Malaysia: Labuan - A Southeast Asian Treasure

One of the great joys of the roving consultant on captive and cell captive issues is the ability to view, dispassionately, the development and offerings of various financial services jurisdictions. Simplistically there are the good, the bad and the ugly. There are few jurisdictions that have not, at some stage of their development, come under ill-informed scrutiny. In some cases that ill-informed scrutiny reflects the reality of the situation while in others it is because the scrutiny has come too early in the development of the financial centre. In the case of Labuan, few, myself included, appreciated that Labuan is not an offshore centre (other than in the purely geographical sense) and there is far more to it than get to Kuala Lumpur and then fly East for two hours. 

If ever a jurisdiction has been misrepresented it is surely the case with Labuan, which now presents itself with modern, and in some cases unique, legislation placing it at the forefront of financial services centres in Southeast Asia. The following paragraphs examine how and why Labuan is now able to offer credible top flight financial solutions in the insurance sector.

It is against this backdrop that the development of regional financial centres enhances a fairer and more transparent market mechanism, creating a lower cost of capital as well as an improved allocation of capital, supporting the further growth of Asia.

The requirements

Captive insurance companies have been a feature of risk financing for some fifty years and cell captives now have reached their teenage years^[1]. The so called rent-a-captive, much vaunted in the United States, has all but disappeared from vocabulary and key words now embrace credibility, acceptability, regulation and corporate governance. Add to this IMF review of regulatory regimes and the critical element is no longer the insurance solution, offered by or facilitated through a captive, but the acceptability of the environment from which the captive is to operate.

Multiple articles written over many years expound the virtues of captive oriented techniques. The ultimate focus of any captive technique is to deliver added shareholder value and if the captive does not achieve that goal it is failing its owners. However, in achieving added shareholder value it is undeniable that many organisations benefit en route from improved risk management techniques, better insurance terms, improved cashflow and, frequently, reduced tax burdens.

Captives and cell captives have had, continuously, to evolve. It is not by chance that legislation in many captive centres has not stood the test of time. The simple and lightly regulated vehicle, of the early 1980's and prior, no longer has a viable place in present day corporate regimes and this has demanded, sometimes radical, changes to legislation. Evolution means that lessons are learned and flaws are corrected; it means that core attributes that worked remain untouched and new responses are embodied into effective legislation and regulation. Development means that these enhancements allow a jurisdiction and its clients to prosper and flourish.

Radical Solutions

Perhaps the most radical global risk financing solution of recent years has been the introduction and, almost, universal acceptance of the Protected Cell Company (PCC). The PCC evolved as a means of delivering rent-a-captive techniques in the European insurance environment where the rent-a-captive concept had struggled, principally on account of legal and accounting issues. Development of the rent-a-captive principle was further hindered by insurers who regarded the concept as a means of permitting clients to reduce premiums and thus reduce their own (insurers') profits. PCC legislation was to change the entire approach to the rent-a-captive on a global scale. It started as "enabling legislation" intended to deliver a low cost entry point to the captive arena. The legislation merely stated that a company could be established, with a single legal persona and, by contractual wording, create different classes of shareholder with different rights, most significantly all classes being ring-fenced, one from another. Development thereafter was in the hands of the legal draftsman and subject to the innovative approaches of insurance communities.

The generic use of the term cell company and the application to insurance need was not new. The new element was the legal enforceability of the separation of cells and the opportunity to create variable underwriting accounts, participations and rights within one legal entity - and this is just one area of the sector's development. Yet, evolution has been an ever-present feature of the captive insurance sector. Controlled Foreign Company rules, tax-free investment subsidiaries, premium taxes and the demands of corporate governance have all impacted on the sector and the sector has continuously responded.

The responses have been as varied as the threats. Captives and cells deliver increased focus on insurance techniques, while tangible expertise has been developed throughout the sector embracing insurance managers, auditors, lawyers, investment bankers, non-executive directors and regulators alike. The idea that a captive is a simple route to a quarterly fee cheque and a free lunch has truly been consigned to the past.

Evolution in Labuan 

Labuan too has played its part in innovation and development. The Labuan Financial Services and Securities Act 2010 sought to consolidate and update previous items of legislation while complementing existing legislation including the Labuan Companies Act 1990. Now, in one single piece of legislation, each of the territory's financial services' sectors is addressed in a manner that reflects international standards such that the territory is white listed by the OECD. The commitment to deliver a top flight financial sector does not stop there. Alongside the 2010 Act, as well as embodying legislation that had seen through initial development of the territory's finance sector, Labuan sought to recognise Shariah principles through the enactment of the Labuan Islamic Financial Services and Securities Act 2010 (approximately 60% of Malaysia's population is Muslim). The legislation is modern, clear and workable identifying critical elements of performance and regulation, seeking, at the very least, to match legislation in other financial services jurisdictions and ensuring flexibility to respond to changing international requirements.

