1 January 1970Analysis

Onwards rolls the US frontier

If you are a captive owner, or one considering its advantages and alternatives, you really are spoilt for choice in the US. There are mature domiciles—the usual suspects of Hawaii, South Carolina and Vermont—rising stars such as Arizona and Missouri and nascent captive jurisdictions such as Florida, New Jersey and Oregon. It seems that every state is getting in on the act, with the US captive landscape proving a decidedly crowded field.

Much of this seems to be down to the increasingly mainstream nature of captives. As Andy Sargeant, chief operating officer at USA Risk Group outlined, “increased knowledge and acceptance ofcaptives by regulators, legislators, insureds and service providers” has helped to raise awareness of the potential of the sector. At the same time, states have also come to realise the potentially lucrative benefits of having a home state captive industry, particularly in the face of the economic downturn.

“States are also seeing captives as good tools for their businesses in terms of development and revenue generation,” said John Rehagen, captive programme manager at the Missouri Department of Insurance. Sargeant concurred, arguing that captive legislation represents an “opportunity to attract captive business from those companies headquartered in the home state”.

Jeff Kehler, programme manager at the South Carolina Department of Insurance, argued that states were enacting captive legislation for both defensive and offensive reasons. “Defensively, if states don’t have captive laws on their statute books then some of their larger industries may opt for other states to form their captive, placing economic development outside their home state.” This factor has become all the more pressing in the current economic downturn. While “offensively, if you can encourage captive development in your home state it encourages economic development associated with the recreation, hospitality and service industries that service the captive sector”.

The Nonadmitted and Reinsurance Reform Act (NRRA) provision of the Dodd-Frank Act is providing further impetus for captive formations and new entrants, with states “entering or reigniting their involvement in the captive industry as a result of the Act”, said Gregg Sgambati, president of the New Jersey Captive Insurance Association. Sgambati added that although there remains some debate regarding whether captives will be included within the full scope of the NRRA, “it appears that risk managers and captive owners are acting under the belief that captives will be taxed in home state domiciles”, prompting them to create home state captives. He clarified that in New Jersey’s case its choice to enter the captive field was driven by the “public economic opportunity demonstrated by states like South Carolina and Vermont over the last 10 years”, rather than the pressures of Dodd-Frank, but it is evident that other states and formations may well have been swayed by the Act.

Feeling the pressure from Dodd-Frank, and with more small and medium-sized businesses getting in on the captive act, the home state advantage appears to have strengthened. Nevertheless, mature domiciles continue to be able to draw on experience, a pool of service providers and critical mass. As Kehler indicated, “considerations are more than simply geographic ... parents will inevitably consider the domicile’s ‘brand’ and its captive capabilities”. Addressing the issue of home state advantage, Rehagen said that is “very important”, with Missouri gaining particular benefits from its home state advantage. “There are a lot of efficiencies and cost savings associated with staying at home. If the home state has a good law, is well staffed and is receptive to captives, the home state ought to be a top contender for domestication,” he said.

Sgambati agreed that the advantage was “quite important”, citing tax liabilities associated with Dodd-Frank as a driver of redomestications and recent moves to set up branch captives in home states. Sargeant said that a lot of companies are looking to “play it safe by domiciling in their own state” in the face of tax conditions outlined by the Act, but indicated that he did not believe that Dodd-Frank was sufficient to “overshadow the benefits of incorporating in states that have a well developed infrastructure ... and a regulatory environment that understands the needs of captives”.

"There needs to be an understanding the specific needs of the industry, with the streamlining of formation and appropriate regulation being prerequisites for success."

The home state advantage is likely to be all the more pressing for small and medium-sized firms (SMEs), who cannot perhaps afford to take their captive enterprise further afield. And it seems that SMEs are the major growth area for the captive sector, with most Fortune 500 firms already employing, or having considered, a captive insurer. Rehagen indicated that this is an area in the industry where there had been the most growth in numbers in recent months, as companies have sought to drive down insurance costs in the face of the economic downturn. He said that SMEs don’t enjoy significant premium volume or substantial returns from their captive, meaning that for them “every penny will count”. Sargeant highlighted the growth in pareddown 831b captives, which have been tailor-made for the US SME sector. He added that the industry was also seeing “increasing interest from group captives wanting to integrate 831b captives—or private enterprise risk captives—as reinsurers to their existing programmes”.

