2 December 2019Accounting & tax analysis

Cayman’s disruptive innovators

The way the world does business is evolving rapidly, and the Cayman Islands is leading the charge of disruptive innovation. Its captive insurance and reinsurance markets, in particular, are hives of activity, in the vanguard of this charge.

“Some of these captives are also exploring the opportunity of investing a portion of their unencumbered surplus assets in a portfolio of digital assets.”

Innovations that can be seen in Cayman include the development of digital assets, stop loss programmes, revenue-enabling products and captives writing life and annuity business and reinsurance business.

Digital assets

Within the last two years, there has been a proliferation of activity in the digital asset, cryptocurrency and blockchain space within the Cayman Islands. Cayman Enterprise City Special Economic Zone has seen compounded growth where blockchain and digital asset companies are congregating to help develop their intellectual property on these next generation solutions.

From a more traditional perspective, we are seeing a marked increase in activity from these new assets and technologies in sectors such as hedge funds and insurance. The melding across industries, where investment firms and hedge funds look to reinsurance structures to lock in long-term capital to implement their investment strategy, is not new.

Some reinsurers are seeking to incorporate a component of digital asset investment into their overall investment strategies. Such investment does not correlate with most traditional investment classes and while recent volatility has been high, returns may be favourable on a mid-to-longer term basis.

Meanwhile, digital asset exchanges and custodians are evolving from a niche industry into the mainstream sector as they target institutional money to participate in their industry. However, unlike fiat currency deposits, Federal Deposit Insurance Corporation (FDIC)-type protections are unavailable for these classes of assets. These digital asset custodian entities opt to purchase commercial insurance protections to provide more traditional sophistication and commerciality to their business, allowing them to attract more institutional investors.

By using a captive for indemnification of the custodial entity at certain/various limits within the required insurance programme, they can participate in the risk and obtain more favourable terms with the commercial re/insurers.

Some of these captives are also exploring the opportunity of investing a portion of their unencumbered surplus assets in a portfolio of digital assets. This could be a means to seek alternative uncorrelated investment exposure and returns. Alternatively, it could be a risk management mechanism to effectively hedge against currency risk that could occur between fiat denominated insurance limits and a digital asset based exposure (the client’s custodied cryptocurrencies).

Stop loss

It has become commonplace for Cayman Islands captive insurance companies to provide (employer) medical stop loss indemnity protections to their parents in respect of self-insured health plan exposures. In a commercial marketplace where pricing is increasing, captive placements enable clients to leverage existing capital surplus to reduce and manage their cost of risk while writing a relatively predictable exposure in a controlled manner.

Limits, attachment points and the use of outwards excess of loss commercial reinsurance protection can vary on the scale of existing surplus and the client’s risk appetite.

Less frequently, Cayman Islands captive insurance infrastructure is being used to support parent regional health plans as a full reinsurer or co-reinsurer of affiliated sponsored licensed insurers. Having ‘skin in the game’ is generally viewed favourably by commercial market reinsurance partners. This risk exposure can also provide captives with a risk balance to non-correlating first party medical malpractice and associated coverages.

“We are seeing a trend where B(iii) licensees are starting to convert themselves into reinsurance companies in the Cayman Islands.”

Meanwhile, US-based health systems and providers are increasingly being reimbursed by Medicare/commercial payors based on the value of care they deliver, as opposed to the number of visits and procedures performed (fee-for-service). Health systems are increasingly looking for means to mitigate the financial risk created by these at-risk contracts, and an existing captive infrastructure may offer a solution in this regard.

Leveraging surplus capital, the captive can issue cost-overrun type indemnity protections to parent to transfer the downside contract risk (created by high frequency utilisation and/or catastrophic claims) from parent to captive on either a specific or a general/aggregated basis. A captive insurance programme can also act as a conduit for the parent to transfer some, or all of this risk to facultative reinsurance markets.

Revenue-enabling products

Captive insurance entities have typically been used within an organisation’s risk management programme as an integral risk-financing tool, as well as providing access to the reinsurance markets and the leverage thereof.