However, Labuan recognises that it cannot rest on its laurels. Multi-faceted legislation does allow corporations to have the comfort of one jurisdiction and one financial services' law but the territory, undeniably, is two hours' flying time from Kuala Lumpur. While board meetings in territory are encouraged, they are not required. In fact, legislation goes substantially further than merely acknowledging the potential inconvenience of additional travel and, over the last couple of years, the Labuan Financial Services Authority (Labuan FSA) has embraced the idea that the Labuan framework, specifically its legal and tax structure, should not be limited to the confines of the island. To assist in promotion of this concept, the Labuan FSA has issued a Guideline on Co-Location of Labuan Insurance and Takaful Licensee. The effect of the Guideline (effectively a statutory instrument) is to permit Labuan insurance and takaful licensees to be based in Kuala Lumpur and any other part of Malaysia in order to access all available infrastructure, facilities, human capital and professional services that are available rather than facing any limitations that a smaller business environment might present.

Labuan, as a territory of Malaysia, is able directly to access double taxation agreements yet companies in the territory can cap tax at MYR20,000 or 3% of audited net profit. Capital and solvency requirements separate requirements of wholly owned captives and those writing third party business. Incorporation and regulatory fees remain competitive while regulatory requirements and response times are on a par with peer group territories. Labuan's evolution has successfully embraced offshore principles and costs with onshore resource and accessibility.

Making captives work

Labuan, and the Labuan FSA as regulator, has gone out of its way to seek to ensure the territory can deliver a tangible, workable and cost efficient financial services platform in Southeast Asia. The Labuan IBFC Incorporated, as the Malaysian Government Agency authorised to market Labuan, is now seeking to ensure that significant audiences hear at first hand as to the territory's development. Part of that development initiative includes listening to reservations and responses, and then addressing any reservations and building from responses.

Captive insurance has, more than any other innovative financial services' product, stood a significant test of time. It delivers cost-effective insurance solutions to an estimated 5,000 companies globally generating in the order of USD50 billion of annual premiums. However opportunities abound as the foregoing can be broken down and analysed to show that the USA and Europe generate approximately USD1,200 billion of premium and provide domiciles to 4,900 captives, while the rest of the world generates approximately USD1,000 billion of premium and provides domiciles to 100 captives^[2]. By any standards this points to the potential of 1,900 new captives or cells outside of the USA and Europe. As new economies mature there will be continuing demand for captive and cell captive responses and those responses will be sought in territories and jurisdictions that are robust, pragmatic, established and convenient.

Regulators and promotional agencies can only do so much. Ongoing development of captive strategies is a collective responsibility of all in the captive insurance sector. Figures suggest that the concept is substantially under-developed outside the USA and Europe and this calls for new approaches to risk retention and insurance buying. The catastrophes of the first few months of 2011 will impact on insurance markets. Those companies, with significant insurance expenditure and good loss experience, having invested or prepared to invest in sound risk management principles will place themselves with a significant insurance purchasing advantage. There is no guarantee that captives or cell captives will be part of their future insurance and risk management strategies but jurisdictions that have themselves invested, listened, learned and responded, creating sound and credible insurance and financial services' business environments have themselves created opportunity and this opportunity can only evolve further in Asia and Australasia.

Conclusions

Captives came of age some while ago and remain at the forefront of risk financing, but the greatest risk they face is complacency in the face of new challenges. However, captives have continuously evolved and further evolution is not in doubt. Labuan also is evolving and fully recognises that its financial services' sector must move continuously to gain and maintain international recognition as a fully-fledged financial centre.

Over 175 captive, insurance and reinsurance companies, writing USD1.2 billion of gross premium in 2010, are registered in Labuan including a number of Lloyd's syndicates. The introduction of PCC legislation within the Labuan Financial Services and Securities Act 2010 places Labuan on a par with leading captive jurisdictions in terms of its offering. Labuan's position on the borders of Asia and Australasia provides ready access to and from the World's fastest developing economies and also to the greatest population densities on the planet.

As with any business or financial service there is one keyword: "credible". Credible benefit, credible legislation, credible management and credible access. Labuan has made significant and continuing tangible efforts to place itself on the global financial services map and provides a very credible offering.

Footnotes

^[1] Protected Cell Companies – The Teenage Years, author Callum Beaton, published Captive Insurance Company Reports, August 2010

^[2] 2004 figures from varying sources