A lesson in captives

Recognised as one of the world’s fastest-growing emerging markets, Latin America is starting to gain more traction, particularly in its captive insurance industry.

Although not every country within the Latin America region is excelling, Colombia and Mexico are leading the way.

Eduardo Fox, Latin America consultant, private client and trusts and corporate at Appleby, explains that traditionally both countries have been at the frontline of the industry, due to their advanced knowledge of offshore and captive markets and have tax information exchange agreements (TIEA)’s in-effect with Bermuda and other global jurisdictions.

Although Colombia has the advantage at the moment, due to the consistency and unity of their markets, according to Fox, Brazil could have been the leader not only because it has the largest economy in Latin America but because they have the largest insurance market in the region.

According to the MAPFRE Economic Research in 2018, Brazil’s premium volume was worth $57.57 billion, versus the second largest, Mexico, at $27.25 billion. In comparison, Argentina, Chile and Colombia come in at $13.93, $13.85 and $9.22 billion respectively.

Fox explains that Brazil’s reinsurance monopoly stopped its international growth, however, with the help of business partners, there is a huge effort to revive the captives’ interest and company formation.

He says: “We are also in renewed talks to finalise negotiations and put the signed TIEA into effect, in order to fully affect transactional work.”

Argentina and Chile, both with TIEAs in-effect with Bermuda and possibly other offshore jurisdictions and neo-progressive industries’ regulators, are next on the list and already making serious plans and enquiries, on which we are advising at the moment, according to Fox.

COVID-19

The captive market has been around for decades and went through different insurance cycles and pandemic risk events. Adriana Scherzinger, head of international business and captive services at Zurich, suggests that the growing interest in (re)insurance and risk transfer solutions means captives will remain, as they are, “a valuable mainstay for addressing the need in self-insurance”.

Even before the breakout of the global COVID-19 pandemic, following a prolonged soft market cycle, insurance premiums had been rising.

In this environment, Latin American customers and brokers are facing increasing challenges.

Scherzinger says: “Increasingly, customers need to manage their incubating risks, increased deductibles, greater risk retention and increased reinsurance premiums as best as they can. These factors lead to increased use of captives, with new formations and expansion in several cover-age lines.”

Even though few of the more recently created captives specifically cover pandemic-related losses, Latin American companies are making use of their captives which are designed to support them through the COVID-19 pandemic.

“The result is that the captive owners are better able to respond to their risks, which leads to better protection of their employees and assets,” she adds.

Agreeing with Scherzinger, Fox predicts that there will be a promised rise to continue next year for a number of reasons.

Fox explains that the adaptation of Latin America’s private sector to the “new normal” has created an unprecedented level of innovation in planning and strategy that will deliver positive results. He suggests that there is now more knowledge sharing and exchange of ideas between industry members.

“A good example of such cooperation can be seen within the Energy industry of Colombia, where the giant, mixed stock-holding corporation, Ecopetrol, was pivotal in the development and creation of, not only one of the first captives from that country, its own Black Gold Re but several other captives,” he says.

Such influence continues to date and has given rise to a renewed view of captive formation planning, efficient offshore investment and formation of risk coverage vehicles.

Fox highlights that there has been a new wave of interest from Brazil, which has re-opened its market to the international reinsurance market, following the abolition of the 70-year-old reinsurance monopoly of the Instituto de Resseguros do Brasil (IRB), and has resulted in private/public sector joint ventures and their linking with global service providers, in order to form captives or other reinsurance vehicles outside of the ex-monopoly’s influence.

Education is key

Latin America’s captive industry has always struggled with a lack of education in the sector, which has been a contributing factor to its minimal growth over the years.

Alejandro Santos, Marsh advisory, analytics and captive solutions, Latin America and Caribbean (LAC), states that education related to captive concepts and risk management is one of the most important factors to help promote captives in the region.

Large multinational companies know captives quite well, with several of them operating their insurance programmes using captives as a means to reduce cost, increase flexibility on coverages, and provide alternatives for lack of capacity. However, Santos highlights that many local companies and smaller multinationals do not have a complete picture of how captives can create value for them.

Scherzinger also emphasises that education for growth in Latin America’s captive industry presents a major opportunity.

There has been a lot of progress in the region over the last few years; knowledge of captives has deepened, and they have become more acceptable as a result.

