsurers and reinsurance brokers alike are visibly shifting their focus to emerging markets such as Asia, MENA and Latin America. These regions offer huge opportunities for growth, both at a consumer and reinsurance level. This is primarily as a result of the overseas investment which is a rapidly expanding middle-class and a growing demand for more sophisticated insurance products.
While these trends do not directly always correlate with captive growth, developing markets undoubtedly create opportunities in the alternative risk market.
Developing markets undoubtedly create opportunities in the alternative risk market.
Focus on Latin America
Despite GDP growth being affected by a strong US dollar and the recent reduction in China’s demand for natural resources, Latin America is very much on the radar of both reinsurers and the offshore captive industries.
Moreover, given that the predominant forces of the traditional and alternative risk industries have a significant presence in the Caribbean, the Cayman Islands’ close proximity and existing ties to the LATAM region make it an extremely attractive proposition as a potential hub for related transactions and business structuring.
Complexity in Diversity
When trying to successfully penetrate new markets, it is imperative to fully understand them, their nuances, their needs and their problems. Only then can we offer truly effective products and solutions.
From an insurance perspective, there are many overly confusing licensing requirements and excessively complicated taxation systems that apply in many parts of Latin America. While there are similarities in licensing and tax requirements in certain countries, the only truly consistent feature of a diverse region, is unprecedented legislative complexity.
Brazil provides a good example in this regard. It is the largest economy in Latin America (the seventh largest in the world). Its insurance market is equally dominant from a statistical standpoint, accounting for over 40% of the region’s total non-life premiums. However, it is also the World Economic Forum’s worst performer in terms of the “burden of government regulation”, a fact that becomes immediately apparent when considering the cumbersome and restrictive laws in relation to reinsurance cessions.
“reinsurers and reinsurance brokers alike are visibly shifting their focus to emerging markets such as Asia, MENA and Latin America.”(quote)
In summary, Brazil has strict licensing laws in relation to insurance. An admitted paper is always required. This means that insurance fronting for captives is a pre-requisite. This is proliferated by the fact that, until very recently, a minimum of 40% of all reinsurance cessions must be placed with a “Local Reinsurer”. The remaining 60% (or less) was required to be placed with “Admitted” (locally represented) reinsurers, or “Occasional” (overseas) reinsurers (subject to a 10% maximum of the ceded portfolio). Just to further confuse matters, a maximum total cession of 50% to anyone reinsurer was applicable across the board, plus there is a stipulation stated that approved reinsurers cannot retrocede more than 20% out to affiliated entities.
Therefore, even in light of planned relaxations to reduce the extremity of the percentages above, as captives are not generally licensed by the local regulators (SUSEP), they are unable to directly assume a Brazilian retrocession. This effectively means that captive participation in Brazilian risks is only possible when the related risks have been fronted at both the insurance and reinsurance level.
A similar protectionist stance applies in Argentina, where the regulators seem to consistently frustrate the country’s local insurance market with cumbersome, confusing and restrictive requirements. While there is some hope that this may change in the near future, this will be politically driven and largely dependent on the result of this month’s presidential elections.
More positively, both Mexico’s and Colombia’s laws are less complex, but they also dictate that dual fronting is required. In Panama, similar requirements came into force in early 2013.
While regulations other countries in the region are arguably more straightforward and open to unlicensed reinsurers and captives, it remains to be seen if they will stay that way.
With all of the above in mind, the question then becomes: Are captives actually a viable proposition in the region?
Innovative Captive Solutions
From our perspective, we have an obligation to completely understand Latin American needs and requirements and we have committed to undertake this responsibility. For example, we recently established a Segregated Portfolio Company (“SPC”) structure for a large Latin American financial services group. This vehicle was purposely domiciled in the Cayman Islands, primarily because of its standing as a leading financial services jurisdiction. The company has since been assigned a financial strength rating of A-(Excellent) and an issuer credit rating of “A-”.
The primary intent of this structure is to afford the SPC’s clients with enhanced risk management and risk participation opportunities. This includes the provision of dual fronting services that have been approved by the respective authorities in the jurisdiction of the underlying risks. This alone can effectively resolve one of the key regional challenges facing reinsurers and captive owners alike.
With specific regard to captives, the other major challenge in LATAM is the potentially prohibitive costs, especially in those instances where both insurance and reinsurance fronting are required. Coupled with a continually changing local regulatory environment, it becomes immediately apparent why most Latin American captive owners have chosen to domicile in flexible and pro-active offshore jurisdictions.
Firstly, the fact that most offshore jurisdictions have low or zero corporate, dividend, premium and other tax rates, make them immediately appealing. Furthermore, there are certain offshore jurisdictions that already have the benefit of Double Taxation Agreements (“DTAs”) and Bilateral Investment Treaties (“BITs”).
Many others are actively seeking to sign Tax Information Exchange Agreements (‘TIEAs”) with numerous Latin American countries. By reinforcing the offshore world’s commitment to cross-border cooperation and its commitment to transparency, many of the subscribing jurisdictions may even be afforded some tax treaty-style benefits that will further increase their appeal.
Finally, and probably most importantly, many offshore regulators have played a significant role in the success of many domiciles thanks to their pragmatic, yet flexible, approach to regulation. Their rare willingness to assist the private sector and captive owners in finding solutions to problems created by legislative changes in other parts of the world is extremely refreshing.
In conclusion, the constantly changing regulatory environment in Latin America and other parts of the world adds yet another noteworthy reason for prospective captive owners to seriously consider Cayman when choosing a suitable domicile. A significant proportion of the world’s existing captive owners already have.