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Many US states are passing legislation that allows them to become domiciles for captives—more than half now have this facility. In a growing and increasingly complex market, what does that mean for owners seeking the right domicile for them? US Captive reports.
An important milestone has been passed by the captive insurance industry in the US—more than half of the states in the Union are now domiciles for captives.
It’s taken the best part of 30 years to get to this point, since Vermont got the ball rolling in the 1980s. But just because more states are opening their doors to captives business doesn’t mean that they are retaining that business over the medium to long term. According to the Insurance Information Institute, there has been some degree of churn in the number of captives in the various US domiciles. Some states have seen substantial increases—North Carolina’s captives rose from 94 in 2015 to 190 in 2016—but in others the numbers have dropped. Kentucky’s captives fell from 92 to 84. In Vermont, one of the oldest domiciles in the US, the numbers remain relatively stable, going from 596 in 2015 to 593 in 2016.
According to broker Marsh, there are currently just under 3,000 captives in the US—not far off half the global total of around 7,000. It’s therefore big business and is increasingly being considered by a wide range of companies, both in and out of insurance.
How to choose a domicile
What are the issues firms need to address when looking to set up a captive?
“There are three major factors to consider,” says Nancy Gray, regional managing director of Aon Captive and Insurance Management. “The first is cost. Cost is frequently one of the key drivers of domicile choice for an organisation establishing a new captive. There may be different costs associated with being in a specific domicile which include the premium tax structure, annual licence fees, and so on.
“The states that have been the most successful from my perspective are the ones that have strong regulators.” Nancy Gray, Aon Captive and Insurance Management
“Next is the regulatory environment. When you have a well-established domicile with a consistent regulatory environment, the domicile tends to be more successful in maintaining existing captives as well as attracting new ones, as there is certainty around the operations of that captive entity.”
The third factor is geographic preference. “For some organisations, it may not make sense to have a captive domiciled on the East Coast if they are on the West Coast, especially if they have to travel to the domicile for their annual board of directors’ meeting. It becomes a question of cost and time—it’s easier to travel to a domicile that’s closer to their location,” she says.
“Around 35 US States now have captives legislation in place and with that comes a lot of competition,” says Ellen Charnley, managing director with Marsh Captive Solutions. “The winners and the losers are quite different in terms of how they have gone about winning, or unfortunately losing, business.
“The big players, who have history, volume and infrastructure, are now established domiciles, such as Vermont, Hawaii, New York, South Carolina and more recently Utah, Nevada and Arizona. They, especially the first few on that list, have been around for a long time, so they have reputations to build from, as well as resources and infrastructure to allow them to carry out outreach for new business,” Charnley says.
“If you go back 10 or 15 years there fewer than 10 successful US captives domiciles, with the two major ones being Hawaii in the West and Vermont on the East Coast, as well as some smaller domiciles such as South Carolina, DC and Arizona,” Gray adds.
“The number of US captive domiciles has grown tremendously in recent years, driven by the passage of the Nonadmitted and Reinsurance Reform Act of 2010 (NRRA), a subsection of the Dodd- Frank legislation. Under NRRA, there may be a tax advantage to form a captive in the organisation’s home state,” she says.
According to Gray, NRRA didn’t create any new taxes but it changed the mechanism of the way organisations pay self-insurance tax. Under the old model companies paid self-insurance tax based on where the pro-rata risks were across the US. Under NRRA, selfprocurement taxes are typically assessed based on the home state of the organisation forming the captive insurance company.
“If you form a captive in your home state you pay only a captive premium tax as opposed to a self-insurance tax. If you form a captive outside your home state then potentially you have to pay a self-insurance tax to that state, and to your home state, as well as the captive premium tax,” she explains.
“This drove an increase in terms of domiciles for captives. As a result of the NRRA, large corporates that wanted to form a captive in their home state were allowed to do so and reduced the amount of their tax obligations, so it did have a significant impact on costs.”