Evolutions in captive utilisation, specifically in the for-profit sector, have seen entities that originally established captives to provide traditional first party parental protections, move to use this same captive infrastructure to launch innovative revenue-enabling third party insurance programmes. Such programmes can directly indemnify the parent for responsibilities they assume via customer or supplier contract, or sit behind facilitating fronting companies as reinsurer of the original exposure where admitted paper is required for statutory and/or entity separation purposes.

Regardless of structure these programmes typically provide attractive returns even when accounting for the cost of fronting arrangements and associated fees involved.

Programmes are generally tied to the captive parent’s business sector and depend on the ability of the parent to provide contractual and/or insurance solutions to its client base.

Examples of such programmes include extended warranty, self-storage, shippers’ interest, and student renters’ insurance.

With a proportional regulatory framework and using a common risk management programme approach, this programme business/revenue-enabler may be conducted within an existing B(i) licence class. On the other hand a B(iii) might be more appropriate, dependent of course on the underlying risks and exposures to third parties, and of course always subject to Cayman Islands Monetary Authority (CIMA) approval.

This still makes it very easy and efficient for existing captives that can identify new revenue-enabling programmes to implement them efficiently and quickly.

Life, annuity and captive reinsurers

The Cayman Islands captive insurance industry is renowned for its single parent healthcare captives and other property and casualty captives. Such captives typically hold a class B(i) insurance licence with CIMA, defined as “carrying on of insurance business, other than domestic business, in respect of which at least 95 percent of the net premiums written will originate from the insurer’s related business”. In other words, they write predominantly related party business.

Over the last few years, however, we have seen an exponential increase in the issuance of B(iii) licences in the Cayman Islands for writing unrelated party business. To qualify for a B(iii) insurance licence, a captive must be “carrying on insurance business, other than domestic business, in respect of which 50 percent or less of the net premiums written will originate from the insurer’s related business”.

The types of business we are seeing written by B(iii) licence holders varies, but we are seeing more of these licence holders now assuming or writing life and annuity type insurance business. The Cayman Islands has become an attractive domicile of choice for these types of re/insurance vehicles, due to the close proximity and similarity in working practices with the US.

On August 4, 2018, CIMA signed a memorandum of understanding with the National Association of Insurance Commissioners (NAIC) to help insurance supervisors in the US and Cayman coordinate on regulatory issues, to create efficient, fair, safe and stable insurance markets.

The Cayman Islands has a strong, locally regulated environment, headed by CIMA, which has its own solvency and capital requirements, but is not based on European Solvency II or equivalent requirements. Subject to CIMA approval, reinsurers can adopt their own capital model, for example in line with NAIC requirements. This makes the jurisdiction more attractive to investors who want to place life and annuity books of business in the Cayman Islands and not to be constrained by stringent Solvency II or other type of measures.

According to CIMA, as of September 30, 2019, there were 628 class B licences issued, with 145 of these being B(iii) licences. There were 49 new B(iii) licences issued for the period January 1, 2017 to September 30, 2019, whereas there were 50 new B(i) licences issued for the same period. The comparable growth seen between B(i) and B(iii) insurance captives for the last 33 months is a clear indication the Cayman Islands, as a domicile, is attracting new markets and creating disruptive innovation.

Furthermore, we are seeing a trend where B(iii) licensees are starting to convert themselves into reinsurance companies in the Cayman Islands, which is contributing to the growth in the reinsurance industry space.

The Cayman Islands captive insurance and reinsurance market is evolving for the better, finding new and innovative ways of providing value for all stakeholders. The times ahead are exciting for the domicile, with all stakeholders working collaboratively to position the Cayman Islands as a favourable jurisdiction for captive insurance business.

Howard Byrne is director of captive services at Aon Insurance Managers in Cayman. He can be contacted at:  howard.byrne@aon.com

Ghislain Ghyoot is vice president of Aon Insurance Managers in Cayman. He can be contacted at:  ghislain.ghyoot@aon.com

Ricardo Agrella is director at PwC Cayman Islands. He can be contacted at:  ricardo.a.agrella@pwc.com