Developing and Managing Contracts - Case Study Example

?PRINCIPLES OF RISK TRANSFER s Introduction Captive insurance firms are insurance firms set up witha particular aim of ascertaining risks resulting from their parent firms or groups; they also cover risks of the company’s clients (Adkisson, 2006, p. 67). An Australian multinational with yearly earnings in surplus of $ 10 billion wishing to set up a captive insurance firm to cover different business activities would be recommended to set up its captive insurance in Bermuda. With 45% of its operations located in Australasia, 35% in Asia and 20% in Europe, the company has a better opportunity in Bermuda due to various reasons. In assessing the captive insurance industry in Bermuda, there is a need to understand the nature and merits of considering Bermuda’s domicile. Bermuda’s Captive Domicile Bermuda is a leading offshore captive domicile globally. This is a result of onshore administrative burdens and the costs related to conducting business in a US-based or Lloyd’s-based captive in the mid 20th century. This forced Reiss to look out for authority that would permit the flourishing of the captive insurance. Bermuda was selected due to its unique geographical site, good image and status as a British sovereign boundary that disliked uncertainties and perils normally encountered by multinational corporations conducting their business in politically volatile and irresponsible nations. Besides, captives in Bermuda are majorly owned by huge US firms. It can be noted that the second biggest licensing authority in relation to the number of captives is the Cayman Islands (Duffy, 2004, p. 97). Vermont ranks second in connection to the assets owned by insurance firms and third in relation to licensing of the captives. Regulation of Bermudan is done by the Registrar of Companies and the Minister of Finance under the Insurance Act of 1978, the companies Act of 1981 and the Insurance Amendment Act of 1996 (Sierk, 2008, p. 51). Through the regulation a better flexibility is offered compared to other authorities, with the industry carrying the burden of self-regulation, which accounts for the great success of insurance in the state. Moreover, the insurance industry has frequent annual audits jointly with a certificate of solvency, which ensures transparency in the manner risks are managed. Furthermore, most of the captives are registered in two classes under the Insurance Act. Class 1 insurers are unit parent captives, which are not allowed to write any form of unconnected business, while class 2 are relational captives or multi-parent, which are allowed to write up to 20% unconnected business (Sierk, 2008, p. 59). Class 1 insurers have a minimum solvency requirement of $ 120,000 during the time of writing while class 2 has a minimum solvency requirement of $ 250,000. However, there are other classes which insurers can register; one of them is class 3, which does not include insurers and reinsurers. This class has a minimum requirement of $ 1 million. Class 4 has a minimum requirement of $ 100 million, which includes insurers and reinsurers writing instant additional liability or asset catastrophe risks. In addition, Bermuda is the best domicile since it has no income, corporate or through withholding taxes for operation of the captive insurance. Besides, the initial cost of putting up an insurance company is approximately $ 10,000. The legislation also provisions for rent-a-captives and secured cell firms (DFA, 2007, p. 13). The insurance industry’s rent-a-captive projects permit unconnected participants to be involved in the process of profits underwriting from the insured risks in the captive. It also allows them to place irrelevant perils via the captive. Securitization of debt is eventually enabled in the risk securitization. Protected cell firms permit a firm to have distinct departments or cells independent of the other cells in circumstances of liquidation. Apparently, the joint combination of secured cell regulation and the rent-a-captives gives more benefits, due to which there is so much flexibility in this perception. Last but not the least, Bermudan insurance industry is more secure given the fact that Bermuda has tightened up regulation of the insurance sector. This is provided in the bill that was passed by House of Assembly in December 2004, which grants Bermuda Monetary Authority (BMA) more authority to autonomously control the industry. Thus, whistle blowers are also provided with protection as a result of the Insurance Amendment Act of 2004, owing to the IMF evaluation (DFA, 2007, p.31). The bill also elaborates the selection and dismissal of auditors and loss reserves experts whilst giving the BMA the official authority to provide direction in regard of the stipulated standards and methods of those firms registered under the same act (DFA, 2007, 69). Other modifications in the law imply that a chief agent must put it in writing to the BMA if there is a doubt that the firm for which the representative acts may become bankrupt, and the BMA has also the prerogative to select an auditor where the company is inefficient. Reasons for not recommending Australia, Guernsey and Singapore Singapore makes use of the annuities in managing