Latin American captives: great opportunities and challenges

Topics discussed included impact of the hard market; challenges for LatAm companies setting up captives; regulatory issues and opportunities; the latest trends in how LatAm owners are utilising their captives; long-term benefits of captives; domicile considerations; and self-insurance opportunities for small and medium-sized enterprises (SMEs) and high-net-worth individuals.

In attendance:

Geronimo Cello: assistant manager in the insurance audit practice at KPMG Bermuda. He focuses on providing audit services to Latin American captive re/insurers in the manufacturing, finance and healthcare sectors.

Luis Delgado: vice president and director at SRS. He is based in Bermuda and is responsible for developing and managing business for Latin American-owned captives across the firm.

Eduardo Fox: consultant–corporate and private client and trusts at Appleby in Bermuda. He has worked at Appleby for 30 years and is a member of the firm’s global Latin American and Latin European team.

Chiara Nannini: director in the corporate department at Conyers in Bermuda. She advises on insurance regulatory and transactional matters including new insurance incorporations and segregated account structures.

Jose Pena: senior vice president at Marsh Management Services (Bermuda). He is team leader for the LatAm market and commercial sector and has more than 17 years of experience in the re/insurance industry.

Bron Turner (moderator): director in the audit practice at KPMG in Bermuda. He is responsible for a significant captive portfolio, covering multiple jurisdictions including the US, Canada and Latin America.

Bron Turner: The flow of inquiries to Bermuda from Chile, Peru, Columbia, and Mexico has increased significantly over the past 18 months. How has the hard commercial insurance market impacted Latin American industries?

Jose Pena: We have seen increases in double digits across the main industries, in particular the energy sector and in professional lines such as D&O. It’s not only increases in pricing, but also less capacity, or no capacity at all.

Markets are exiting certain industries or countries, because they have no risk appetite for them. Terms and conditions have been less favourable for the clients. This combination of factors has been made even more challenging by COVID-19.

“We saw multiple startup successes in the energy industries.” Geronimo Cello, KPMG Bermuda

Eduardo Fox: Many LatAm companies have repositioned their captives to better utilise them. Those who do not have captives are exploring forming one, or entering the rent-a-captive market. From our experience at Appleby, a lot of the renewed interest has come from Mexico.

Turner: A hard or hardening market is clearly a trigger for exploring captive insurance solutions. But specific to Latin American countries, what are some of the barriers for setting up a captive, whether onshore or offshore?

Luis Delgado: Finding fronting options has been difficult—nearly impossible in some countries. The other barrier is capital needs. The hard market is forcing companies to find alternatives to manage risk and to access international capacities. But finding the capital to enable a captive to start retaining risk, at a time of economic strains caused by COVID-19, is a challenge.

Fox: Fronting has been a constant problem, but it cannot be helped—it was imposed by the LatAm governments in order to achieve tax exchange information agreements (TIEAs). It has limited the creation of captives in Latin America, but that has not been the only major obstacle.

Delgado: Five years ago, it was easier to find fronting options. Those still prepared to do it have increased the requirements, for instance requiring parental guarantee, which some companies are not able to provide.

“Finding the capital to enable a captive to start retaining risk, at a time of economic strains caused by COVID-19, is a challenge.” Luis Delgado, SRS

Pena: There are markets that are willing to participate in a fronting arrangement, but the logistics are complex and it could be expensive. The direct placement of risk in Latin America is almost nil. In most countries in the region, you need to find double fronting: an insurance company to do the local placement and a reinsurance company to export that premium.

That adds an additional layer of complexity, as not every carrier has the capability to be an insurer and reinsurer in each country.

Turner: In the current market, with hardening rates and lack of capacity, captives make sense, but it seems like a challenge. For some new entrants to the market, why should they consider a captive as a solution?

Fox: You can use the example of those clients who have been successful with captives. That is what we should be promoting. We have to explain that the advantages outweigh the disadvantages. We need to continue the instruction, training and education, and promoting successful case studies among our own potential clientele.

Pena: Yes, you need to look at the captive process as a whole to see the benefits. At a time when we’re seeing double-digit rate increases, or markets exiting a line of business or a particular country, if the insured can’t find a traditional cost-effective solution the insured will basically retain that risk in its own P&L. The captive will help a company to formalise that risk retention process in a regulated and structured way.

Delgado: For companies who established a captive five or 10 years ago and who have accumulated some profits, now that we have a hard market and less capacity, then those captives are able to help their parent companies. It may not be the best time to set up a captive because capital strains are high, but clients who did it in the past are seeing the benefits now.

