Experts offer an insight into Malta as a captive insurance jurisdiction
As a fast growing financial services centre, how is Malta competing to attract new captive business?
Stuart King: Before the island’s accession to the EU in 2004, the Malta Financial Services Authority (MFSA) had a very connected approach to promoting and developing Malta’s financial services legislative infrastructure. Later, EU accession afforded the MFSA the luxury of being able to: analyse other domiciles, define its competitive edge, develop its strategy and then implement legislation in comparison to others.
Malta has developed a framework that is structured in a manner that provides clearly defined Insurance Act Subsidiary Legislation that includes: captives, protected cell companies (PCCs) and incorporated cell companies (ICCs). In my view, creating specific risk retention legislation provides a neat mechanism to accommodate flexibility as market conditions change. The island is forward thinking as it avoids the slow process of governmental lobbying to change, clarify or create new legislation. Clear legislation that can accommodate flexibility is a significant factor that many potential captive owners consider when deciding on a domicile.
Ian-Edward Stafrace: Innovation is key. Malta is the first, and to date, only full EU member state to have adopted PCC legislation.
The regulator’s increased workload arising from new EU requirements such as IMD2 (Insurance Mediation Directive) and Solvency II have not stopped it from further innovations such as implementing ICC legislation and proposing reinsurance special purpose vehicles (RSPV) legislation.
Malta is a jurisdiction that complies with and helps to develop international best practice and is actively involved with the OECD and the EU in modelling global regulatory policy. The MFSA is a member of the European Insurance and Occupational Pensions Authority (EIOPA) and the International Association of Insurance Supervisors (IAIS). The efficient Maltese income tax legislation has also received approval from the European Commission.
Malta’s finance industry has built a solid mass of skills, knowledge and products with a proven regulatory system, a trusted legal system and political consensus on this growing sector of our economy.
Cell companies are a viable alternative for those that do not wish to set up a standalone company. How does Malta embrace this type of structure?
King: Rather than competing with a wholly owned captive, it is perhaps worth considering a cell arrangement as a complimentary tool that is available to captive owners. For example, a cell in a Malta-domiciled PCC is permitted to issue admitted insurance paper directly to EU territories. This is particularly effective for US captive owners with unique short-term European risk exposures. Administration costs and a reliance on an insurance carrier’s non-US based network, underwriting criteria and policy form can often be disadvantageous to include the risk in a global insurance programme in comparison to the relative ease of establishing a cell.
A cell is certainly a lower cost alternative to a wholly-owned captive, in addition to reducing the routine governance and compliance burden. However, what is often overlooked is a cell owner’s internal cost of collateral and security that is requested by PCC promoters and regulatory authorities to cover the ‘risk gap’ of the cell, given that cash-backed capital is generally minimal. In particular, issued parental guarantees can often raise challenges from tax authorities that may seek clarification on the arrangement in order to permit premium paid to be an allowable expense for corporate tax returns.
Stafrace: PCCs are essentially segregated business structures. Third parties are allowed to enter the PCC as cell owners with their business segregated (ring-fenced) and accounted individually. Each cell’s assets and liabilities accrue solely to the shareholders of that cell. Such cells could be used for multiple purposes, such as captive risk financing tools or writing third party risks for added revenue and profit.
Being domiciled within the EU, the PCC, on behalf of its cells, is allowed to directly write into Europe and this eliminates the requirement of European fronting insurers.
One of the most important features of Maltese PCC regulation is that the regulations presuppose that the individual cells will have recourse to the PCC core capital. While absolutely protected from liabilities from the core or other cells, a cell will not have to be capitalised to the minimum EU directive requirements for standalone insurers, so long as such requirements are met by the PCC as a whole. Maltese regulations establish that once the cell has exhausted all of its assets in meeting its liabilities, it will have perfect access (secondary recourse) to the PCC core capital. Non-recourse provisions are allowable under regulations, but solely for pure captive (affiliated) or reinsurance cells.
Where does Malta currently stand on Solvency II? Is its eventual implementation a worry for the country?
King:Malta is subject to the Solvency II regime, and as with all domiciles both regulatory authorities and insurers grapple with their respective challenges. Regulators have to ensure that adequate resources are available and that they have the skills to fulfill their supervisory obligations, while insurers and captive owners continue to analyse the commercial impact the regime may have. I imagine both regulators and insurers will be relieved when Solvency II is implemented. It has been a long process, especially considering the time and cost incurred to both parties.
Not withstanding its challenges and perhaps having fewer resources available than other supervision departments, I believe the MFSA is well positioned given its early investment in quality staff and upfront engagement, approachability and collective openness with industry representative bodies and service providers.
PCCs are not currently addressed in Solvency II. This does raise some interesting questions, challenges and potential benefits with respect to their treatment. A particular challenge may be the calculation of required solvency margins (catastrophe risk charges and the like) and the solvency margin admissibility and classification of the numerous forms of security (letters of credit, parental guarantee, unpaid capital, etc) that is utilised in PCC structures. I have no doubt that the MFSA will do the right thing to ensure that the structure remains commercially viable, competitive and well regulated, recognising the importance of continued dialogue with service providers and professionals who actively promote the structure.
Stafrace: From a PCC perspective, Solvency II is actually an opportunity that we are keen to embrace. The Maltese PCC provides benefits on all Solvency II pillars, causing substantial cost burden sharing and reduced own funds requirements.
