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Dubai braces for boom in captive insurance

Dubai braces for boom in captive insurance

Captive insurance may be gaining popularity elsewhere, but for Middle Eastern companies the concept hasn’t quite caught on.

August 17, 2008 10:01 by

Ehtesham Shahid

Khalid A. Mohomed is fascinated by insurance. His days of training in the UK and the United States, and working as a risk management practitioner in the US in the 1980s make him something of a local authority on the subject. But even Mohomed, who now works as a director at Dubai-based Dana Insurance Brokers, is surprised that something as useful as captive insurance has failed to capture the imagination of businesses in the Middle East.

This, in spite of the region’s asset boom – which is creating large physical assets that command huge insurance premiums. It provides a great environment for the growth of captive insurance, which consists of limited-purpose insurance companies established solely to finance risks for their parent corporations. They ensure some or all of the corporate risks remain within a group, and save profits that would normally be paid to a commercial insurer. A captive firm can effectively build up a fund to deal with flush years, and it’s usually more tax-efficient to do this through a captive than directly on the firm’s balance sheet. Captives also mean a reduction in the company’s dependence on commercial insurance.

“Captives are a risk management tool and not really an insurance mechanism,” Mohomed says, “even though when captives are formed to look after hazardous risks, then [they are] a form of self-insurance.” From another perspective, a captive is a legal accounting gimmick to save taxes. As a risk management tool, it’s useful to transfer risk from the corporate body to an outside funding mechanism.

In the United States, where corporate taxes hover around 50 percent, Mohomed explains, “When you work on the balance sheet, you take your income and expenditure and then on the balance you work on the net profit before tax. But if you increase your outgo and reduce income, the profit goes down and you pay lesser taxes. To do just that, major corporations form their own captive insurance companies and register them mostly in a little island called Bermuda.”

This is where 29 percent of the world’s captives are based. Worldwide, the number of captives increased from 3,361 in 1997 to 5,119 in 2007, with Bermuda holding the most at 958 captive firms. With Dubai becoming a financial services hub, it should have by now become the first choice for the region’s captive insurers. But despite realizing their potential, captives haven’t been widely adopted.

A USEFUL TOOL. Abdulla al-Awar, the managing director of Dubai International Financial Center (DIFC) Authority, says captive insurance is an innovative risk management tool that has been used globally since the 1960s.

“Today, there are over 4,500 captives worldwide writing over $38 billion in premiums,” he says. “Some of the world’s leading firms such as BP, Microsoft, Proctor & Gamble, and British Airways have utilized captive insurance structures. Captives are especially popular in sectors such as energy, industry, property and construction, financial services, transportation, utilities, healthcare.” Currently 65 percent of Fortune 500 companies utilize a captive to meet at least one or more of their insurance needs.

According to Marsh’s Global Benchmarking captive insurance report for 2008, publicly identifiable companies own about 2,750 captives. “Whilst the total premiums paid to captives in respect of property and casualty insurance are difficult to accurately identify,” the report reads, “it is estimated that they are in the region of $55 to $60 billion reflecting approximately 20 percent of the estimated corporate spend on such insurance.” It also notes that a noticeable impact has yet to be felt from Middle Eastern financial centers such as Dubai.

DIFC says it has one registered captive manager (Heritage Insurance Management) and expects to have two captive entities established and running by the end of 2008. Mohomed of Dana Insurance, however, has a simple answer to this lack of progress. “Here, there is no need for a captive because they are not paying any taxes,” he says. “So the very basis for having a captive doesn’t exist. But it does exist for places such as Iran and India. And for that Dubai is best-placed.”

Al-Awar of DIFC admits that on a regional level, the captive industry is still at its earliest stage. He attributes that to a general lack of insurance awareness by regional firms. “The region has one locally based captive managed by an independent captive manager in Bahrain and a few captives based in global off shore domiciles,” he says. However, he’s certain that things will soon change.

“Now with the first registered captive manager in the DIFC, the regional market will start to have the needed expertise to develop and expand,” he says. “With a multitude of inquiries coming from all around the region, the DIFC is set to be the stage for the boom of the industry.”

Bodies such as DIFC have reasons to believe that the growth of captives is just around the corner. Considering the recent economic turbulence in the West and slow growth in Western Europe and North America, the world’s insurance and reinsurance companies are now looking beyond their traditional markets. Centers such as DIFC are best placed to attract such companies. With that in mind, DIFC’s regulatory body – the Dubai Financial Services Authority (DFSA) – has introduced specific legislation relating to captives. The result is, the DIFC now recognizes captive insurance companies while the UAE and many other jurisdictions do not.

Then there are ancillary services, which are in the process of being developed. DIFC has in recent months organized three seminars to raise awareness about the concept. At one such event – the 8th World Insurance Forum on March 13 in Dubai – George Oommen, the executive director at DIFC’s insurance and re-insurance unit, said: “In order for captive insurance companies to operate efficiently, we need to have service providers around the captive industry, such as auditors, law firms, actuaries, etcetera, which can all be readily found in Dubai.” Bahrain and Qatar have also put in place regulatory captive insurance frameworks that would suit corporations based in the region. No taxes are imposed on insurance premiums, or on the profits of captive insurers whose parent company’s premium payments are transferred to the captive, and whose captive’s profits are 100 percent retained or repatriated.

But despite new regulations, and despite devising ways to attract them, captive insurance remains largely a Western phenomenon. “In such a file, lawyers open a captive account and pay premium to the captive. Once you pay the premium, it shows as an expense. But they don’t recover the claim from the captive immediately and let it pile up. Such amounts are claimed only when there are other losses to offset,” says Mohomed of Dana Insurance. “This way they are able to control the taxes.”

Not surprisingly, a number of lawyers can be found loitering around Bermuda. When they get there, they set up accounts and name the captives; they get a computer-generated number and their new company registered on paper. According to Mohomed, some industries such as explosive manufacturers or people who are dealing with hazardous goods do not get insurers. “So they form captives of their own called association captives,” he says.

David Howden, the chief executive of Hyperion and chairman of the Howden Broking Group, admits that tax is part of the reasons for having captives. According to Howden captives are a very evolved forms of insurance, and are cut out for large corporations. “Captives work better when you have risks where you can predict what the loss ratio is going to be,” he says. “So rather than money-transfer between an insurer and a client, you put it into a captive. Liability insurance is not like that. It has sudden spikes and captives cannot take those spikes because those spikes knock you out.” London-based Howden Insurance Brokers is beginning its operations in the region by opening an office in Dubai.

Most industry observers agree that whenever captives find more takers in the region, mainstream insurance providers would feel the pinch because their revenues would be eaten away. “Around 15 to 20 percent of the revenues in America go to captives, and it would certainly show up on mainstream insurance providers,” says Mohomed.

But not everyone agrees with him. Magne Seljeflot, the chairman of the leading global risk management services provider, Aon, was recently quoted as saying that captive insurance firms in the energy sector are not a threat to local insurers. “Captive insurance firms have existed since [the] 1920s and their role is to complement and support the market and not to compete with it,” he told Doha-based Gulf Times.

According to Seljeflot the notion that captive insurance companies could handle risks in the energy sector alone is wrong. But regardless of whether captive insurance poses a threat to traditional insurance or not, financial centers such as Dubai may have to re-assess their strategy if they hope to become the Arabian Bermuda.

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