Turner: I’ve seen increased retentions and the inclusion of new lines of business such as cyber. What emerging risks and strategies are you seeing?

Geronimo Cello: We saw multiple startup successes in the energy industries. Those clients are adding more emerging risks to their portfolios. In some cases, because of the hardening market and increasing premiums, they are adding more risk into the captive than they did in the past.

Pena: On the strategy side, established captives have been able to assist their parent companies by retaining risk or increasing retention limits. For example, they’re assisting the parent in reducing the cost of its current commercial programme, because the attachment points are higher.

The pragmatic view of a captive cannot be for a 12-month period, it should be for the long term.

The captive is a powerful tool when it’s used properly. For example, we have one LatAm client who has had a captive for 40 years and it’s been a very successful model. It’s never a bad time to assess the feasibility of a captive, because of the potential benefits in the future. You can also benefit right away, but not always. It needs to be assessed as part of your risk-management and risk financing strategy.

“The concern is that countries in the region may follow the example of Mexico’s tax reform.” Eduardo Fox, Appleby in Bermuda

Delgado: From day one, it’s essential to have a feasibility study done properly, when you consider all these variables. Otherwise, down the line you see issues like fronting challenges, capital needs, higher costs and increasing premiums.

These clients end up setting up a captive that may not be the right tool for them and we end up helping them with liquidation. It’s important to establish from day one whether this makes sense for you or not.

Fox: One option could be a long-term hybrid programme that starts with a rent-a-captive and eventually moves to a full-fledged captive. This could be part of the feasibility study. A client may not be ready for a standalone captive yet, but they could benefit from a three-year learning experience.

Turner: Periodic health checks have been very insightful to so many of our clients—are you seeing more of these reviews in the hard market, or are clients not reaping the benefits which they provide?

Pena: Clients, in particular the board, are asking more questions about their role and responsibility towards the captive domicile regulatory framework, now that corporate governance is more embedded in the operation of a captive.

Every year the board of directors asks ‘What’s the three-year outlook? What are the new risks and opportunities?’ That analysis of where a captive is going is being discussed more often at board level.

Turner: How has economic substance impacted the operations of a captive? Is this increasing costs and has that forced the kind of robust discussions that Jose was referring to?

Chiara Nannini: Economic substance has not impacted captives too much since it became effective on January 1, 2019. Before that, most captives in Bermuda had some sort of substance, by having Bermuda-resident board directors, by having a Bermuda insurance manager and by holding board meetings in Bermuda.

In the Economic Substance guidance notes issued by the Registrar of Companies, as it relates to the criteria for economic substance requirements, the definition of the word “adequate” includes reference to nature, skill and complexity.

That ties in nicely with the way the Bermuda Monetary Authority regulates licensed captives based on the “proportionality principle”. Costs generally are probably going to go up. In addition to economic substance, we now have the cyber risk management code of conduct.

“There are changes and captives need to make sure they’re meeting all requirements.” Chiara Nannini, Conyers in Bermuda

All licensed entities will have to be compliant by the end of this year. This will require captives to name a specific officer to fulfil certain reporting functions and each company will need to ensure that it is compliant. There are changes and captives need to make sure they’re meeting all requirements.

Fox: The concern is that countries in the region may follow the example of Mexico’s tax reform. Governments of those countries could penalise captives and other asset-protection vehicles if they cannot prove a certain level of assets and personnel.

The key words here are “certain level” and we have a definition of what that is, so it can be applied on a per-case basis. Bermuda has enough economic substance to provide those resources, such as independent directors or officers, who could be employed directly by those companies, to provide extra substance. Cayman and Singapore have similar substance legislation to Bermuda.

Turner: How important is the reputation of a captive domicile, particularly to the larger, multiLatina entities?

Pena: All jurisdictions need to be upfront in compliance with any requirements from the EU, US, Organisation for Economic Co-operation and Development, etc. Captive owners are looking for transparency and best practices from a domicile.

“Not every carrier has the capability to be an insurer and reinsurer in each country.” Jose Pena, Marsh Management Services Bermuda

MultiLatina companies, in particular, are very risk-averse with anything connected to reputation. They look for a domicile with a robust regime, transparency, and compliant with anything related to international standards on insurance regulations, accounting and audit, legal framework, international exchange of information, etc.

Characteristics of different domiciles are a key aspect of feasibility studies.

Nannini: Reputation is extremely important and that’s one of Bermuda’s main strengths. EU white-listed, Financial Action Task Force-compliant, common law jurisdiction, right of appeal to the Privy Council—those things help Bermuda stand out.

