Captive Q&A with Philip Barnes, managing director, Aon Insurance Managers (Bermuda) Ltd.

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How has the Bermuda captive market changed through the years?

Mr. Barnes said that a cross-check of the captive companies in Bermuda revealed that "pretty much" all of the Fortune 1,000 companies had captive entities in Bermuda. But a new trend is that the Island has begun to attract more business from the "mid-market" companies. He said that Bermuda, as a captive domicile, was also seeing increasing interest from the Latin American and South American markets. And that interest could get a further boost, he said, with plans for The Associasion Latinoamericana de Administradores de Reisgos y Seguros (ALARYS) to have their sixth biennial conference here later this year, with expectations that it could draw 350 to 400 delegates to Bermuda.

What are you seeing in the Bermuda market of today?

Mr. Barnes said that estimates put Bermuda as having 96 captives taken off its register last year while 89 new ones came in leaving a net difference of minus seven. He pointed out that new incorporations data was only one number to be considered with his saying that during 2003 the Island had seen some companies step up their use of captives that were already set up.

Although it sounds like a significant number of companies decided to wind up their Bermuda captive operations, Mr. Barnes said: "Part of the reason the numbers look odd is that this is a mature domicile. One factor to consider, when looking at the numbers, is that most of the Fortune 1000 companies have captives in Bermuda, but this is sector where we typically see the most merger and acquisition activity."

That means, Mr. Barnes said, that if, say, two corporations merge, the three or four captives they hold between them might be consolidated into one.

"Another part of it has to do purely with the length of time in business. Captives formed in the early days (1960s, 1970s) may have been set up for different risk needs than the company has now. They may now decide that captives are not the way to go.

"That type of dynamic is not kicking in for Vermont and the Caymans as they are younger domiciles," he said.

In addition, Mr. Barnes said incorporation figures in various jurisdictions in recent years had been impacted by the type of businesses seeking to set up captives.

He said an example of that was health care companies, with insurers offering that type of cover having either reduced capacity levels or gone out of the business altogether. That left companies facing either retaining more risk themselves, or paying more for traditional cover from mainstream insurers or setting up a captive.

Mr. Barnes said a captive could be a tool used by companies as a buffer layer between where their appetite for risk retained was, and the attachment point that cover was available at from a traditional insurer.

Mr. Barnes said Aon subsidiary IRMG helped its clients do a review of risk which was wider than captives, and looked at using a mix of various layers including self-insurance, reinsurance of that and commercial insurance.

He added that some of the Island's newest reinsurers ? with a wave of firms setting up here after a void in capacity following the September 11 terrorist attacks ? had been active in providing reinsurance to captives.

One of those was Endurance, which was said to have, along with others, expressed interest in being a part of a company's Alternative Risk Transfer (ART) programme.

Although Mr. Barnes said the insurance industry was starting to "soften" with prices levelling off or coming down, that was not the only factor considered by businesses when looking at insuring part or all of their risks through a captive. He said that terms and conditions, as well as pricing, may lead one to choose to go the self-insurance route.

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Which captive domiciles are Bermuda's closest rivals?

"Vermont and the Caymans are the two major players we see," Mr. Barnes said with Vermont recording a whopping 64 new captives last year while the Caymans saw 44 new captives come to the island.

Although there has been much talk about Hawaii taking on captive business, Mr. Barnes said it was not a competitor of Bermuda as that jurisdiction would be going after West coast business, which probably would not consider Bermuda in the first place. But Vermont is an increasingly successful captive domicile. And he added that South Carolina and Arizona are now "coming into the equation".

Mr. Barnes said that companies exploring the feasibility of risk management through a captive, analysed jurisdictions to see where they might be best placed to do business. But he said Bermuda does not draw that much business from the US as a result of its different tax structure with the captives of US-based companies often electing to be taxed as if 'onshore'.

"It is an added benefit but tax deductibility is not a driving force in (the decision) on where to form a captive."

He said that Bermuda was also perceived as being the "more experienced" domicile, over Vermont.

Mr. Barnes also shot down speculation that Bermuda could be pricing itself out of the market. He said that there were some costs, notably staffing costs, that were higher on the Island than in some other jurisdictions but that, in general, the costs incurred by a captive were the same in Bermuda, Caymans or Vermont. "The choice of jurisdiction is definitely not being made as a result of costs. In general the costs in the three captives are not dissimilar."

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Which of the leading captive domiciles would you say has the most to offer?

Mr. Barnes said that he would say Bermuda, which has long held the leading spot as a captive domicile, still had the most to offer. Although saying he should declare his interests (having lived and worked in Bermuda since coming to the Island 20 years ago to work for one of the accounting firms), but that the Island was recognised as a mature market with much experience in this industry. Although there are a growing number of competing captive domiciles, he said the Island was holding its own. As a case in point he said there were captives celebrating 35 years of being in the Bermuda market, and their feedback was that the Island was still the place to be.

"They see Bermuda as still being valuable. These companies are committed to the captive concept and are committed to Bermuda."