With the rapid growth in captive utilisation, she comments: “A number of factors are behind this, such as the evolving role of risk management, changes in the needs of insurance and risk managers, increased education and promotion of the captive sector in the region among insurance carriers, brokers, captive managers and regulators.”

Fox also weighs in suggesting that education is “crucial and useful” to both the public and private sectors in the region.

He explains: “During our business development visits, face-to-face meetings/presentations with potential private sector clientele, their risk managers and brokers/advisers, combined with discussions with the public sector, require clear and concise guidance on the usefulness and advantages of establishing a captive.”

“For example, Bermuda negotiated and obtained the first offshore jurisdiction’s TIEA with Mexico, which was also the first with a Latin American nation, through a robust learning process between the two governments’ International Treaty teams. This TIEA was signed in October 2009 and came into effect in January 2011, and became the Organisation for Economic Co-operation and Development (OECD)compliant international standard for the rest of Latin America.”

Fox suggests that if the education process in Latin America was not patiently conducted, “Bermuda would not have obtained the reputation it earned from the governments of the region or the establishment of an estimated two thirds of Latin America’s world-wide captives”.

Regulation

Aside from the previous challenges around education in Latin America, regulation has also been a key factor stubbing the growth of the region’s captive industry.

Discussing if new regulations are being implemented to help the growth of captive insurance in Latin America countries, Scherzinger states that Latin American governments are taking a ‘substance-over-form’ approach with general anti-avoidance rules (GAARs).

The aim is to establish a clear direction to taxpayers so that they can define substance in the view of tax authorities.

This is currently being codified for the first time in Colombia, Peru and Brazil. Mexico has recently introduced GAARs to ensure that new captives are formed for business rather than tax reasons.

Scherzinger states that in this instance, business reasons are defined as objectives such as risk retention, actual risk transfer and asset protection. With any loan structure established through a captive, Mexican captive owners must record in writing the business reasons behind such lending.

She says: “Many Latin American governments are moving towards the promotion of transparency and exchange of information, particularly Colombia and Mexico. Again, Mexico also recently introduced transparency measures and reporting obligations to disclose information about ‘reportable schemes’, similar to the OECD guidelines for mandatory disclosures.”

This will be effective from 1 January 2021 and the measures will define tax benefit as reduction, avoidance or deferral, with tax advisors as the primary responsible party. She highlights that one evolving focus of Latin American governments is on anti-deferral rules, to prevent the accumulation of wealth without appropriate reinsurance coverage. Unlike Chile and Peru, Brazil does not yet have these rules in place.

“Overall, the efforts of Latin American governments have the common objective of increasing the amount of tax they collect,” Scherzinger adds.

Additionally, Juan Pablo Cuartas, Carpenter Marsh Fac, captives vice president, Latin America, states that they are not seeing specific captive-related regulation in the Latin America region.

However, he notes: “Some countries are relaxing their insurance and reinsurance regulations through law and tax reforms and that might eventually result in changes favouring the creation of captives.”

In addition, Santos suggests that as each country in Latin America is facing its own political challenges, in many cases, law reforms and regulator decisions may come with consequences in terms of market capacity restrictions, so captives could be a way to add capacity for some specific lines, such as director and officer (D&O).

What next?

Although it may be hard to paint a picture of the future given the ongoing uncertainty around the pandemic, the outlook of the captive insurance market in Latin America remains positive with Scherzinger expecting to see increased captive utilisation across Latin America over the next 12 months.

A hard market could prompt risk managers to decide to finance more risk within captives because of traditional market underwriting restrictions or pricing.

Scherzinger highlights: “I am seeing more interest from customers looking to better manage their multinational exposures. They are looking for stability and certainty in these unprecedented and uncertain times.”

Although Santos believes that there are many hurdles to tackle within the region, he predicts that in the near future, there will be many opportunities for new formations as well as more active utilisation of existing captives. Santos notes that the key to a successful project is to focus on the strategic use of the captive for risk management.

He explains: “This includes a risk retention review to determine whether a captive is feasible to assist in increasing flexibility in the underwriting process; accessing reinsurance market capacity or facilities; and reducing the cost volatility of insurance for the organisation.”

Once we see scientific advance in controlling or minimising the effects of the pandemic and that there is more economic certainty in the world, Fox believes that all parties involved should emerge stronger and better equipped to recover Latin America’s captive market.

Assuming a return to a ‘new normal’, after COVID19, Fox concludes: “We could cautiously aim for progress and growth in captive formations from the region, beginning in Q2 2021 and exponentially growing after that.”