Delgado: Governments are always going to look at offshore domiciles in more detail. A captive insurance domicile must tick all the boxes in terms of regulation and corporate governance. When a company sets up a captive in an offshore domicile, they know there is a risk it will be attacked by their local government.

Fox: Bermuda has implemented TIEAs with Mexico, Argentina and Colombia. It has also signed one with Brazil that’s awaiting debate in the Senate, as well as Chile and Spain. The fact that Bermuda has treaties with these countries provides a level of confidence to companies.

Turner: Are there upcoming regulatory matters that may hinder formation of captives, or equally, open the market?

Delgado: Brazil came up with a regulation to establish itself as an insurance-linked securities (ILS) domicile. That was quite new as Brazil has a reputation of being extremely difficult, in terms of regulation, to take premium out of the country. This could mean that at some point they will bring in something related to captives to allow more freedom in exporting premium.

Turner: We’ve seen more interest from high-net-worth individuals and family offices, as well as SMEs. Are there opportunities for captives in this space?

Fox: The enquiries we’ve received include asset protection—a captive could be one of those vehicles. Also trusts, which take care of the family, as well as the commercial entities, including captives. We’ve had this kind of programme with Peruvian clients for decades. That’s something that can be applied to other countries in Latin America.

Delgado: SMEs that set up a captive tend to be those who have established risk-management departments, rather than simply buying insurance because they need it. Other SMEs may tick all the boxes, but they don’t have enough knowledge and education in this area to go ahead and form a captive.

Turner: Some would say that the Colombia market is saturated—do you agree? And which region do you think will embrace the captive concept next?

Delgado: In Colombia, there’s still space to grow. But the economic situation makes it more difficult. The C-suite is busy dealing with other things, such as protests and tax reform, rather than exploring captives. Mexico is the other country that’s strong on captives, although the tax reform will hold it back a bit. Argentina and Chile have a lot of potential and Brazil, if they open up their regulation.

Pena: One of the reasons Colombia has embraced captives is that they have some of the most advanced re/insurance legislation in the region and also advanced risk-management knowledge. Greater knowhow on risk in general in a country means captives are more likely to find a place in risk-management philosophy.

“There is a strong argument for group captives, especially in the region’s large agricultural sector.” Bron Turner, KPMG in Bermuda

Delgado: You’re right—I’ve had calls from brokers in Argentina, Chile and Peru who don’t know what a captive is.

Tuner: What other trends are you seeing in the region?

Pena: We have seen energy companies joining the energy mutual OIL, again because of the hard market conditions. Also, we are seeing a lot of interest from insurance groups in the region in establishing retro vehicles to facilitate the placement of intragroup programmes and obtain reinsurance protection more efficiently.

MultiLatina groups can use an insurer in domiciles such as Bermuda or Cayman to help with their reinsurance solutions.

Fox: There are opportunities for group captives, for example the coffee growers of Colombia, who individually could not contemplate forming a captive, but if all the growers pulled together, they could form an association captive.

Even if individual companies are large enough to form their own captives, if they put their resources together to form a large group captive, they are further diluting the risk.

Pena: A group captive is owned by more than one shareholder and one of the features is that you spread the risk among the members. It’s a similar concept to a mutual. We explored this model with avocado farmers in Mexico, because they didn’t have proper coverage. You spread the risk among members and you have the opportunity to scale up type of coverage and limits. You share profit and losses.

It’s certainly something that could be explored further in Latin America, because agriculture is such a significant part of its economy.

Turner: Thanks to everyone today for your contributions to a wide-ranging discussion, full of great insights. Reflecting on the key takeaways, it’s clear that the hardening commercial insurance market in Latin America creates a compelling case for captives. However, there are challenges specific to the region, including limited and expensive fronting options, and capital constraints stemming from the heavy economic impact of COVID-19 in Latin America.

We touched on how established captives are proving their worth in this environment, with their accumulated capital giving their parent companies options to retain more risk. For those not ready or able to form a standalone captive, rent-a-captive or segregated cell structure options are proving attractive, and there is a strong argument for group captives, especially in the region’s large agricultural sector.

While Colombia and Mexico are the LatAm captive insurance leaders, there remains huge growth potential elsewhere, notably in Brazil, where the new ILS framework suggests a growing willingness to accommodate the export of premium, which we hope will herald more captive-friendly rules at some point in the future.

On the governance side, we have seen economic substance rules having a limited impact on operating costs, because most captives had a high degree of economic substance before the new regulations took effect in offshore domiciles. Reputation is a key consideration for captive owners, particularly the large multiLatina entities, which seek domiciles that are transparent and compliant with international standards.

In summary, there are challenges to overcome in the LatAm market, but there is great opportunity for growth.