As an EU member state and EIOPA member, Malta is contributing to the development of Solvency II. Under the quantitative capital requirements of Pillar I, the core puts up the minimum capital requirement (MCR). EIOPA, in its updated Solvency II Technical Specifications, prescribes that cells in PCCs should be considered and treated as ring-fenced funds. As such, a cell will typically only put up own funds equivalent to the calculation of its notional solvency capital requirement (SCR), which with a small undertaking often falls far below the €2.3 million/€3.5 million MCR absolute floor. A PCC may lend its surplus core capital to cells to meet their notional SCR where in deficit and the cell will therefore always be backed by the core capital.
A fully operational PCC will have all of the risk management, internal control, own risk solvency assessment (ORSA) process and other governance system requirements of Pillar II catered for under its regulated licence, with cost sharing significantly benefiting cells. The same applies to Pillar III’s reporting and disclosure requirements where all procedural structures and resources will be in place to meet the new extensive quarterly and annual reporting requirements as one single legal entity.
Small monoline insurers and captives struggling with Solvency II requirements could very well consider converting to cells as an alternative to consolidation or closure.
Protected cells are therefore a cost-effective, extremely flexible and secure alternative to owning a standalone insurer, reinsurer or captive. Such structures can result in significant cost and capital savings for cell owners, even more so in the EU once Solvency II is implemented.
How do captive managers make sure they stay premium-tax compliant, and is this getting harder with ever-increasing specialist lines being written?
King: The approach captive management firms adopt to ensure premium tax compliance differs between firms. Some consolidate the function with outsource service providers, whereas others internally manage numerous providers across multiple countries.
In my view, it makes commercial sense to standardise and automate the process, achieving economies of scale and ensuring full compliance rather than exposing a captive management firm’s balance sheet to potential error, omission and reputational risk for non-compliance. As many firms are not contractually appointed by captive owners to provide tax services, this can often lead to awkward discussions between manager and client as the captive, the legal insurance entity, is issued the penalty. In addition, an increasing risk for firms is keeping abreast of subtle tax code changes, particularly in emerging economies, which are often not widely published.
With respect to specialist lines, I don’t believe it poses a substantial challenge as many risks can be classified in globally accepted classifications of insurance, such as: property, casualty, life and health, etc. These are broadly the same classifications that the vast majority of tax authorities adopt.
However, when you consider the growing trend of cross-class global insurance products, tax and regulatory compliance, it becomes more challenging for international captive owners. On the one hand, cross-class cover simplifies a captive insurance programme, whereas on the other hand, it increases the risk of non-compliance. This is not so much on day one, but it is rather more obvious when settling and funding a large claim as this can often trigger an investigation by local authorities on premium allocation (premium tax collection) and admissibility of insurance policies.
Considering the increased communication and information exchange agreements between global regulators (the MFSA has a good network) and tax authorities, it now makes it easier for authorities to pursue non-compliant captives. Captive owners would be wise to ensure global programmes are compliant (both from a regulatory and insurance tax perspective) when first underwritten as challenges can often lead to delays in cash-flow funding of foreign subsidiary claims, an increase in advisory fees, and detract risk management resources from other duties.
This year is nearing its close—how has 2013 been for you and what do you see on the horizon for 2014?
King: In my experience, there is a growing trend among the senior management of multinationals to challenge insurance arrangements, ensuring that they are optimised, adequate, provide value for money and are aligned to the board’s risk appetite and the corporate’s financial tolerance. Business environments have changed significantly, whereas insurance programmes often remain static or ‘renew as expiring’. This includes many captive programmes and strategies—I envisage (and recommend) that captive owners will perform more regular captive strategic reviews to align/compliment overall risk management efforts.
I say this as I believe that the risk management function will continue to gain a higher profile within corporates (an upward trend in chief risk officer role creation) as risk management efforts are being realised in bottom line results. This is attributable, in my view, to the increasing availability, importance and use of data analytics and understanding one’s own risk profile. Not only does this improve board-level decision making, but it also provides accurate quantification of risk, which in the past was often challenging to do—a captive being a perfect vehicle for data warehousing.
Historically, a captive’s role was judged more on its profitability, however, when you actually consider this, it is not an entirely correct judgement to make because a captive’s actual profit is as a result of transferring cost from another subsidiary business unit. I think that in the future a captive’s role will be judged more strategically, as a conduit for improving (and funding) risk management data and efforts. Increasingly, captive owners are assessing less traditional risks, such as cyber and reputation, where many are ‘incubating’ the risk to build up a risk profile for an eventual underwriting submission.
Looking to Europe, I suspect many captive owners will focus on preparing and understanding their Solvency II ORSAs—captive management firms are (or should be) well positioned and adequately resourced to provide client advisory services in this respect, using the opportunity to increase firm revenues.
Looking to US captive owners, I envisage a growing trend and desire for catastrophe risk transfer mechanisms/products, particularly those corporates in natural disaster-prone areas. Captive owners may indeed consider establishing a new captive (or using a dormant captive) to act as a conduit for this risk type. The recent introduction of SPRV legislation, coupled with the ability for captives to redomicile, puts Malta in a positive position to benefit.
Stafrace: The positive flow of enquiries and conversion rate has remained consistent for us at Atlas. Admittedly, with increased regulation, the work and time taken to implement vehicles has increased, especially for standalone companies. Significant timing advantages remain with protected cells.
We are also pleased to see an increased number of enquiries and licensed cells coming through leading insurance management companies. Our independence, together with our active core, provide the possibility of offering a manager’s clients an EU onshore protected cell facility that is also able to write third party risks. The management companies retain management of cells hosted by our PCC.
With increased certainty around the imminent implementation of Solvency II, we expect to see an increase in enquiries and applications in 2014 from various entities seeking cost and capital savings, and new prospects preferring the more efficient cellular route to write insurance.