He said the Island had much to offer including highly experienced captive managers, well-recognised legal and accounting services, and "a non-intrusive level of regulation".

As an example, he said that every captive that was formed in Vermont had to first meet with the insurance regulator. While that sometimes occurred in Bermuda, it was not a necessary prerequisite "to physically stand before the regulator" before setting up.

He said Bermuda's regulatory body, the Bermuda Monetary Authority, had a reputation as being thorough but not heavy handed.

"An independent panel of industry specialists reviews applications and gives (the BMA's insurance division) its recommendation. There will sometimes be problems in terms of timing of filings but in general we have a flexible system that works. Bermuda's regulatory environment does not put it at any disadvantage at all. It has stood the test of time and there are not many horror stories."

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Does Caymans have an advantage over Bermuda as a captive domicile for the health care industry?

Mr. Barnes said that Bermuda regulation in place years ago did not allow medical malpractice captives to set up and write business in Bermuda.

Seeing this as a business opportunity, the Caymans "got on the band wagon and have grown a niche market, and the service providers for that market. Bermuda realised it was losing out on a fair amount of business and amended the Insurance Act to allow the Island to incorporate these kind of captives.

Mr. Barnes said: "There is nothing that can be done in the Caymans that that you can't do in Bermuda."

He said it was more a problem of perception, with the Caymans now being thought of in corporate circles as the health care captive domicile. He said that was backed up by a well-attended health care captive conference held there each year. In addition, Aon saw its clients set up 83 captives in the Caymans last year ? of those 60 percent were for health care companies. But he said there was no reason why the Island could not capture more of this business, and that there were health care captives that had chosen Bermuda over the Caymans.

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What are some of the factors that might lead a company to pick one of Bermuda's rivals as a captive domicile over the Island?

Mr. Barnes said one factor that might work in favour of the US domiciles was the Terrorism Risk and Insurance Act (TRIA). The legislation was put in place after the September 11, 2001 terrorist attacks and offers a temporary reinsurance mechanism for US-based insurance companies in the event of another terrorist act on US soil.

Although the terms of the act, enacted in late 2002, are set to expire at the end of 2005, an insurance venture must be based in the US to qualify. But he said that the pull of TRIA coverage, if based in the US, was not as big as it had been originally thought.

In fact for some, TRIA's enactment may have been a reason to set up a company offshore. This is because those with little exposure to a possible terrorism risk may see little benefit from being included under TRIA, and it may cost more than its worth as a surcharge would be levied on all insurers.

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Political pitfalls

Mr. Barnes said the political climate in the US could lead some to rethink setting up a captive in an offshore jurisdiction.

"The political rhetoric that we have heard from (now dropped out presidential contender) Howard Dean and (Democratic presidential hopeful) Senator John Kerry against companies that are offshore is really unfair because it is the rules and regulations (of the US) that have driven companies away. And they are (by moving offshore) helping their shareholders and saving jobs for their employees."

He said that captives are not sending jobs overseas, which is one of the claims of the political rhetoric levied against companies that offshore entities. But he said: "At the end of the day, political rhetoric does absolutely come into play. It comes down to a decision made by the risk manager, but the board may influence that, and in some cases, customers and clients."

He pointed out that a media report claiming that a company had a Bermuda or Caymans-based entity could be negative for a company, especially to a customer base that was not aware of the business rationale in doing business offshore.

"Customers may make a subconscious decision not to buy a product if there is a report that the company has a captive in Bermuda. This is the buying power of the consumer. It could have a big impact on a company. If that is the thinking, Vermont wins out," he said.

But he said there was no reason for the Island's captive management industry to panic. "We are a mature domicile with a lot of experience and ready access to world-wide insurance companies. The ease of doing business here is also a plus. We have companies writing many lines of business from Directors & Officers (D&O) to property catastrophe; it is a one-stop shop for risk managers."

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EU market

Mr. Barnes said that some of the captive domiciles on the European side were attractive to that market. For example, Dublin has no fronting requirements when it deals with companies in EU countries, and Gibraltar and soon, Malta will have that same advantage.

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Marketing

Mr. Barnes said that rival jurisdictions were making an impression on potential clients with a big marketing push, including quickly releasing statistical data on captive numbers and formations.

The BMA does release monthly reports on the Island's insurance incorporations, but the numbers do not break out definitively how many of the incorporations are captives, nor the type of captive. In addition, financial information on the level of business written by these companies ? with companies having a window of time before they have to report results to the regulator ? is over a year out of date.

He said that BIMA was forming a statistics sub-committee to work with the BMA and the International Advisory Committee (IAC) to get statistics out on a more timely basis.

In addition, other jurisdictions are actively promoting the benefits of setting up a captive in that domicile at conferences and in business and industry publications. Mr. Barnes said: "Vermont has been able to quickly put out data," showing their increasing rate of incorporations. "And South Carolina is making a big marketing splash. They are really pushing themselves as a (captive) domicile and that is how they have got on to the corporate radar screen," he warned.