The rise of the 831(b)s
In addition, there has been the rise of a form of captives that elect to be taxed under the rules of section 831(b) of the Internal Revenue Code. According to Gray, there are now many of these entities throughout the US, especially in places such as Utah. These 831(b) captives tend to be wealth transfer-type captive insurance companies and are formed via the small company exemption with less than $2.2 million in insurance premiums.
“Rather than starting from scratch in terms of drafting captives legislation, many states have taken existing laws, many based on Vermont’s, and enacted them in their own individual states,” Gray says.
“Some states such as Delaware have enhanced their laws to be more competitive from a new formation standpoint. But then another state will up the game by passing and updating its own captives laws to allow for the same enhancements, so there’s constant change, but many of the changes are tweaks to their existing laws to remain competitive with other jurisdictions,” she says.
“They may also need to be generating revenue for their state to support the regulatory infrastructure that is required to regulate the captive insurance companies, so there’s only so much you can do to enhance the laws while also ensuring that the entities are properly regulated.”
Keeping it local
Some states aren’t interested in competing for captive insurance business, however. Their interest in having captives legislation is to accommodate the large corporates located in their state, and they are not looking for any other captives.
“They may see no benefit to their states in trying to attract a great deal of additional new formations, so they’re comfortable with making sure that they are meeting the business needs of the organisations operating there, and are catering their captive laws to accommodate them,” Gray says.
“The states that have been the most successful from my perspective are the ones that have strong regulators. Most organisations are not opposed to regulation and recognise the importance of a strong regulatory environment.
“Regulation is important to ensure the continued solvency of the industry but it is important to recognise that most captive owners are sophisticated risk buyers, providing insurance coverage to the owners and related entities, and regulations have been adopted and are applied in most states to recognise this.”
Keeping hold of captives within a domicile might also come down to being proactive.
Charnley says that the newer domiciles, such as Oregon and Florida, have fewer captives, and therefore less resources. That points to less outreach—and outreach, she claims, is important.
“If you want to be successful at sales then you have to proactively reach out to a targeted audience in a specific way to allow you the chance to have conversations with prospects, and hopefully convert those conversations into opportunities and then ultimately into action,” says Charnley.
“It’s the same process with a domicile. If a domicile sits back with very little activity being shown then it’s very easy for people to forget about it, or not even know that it exists and therefore not to consider it.
“What does being proactive mean for domiciles? It means visiting companies, holding webinars, reaching service providers, building a network, doing breakfasts and lunches, attending conferences, positively doing outreach.
“Domiciles that do that will be more successful and domiciles that don’t will be less successful. There’s too much competition to sit back and do nothing,” she adds.
“People might think that it’s the specific legislation of a domicile that will attract or not attract certain companies, but I would challenge that theory. I don’t think that has a huge impact on whether a domicile is successful or not, as most domicile legislation follows approximately the same pattern.
“If it didn’t there’d be a complete shift and an arbitrage happening so that at some point the legislation would normalise. What happens is that one state does something a bit different, for example Utah and Arizona don’t charge a premium tax, but other states offer other things which may be more attractive.
“The actual legislation doesn’t necessarily drive success or failure, what drives it is a solid infrastructure, a lot of experience and a positive and proactive outreach. “If domiciles have all those things, they should have no problem keeping and growing their business, but there are factors that the domicile and the infrastructure in that domicile can’t necessarily influence, for example if a company decides to shut down its captive because it is acquired by another company and that company had a captive of its own in a different location,” she says.
Charnley adds that building a strong relationship throughout the captive’s lifecycle is also vital. “Having an efficient and responsive team in the domicile including both the regulator and service providers creates a trusted adviser philosophy that encourages companies to stay loyal,” she says.
“Some of the well-established domiciles are able to keep and grow their captive numbers despite increasing competition from other states, in part because of the relationships they have built with their captive owners—and that’s more important to them than a potential financial advantage from redomiciling.
“It’s all part of the same thing: getting to know the clients, positive outreach and staying close to them,” Charnley concludes.
Aon Captive and Insurance Management, Marsh, Domiciles, Vermont, Legislation, North America