Although China is the second largest global economy, its economic development only picked up pace in early 2000. With a relatively shorter history of economic growth, captive formation was neither a priority nor was the concept fully understood by large enterprises in China (i.e. lack of knowledge).
Generally speaking, captive growth stems from demand for insurance coverage in capacity shortage environment. The introduction of China’s Belt and Road Initiative (BRI) has brought with it an increased demand for specialty insurance – credit, surety and political risks among others – from countries involved in BRI. As capacity for these new risks are insufficient within China, corporates with captives in Hong Kong would be well-placed to take advantage of the Special Administrative Region’s (SAR) status as a (re)insurance hub to connect with foreign (re)insurers to transfer the risks to the international market.
Since its formation in 2017, Hong Kong’s Insurance Authority (IA) has put in place several initiatives to enhance the city’s positioning as a (re)insurance hub; among these is an aim to promote Hong Kong as a captive domicile. Given Hong Kong’s geographical location, servicing of the Mainland market will be a cornerstone of the SAR’s non-life insurance growth engine. At the same time, the Chinese government is actively promoting the use of captives as a risk management tool to Chinese enterprises. With a captive-friendly regulatory environment, lower tax rates (relative to Mainland) and a common law system, Hong Kong is thus an obvious and natural choice for Chinese businesses to domicile their captive operations.
There are currently eight Chinese captives of which four are domiciled in China, while the remaining four are domiciled in Hong Kong. All belong to State-Owned Enterprises (SOEs).There is no doubt that there is plenty of room for the growth of Chinese captives. Compared to the past when businesses had low awareness and lacked knowledge in using captives as a form of risk management, this risk management strategy is now being actively pushed by regulators in China. In February 2019, IA and the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) co-hosted a two-day forum to invite senior executives of SOEs to promote Hong Kong as a risk management centre for the Belt and Road Initiatives.
The most recent captive formation in Hong Kong has just been approved by IA in February this year.
Of the Asia Pacific (APAC) captive domiciles, Singapore, Labuan in Malaysia, (and to a smaller extent) Micronesia, are the most active. Singapore is the largest captive domicile in APAC, with 72 captive licenses as at end 2018 (up from 69 in 2017). Labuan comes in second, with 48 captives in 2018 (up from 43 in 2017).As for Micronesia, the territory has currently more than 25 captives - mainly Japanese - as of May 2018.
AM Best expects to see growth in both the Singapore and Hong Kong domiciles. Thus far, Singapore has the most comprehensive ecosystem to service captives (ancillary services such as captive managers, accounting firms and legal firms), which naturally makes it a more attractive captive domicile. This being said, the Hong Kong Financial Services Department Council (FSDC) expects to see the city add five to 10 captive insurers licenses yearly to reach a total of 50 captive insurers by 2025.
Previously, captive insurance companies in Hong Kong enjoyed a 50 per cent tax relief on their offshore insurance business.However, to comply with the OECD BEPS minimum requirements, Hong Kong’s Inland Revenue Bill was amended to extend this concessionary tax treatment towards onshore businesses as well.
Education and knowledge are required
In order to become China’s captive hub, the government and the regulator would need to educate and raise awareness among Chinese corporations’ C-suite and risk managers on the benefits and uses of captive insurance. There remains a general lack of knowledge and experience on the use of captives in the second largest economy in the world.
By comparison, Hong Kong would be better positioned as a captive hub than China. Firstly, in addition to a low tax regime, Hong Kong offers an additional 50 per cent tax reduction to captive insurers.
Hong Kong’s regulatory environment – with lower capital requirements – is friendlier relative to China. Despite the planned adoption of a risk-based solvency regime in Hong Kong, captive insurers are expected to be exempted. In contrast, the operating costs for a captive in China is higher, since the Mainland insurance regulation makes no distinction between captives and commercial insurers. For captives, this translates to higher capital requirement and more personnel required to run the same operations in China. This being said, the China Banking and Insurance Regulatory Commission (CBIRC) is in the midst of studying and formulating captive-specific regulations under the China Risk Oriented Solvency System (C-ROSS) Phase 2, with a preliminary deadline in June 2020.
Separately, Hong Kong has its own fundamental strengths as an international financial centre, including a simple tax regime, common law system, free flow of capital and supply of talent in risk management, as well as underwriting and claims management.
However, Hong Kong will also need to develop the full suite of services to serve the needs of existing and potential captive insurers – captive managers, accounting and legal firms experienced in captive business among others.
Christie Lee is Senior Director of Analytics at AM Best Asia-Pacific Limited in Hong Kong. AM Best reports on the financial stability of insurers and the insurance industry. It is the oldest and most widely recognised provider of ratings, financial data and news with an exclusive insurance industry focus.