longevity risks. Though the annuities might be literally an attractive method of controlling the longevity risk in the modern world, a small number of clients or customers might buy them at retirement. Therefore, the probability of retirees living more than their assets is counteracted. In this respect, the government of Singapore has a common provident fund which provides a contribution pension system that has of late allowed workers’ retirement assets to be annuitized. Insurance industry has been made the major public sector provider of the annuities, which was after a consensus among the government agencies. Though Singapore is one of the major providers of insurance services, the country has the highest number of millionaires in the world, and this is likely to increase the cost of insurance. In terms of per capita income, Singapore ranks third globally. Besides, the country is a Westminster system of parliamentary state with a unitary multiparty parliamentary democracy. The country has a strong support for personal rights like freedom of speech and it governs on a foundation of solid government and puts common welfare as a priority. It is due such priorities by the state that foreign insurance firms cannot have the freedom to operate their business soundly. As noted earlier, the asset value in Singapore is very high, which might hamper with the smooth operation of captive insurance by the Australian insurance company. In spite of its economic success, there are no minimum wages in Singapore, which has the implication that since the citizens’ welfare is given the first priority, the operation of foreign firms is likely to face hardships in case of workers’ unrest. This might eventually affect the profitability of the firm. On the other hand, Guernsey has not decentralized the creation of money to the central bank. Instead, it has given out interest free money, which has ever allegedly triggered the development of the economy since 1822 (Duffy 2004, p. 87). Neither public debt nor tax increase has taken place – a move that slowed economic growth since the Napoleon’s war. Furthermore, the Australian insurance firm cannot transfer its risks in the domicile of Guernsey given the fact that the country is not a member of European Union, which might imply that their policies might be contrary to the set regulations by the European Union. The financial sectors such as the banking, insurance and fund administration contributes 37% of the entire income of the state. Notably, Guernsey has a well-known offshore finance centre for individual equity funds. Even though the offshore finance centre is well-known, it is not well diversified to cater for various requirements in the insurance industry. Thus, the insurance sector might have limited covers to offer to the numerous ranges of clients available. Moreover, being an offshore centre, the state is experiencing pressure from other developed countries to modify its methods of doing business. This is likely to amount to environments too risky to conduct business for a multinational firm in. As a result, the country is slowly changing the taxation system to remain compliant to the European Union and OECD. Since January 2008, the country has devised a zero-ten corporation tax structure, where majority of the firms give 0% corporation tax and there are a constrained number of operations subject to taxation. This includes the banking sector that is taxed 10%, and 20% are levied on the land, buildings, and regulated utilities. Consequently, the yearly accounts revealed a general economic deficit of about $ 24 million in the year 2011 (Adkisson, 2006, p. 123). In light of the above discussion, it is important to note that even though the domiciles mentioned or discussed might have a sound financial background or government support, Bermuda stands out as the best option for diversifying risks. The main concept discussed to support regards the issue connected to the classes of insurers and the method of operation. The rent-a-captive programs and protected cell firms have much to contribute to the insurance industry that calls for consideration by the Australian insurance firm in question. Transparency is more essential in the process of risk management and securitization of debts to help the companies be more flexible in the process of handling risks. Lastly, the class 2 insurers with a minimum requirement of $ 250,000 would be ideal for its operation in the sense that the company will be in a position to meet all the regulation requirements in the state. Reference list Adkisson, Jay D., 2006. Adkisson's captive insurance companies: an introduction to captives, closely held insurance companies, and risk retention groups. IUniverse. IncDepartment of Finance and Administration (DFA), 2007. Developing and managing contracts, getting the right outcome, paying the right price. [Online] Available at http://www.anao.gov.au/uploads/documents/Developing_and_Managing_Contracts.pdf [Accessed 15 September 2012]. Duffy, Catherine R., 2004. Held captive. A history of international insurance in Bermuda. Toronto: Oakwell Boulton. Sierk, R. Wesley, 2008. Taken captive: How to capture your piece of America's multi-billion dollar insurance industry. RMA PRESS. Read More