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Risk Management
Sunday, January 1, 1989
Justified or not?

Off-shore insurance companies, or captives, have existed worldwide since the early twentieth century. There are some rumblings both in the South African insurance industry and amongst members of the public that captive insurance companies have been used to funnel large volumes of’ cash out of the country.
But there are controls on the establishment of an off-shore captive, and while there will always be those people who attempt to outwit the law, they will doubtless lose out when their legitimacy is investigated.
The Melamet Commission recently reported that owners or users of captives were in some cases not utilising the privilege legitimately and a detailed investigation should be carried out. It did recognise, however, that captives do have a role to play in the South African insurance industry.
The Registrar of Financial Institutions, the Receiver of Revenue and the Reserve Bank have since called for all documents relating to captives to be brought forward by captive owners.
These include: memorandum and articles of association; all financial statements; and, all motivations for foreign exchange. Several spokesmen involved in captive insurance believe that some companies are biding time in bringing forth these documents, particularly those relating to foreign exchange.
Says Des Vernon, risk and insurance manager for Barlow Rand, “Captives certainly have been abused in the past. The problem is that they are easy to abuse but it is not so easy to detect such misuse. The investigation by the Registrar, Reserve Bank and Receiver of Revenue will lead to tighter controls, but some of those companies abusing the system could still go undetected.
“It is difficult to say how many South African-owned captives there are. Many are actually used by more than one company; that is they are not pure captives. I would estimate there are at least 35 to 40 pure captives though. Some are completely legitimate and recognised by the necessary government departments, others fall into grey areas, and some are not even known about. No doubt the present investigation will unearth some of these.”
Another industry spokesman says, “There could actually be a lot of people using captives and breaking the law in ignorance. This is because the concept is complicated and requires in-depth accounting and legal assistance from highly skilled personnel.”
Basically, a pure captive insurance company is a wholly owned subsidiary, usually located off-shore (outside the parent company’s country) and engaged in the business of insurance.
It underwrites the risks of the parent company and its other subsidiaries.
The decision to establish a captive is made for various reasons:
• the local insurance industry may not be able to handle all the available business due to insufficient capacity. Says assistant registrar of insurance, Willem Heckroodt, “The Reserve Bank consults the Financial Institutions Office (FIO) on applications it receives to establish captives. We liaise with the SA Insurance Association (SAIA) who advises us whether the business can be handled in South Africa. We then make a recommendation to the Reserve Bank which may, or may not, be accepted”;
• business may be able to be written at a far lower cost overseas;
• access to foreign reinsurance markets is facilitated. To reinsure, an insurance company must come between the insured and
• South African identity may need to be masked in order to access foreign markets. Some countries do not reveal the host country of any captive situated on their shores unless there is criminal activity involved; and,
• there are tax benefits to be gained from situating a captive off-shore. Not only are these gained from the countries themselves where captives are situated, and where tax laws may be lenient, but profits repatriated to South Africa are tax-free because they are income earned outside the country.
A captive insurance company is one form of practicing self-insurance. Many large companies, commercial or industrial, find that to pay huge premiums to insurance companies is not viable. Or they may require cover for risks the local insurance industry is not prepared, or is unable, to cover.
Owning a captive is the final and largest of the options open to those wishing to self-insure.
Johan Wethmar, consultant at Prorisk, explains the other options:
1) a company has no fund or insurance and pays for losses as operating expenses;
2) a company has a fund for handling losses. This is a problem if the fund is not used up in the financial year because any funds still available are taxed as profits; and,
3) a company rents-a-captive. In other words it pays a parent company a fee in order to make use of that company’s captive.
“The choice of which self-insurance method to use is specific to each company participating in it. A pure captive may not be the ultimate solution for everyone,” says Mr Wethmar.
He feels that at the moment it is actually cheaper to insure than to self-insure. “This is especially true of insureds who have not already established self-insurance reserves and who are only now embarking on the self-insurance route. This is largely due to local arid foreign competition, which is keeping insurance rates at very competitive levels locally and internationally, as well as the high costs involved in establishing a captive.”
But Mr Vernon points out that his company is obtaining cover, in overseas markets, up to 60% cheaper than it would be if bought locally.

Copyright © Insurance Times and Investments® Vol:2.1 1st January, 1989
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