Industrial and commercial policyholders increasingly complain that premiums are impacting their bottom lines. At the same time, the protection gap remains significant, particularly in Asia, and arguably will only widen with climate change. Unsurprisingly, interest in captives and in insurance-linked securities (ILS) is also trending higher.
Hugill & Ip’s Ms Caroline Thomas discusses some of the recent trends in Asia and whether Hong Kong is likely to host more captives and ILS.
Trends
In November 2023, the European Captive Insurance and Reinsurance Owners’ Association (ECIROA)’s European Captive Forum took place in Luxembourg. It was reported that in 2021, there were 5,985 captives worldwide of which 52.3% were in the US, 33.1% in offshore US (i.e. Bermuda and Cayman), 10.9% in Europe and just 3.33% in Asia Pacific.
At the forum, the consensus was that more captives are being formed and that the captive concept is seeing a renaissance. Protected cell captives, it seems, are also increasingly popular – these structures (which help bring down the cost of setting up and operating captives) are permitted in several jurisdictions such as Malta, Guernsey, Bermuda and – uniquely in Asia – in Labuan. Currently protected cells are not permitted in Luxembourg, Ireland, Singapore or Hong Kong (although it seems regulators in the former three jurisdictions are reviewing this).
The issuance of insurance-linked securities (ILS) is similarly trending upwards but again mainly in the US, Europe and Japan. In 2019, the global issuance of ILS was approximately $11bn, with Bermuda being the leading jurisdiction especially as regards issuance of CAT bonds. Bermuda’s prevalence can perhaps be explained by reference to its large reinsurance and captive market and proximity to North America and its capital (and peak risks e.g. Gulf of Mexico). Rule 144A of the US Securities Act, which allows privately placed securities to be
publicly traded by institutional investors, is often used to place ILS (even if issued elsewhere).
Captives in Hong Kong
The insurance market is expected to grow considerably particularly in Asia. Yet Asia Pacific still hosts relatively few captives. Hong Kong currently has four: CGN Captive Insurance; CNOOC Insurance; Shanghai Electric Insurance; and Sinopec Insurance. This compares to 82 captives in Singapore at the end of 2022 and over 67 in Labuan (including for Petronas and AirAsia).
Hong Kong’s framework is favourable to captives. From tax year 2013-14 onwards, a concessionary 50% profits tax rate (normally 16.5%) on insurance business of offshore risks applied. Starting tax year 2018-19, the concessionary rate extended to cover profits of captives arising from onshore risks. Captives are exempt from the requirements to maintain assets in Hong Kong to match local liabilities and value assets and liabilities in accordance with the statutory basis.
Captives’ required minimum capital and solvency margins are also significantly lower than general insurers (one fifth/one tenth). Furthermore, the Insurance (Amendment) Ordinance 2020 expanded the scope of insurable risks of captive insurers set up in Hong Kong. It is our understanding that there is flexibility as to outsourcing by captives. Thus, it is expected that more captives will be set up in Hong Kong, particularly by Chinese companies.
ILS in Hong Kong
To date, four ILS have been issued in Hong Kong: Black Kite Re (a 144A CAT bond); Great Wall Re; Greater Bay Re; and an International Bank for Reconstruction and Development issued Chile catastrophe bond, that provides the Republic of Chile with $350m of parametric earthquake protection. This compares with 23 SPRVs issued in Singapore (including seven CAT bonds listed on the Singapore stock exchange). However, Hong Kong’s ILS framework is still very new and there is scope for significant further growth.
The Amendment Ordinance was enacted by the Legislative Council in July 2020 to provide for a bespoke regulatory framework for the issuance of ILS in Hong Kong through the formation of bankruptcy remote special purpose insurers (SPIs) as a new category of authorised insurer (distinct from long-term and general insurers). The intention was to introduce “a bespoke and streamlined regime on par with other ILS domiciles such as Bermuda and Singapore”.
The Amendment Ordinance added several provisions to the Insurance Ordinance for the authorisation and supervision of SPIs, as well as a new section 129A under which the Insurance Authority issued Insurance (Special Purpose Business) Rules to provide for restrict the sale of ILS: in terms of scope of eligible investors, minimum investment size and relevant offences.
ILS are expensive to set up (e.g. structuring and legal fees), hence the need for grant schemes. Singapore’s incentive grant scheme was introduced in 2018 almost 10 years after ILS legislation was introduced because in initial years no SPRVs were issued. Having been very successful, the Singapore grant is slowly being phased out (extended until the end of 2025 but reduced from $2m to $1m and narrowed to just covering APAC and listings if any on the Singapore stock exchange).
On the other hand, in Hong Kong, a two-year Pilot ILS Grant Scheme was introduced (without geographic limitations) almost immediately after the ILS legislation was introduced and its two-year extension was announced in the 2023-24 budget by the financial secretary. Both onshore and offshore sponsors are eligible where there is issuance in Hong Kong of HK$250m ($32m) minimum and at least 20% of upfront issuance costs by Hong Kong based service providers. If the maturity is three years or more, the grant will be the lesser of HK$12m or 100% of the total upfront costs. If the maturity is one-three years, the grant will be the lesser of HK$6m or 50% of the total upfront costs. In November 2019, the central government announced support for mainland insurers issuing catastrophe bonds in Hong Kong and Macao by relaxing the requirements for establishing SPIs.
Further thoughts
Considerations will continue to include the cost and ease of establishment and operation as well as access to reinsurance (for captives) and capital markets (for ILS). Currently establishment costs in Hong Kong and Singapore are higher than in Bermuda (e.g. D&O costs, local counsel requirements, IFRS17). Protected cell structures can be a game changer to reduce costs. Singapore is currently working on introducing corporate structures to facilitate multiple ILS issuances using segregated cells and an improving ESG related data and disclosure across ILS transactions.
Supply and demand side factors could also increase captive and ILS use in Asia. There is still a huge protection gap in APAC leading to fewer insured peak risks in the region. Recent natural catastrophes, e.g. in Australia, have put regulators and insurers under pressure to provide cover – long term ILS might be part of the solution?
Moreover, increased familiarity with captives and ILS may increase demand both by companies seeking to manage their risks and by potential investors. To increase the ILS investor pool, legislators and regulators might acknowledge that financial products backed by ILS can be structured to be less risky.
Investors (including retail investors) in Europe can invest in ILS through UCITS CAT bond strategies (about $11bn AUM in 2023), with specific portfolio requirements ensuring sufficient portfolio diversification, risk limits, transparency, investor protection, standardisation and liquidity. The US has similar mutual fund strategies.
Ms Caroline Thomas is a consultant with Hugill & Ip and board member with the Hong Kong Insurance Law Association.
The article was originally published in the March 2024 issue of Asia Insurance Review