In terms of those lines where new starters can hope to harness captive growth, healthcare and construction were cited as being the ones to watch. With the Patient Protection and Affordable Care Act narrowly passing the Supreme Court, it seems that further development is likely in that space. Captives have been following developments closely and there is some hope that the Act will present opportunities for the sector. Construction, after a troubled few years, may well pick up in step with the improving US economy.

In such a crowded field, the question becomes ‘how can new states differentiate their offering from such experienced competition?’ “It will probably be pretty difficult,” Rehagen admitted, with new states necessarily having to focus on their strengths. Kehler agreed that there cannot simply be a “me too” approach to involvement in the captive space, with entry a “big challenge for any new state in what is becoming an increasingly crowded area”. Sargeant argued that new domiciles need to “employ dedicated staff whose job it is to regulate and market the captive industry”. There needs to be an understanding of the specific needs of the industry, he said, with the streamlining of formation and appropriate regulation being prerequisites for success.

True differentiation comes from establishing and carving out a niche in a particular business area, said Sargeant. “It can be trusts, flexible corporate structures or catering to specific industries”, with such new domiciles needing to work to design legislation that can capitalise on the state’s specific strengths. “By building those strengths into the legislation, they can carve a niche that would be difficult to duplicate,” said Sargeant. Kehler highlighted the niches that Utah and Kentucky have managed to build for themselves within the micro-captive space, arguing that an “efficient licensing process and reasonable costs” have helped the two states flourish in the micro-captive area, although he added that the challenge would be in developing a solid regulatory team.

Addressing the specific case of Missouri, Rehagen said the state is a “hub for life reinsurance”, with two of the state’s domestic players writing 40 percent of life reinsurance in the US. This focus has been aided by the Missouri Department of Insurance’s level of reinsurance experience, although he indicated that now that the captive industry in the state has really begun to develop he is seeing increased diversity in the types of captives formed. Rehagen said that the state was now building a pool of “reinsurers’” captives and large and small property and casualty captives, and that the state’s “eggs are not all in one basket”. As he explained, captives and their states “need to be in it for the long haul”.

Developments such as the “NRRA-designated home state advantage” and the emergence of less common captive types such as serial captive formations have helped some states carve out a niche, said Sgambati, but it is evident from talking with players in the market that building a new captive industry is not simply going to happen overnight.

"It is essential that the industry embraces new technology in order to educate the wider business community about captive insurance."

Addressing the steps being taken by the wider captive industry to encourage further formations, Sargeant said that numerous conferences and road shows were helping to get the word out there about the benefits of captive insurance. He added that the main proponents of captives “are still the service providers”, actively securing new business. He added that it is essential that the industry embraces new technology in order to educate the wider business community about captive insurance, adding that it needs to capitalise on mobile technology, social networks and webinars in order to attract a new generation of decision-makers into the captive space.

Outlining New Jersey’s particular approach to development, Sgambati indicated that the association was focused on “emerging risks” and educating risk managers on the potential of captive insurance to insure such risks. “This presents the opportunity for creative applications for captive insurance. And since some of these risks are difficult to insure, have limited actuarial data, or are even ‘uninsurable’ by traditional insurers, a captive insurance vehicle is an interesting enterprise risk management alternative.”

Looking ahead, it is likely to be a battle for some of the new states to gain traction in the captive space. Some domiciles have been home to captive industries for decades. Nevertheless, it seems that the pipeline of states considering a captive programme remains open.Rehagen said that Missouri had been approached by other states considering taking the plunge in recent months. And with the NRRA home state advantage still to play out, growing applications in agitated industries, attractive possibilities for SMEs and the embrace of creative risk management in captives, we may yet see further additions to the captive map. With upwards of 30 US states all in on the captive act, developments point to an industry in decidedly rude health.