12 August 2019

Rates, regulation and innovation: reflecting on a week in Vermont

Attendees heard that writing more business through their captives will likely make them more cost effective, due to the diversification benefits of non-correlated forms of insurance cover. Adding new lines of business can improve captive performance by increasing premiums by more than expected losses, explained Matthew Killough, consulting actuary at Milliman - even if the line being added was relatively high risk.

Generating more premiums via new lines of business can also generate new investment opportunities that may be profitable for the captive, said David Kilborn, president and chief investment officer at Performa.

“Some policies may be more attractive than they seem at first, because they increase returns of the investor side,” he said. “It doesn't work if you look at the business in silos, you are missing an opportunity if you do not think about the associated benefits of increasing the business in your captive.”

Hardening rates
There was plenty of discussion about the broader insurance market, and in particular the arrival of the long-anticipated hard market.

Naturally many were concerned about the implications for captives.

David Provost, deputy commissioner for captive insurance at the State of Vermont department for financial regulation, noted a dramatic decline in the number of reinsurers willing to do business with captives, and insurance companies cutting business lines, all of which puts more pressure on the captive community.

But there was also optimism that captives could play a significant and constructive role in providing a solution. Sandra Bigglestone, director of captive insurance at the State of Vermont department for financial regulation, was one of several speakers over the course of the week to suggest that if captives can live up to the expectations the industry has for itself, it should lead the commercial market back into softer territory.

Vermont's plan to experiment with distributed ledger technology in the regulation of its captives industry should also be great news for captives – as well as tax collectors, James Swanke, director of risk consulting at Willis Towers Watson, said. It was one of the many times speakers returned to the theme of innovation and the role captives can play, and are playing, in leading it.

Vermont had signalled its intention to look at how DLT could be used to regulate captives back in January. Bigglestone said Vermont is working on a request for proposals for the development of a distributed ledger technology platform to maintain records for its captive industry. Such processes have to run through various compliance departments and take time, but will land in due course.

When it comes it could cause quite a stir in the industry. Swanke said a DLT-based system would deliver greater transparency, which could help tax collectors wring more dollars out of the industry. But it would also benefit the industry itself, driving down costs for auditors and other service providers, and improving access to data.

“This is another area where captives are leading the way for commercial insurers,” added Swanke.

He was not the only speaker over the course of the week to make the point. Michael Maglaras, principal at Michael Maglaras and Company, also drove home the point that it is captives, far more than their larger commercial peers, that are driving innovation in the insurance industry.

Maglaras said his Connecticut-based captive to restore crumbling homes, the Connecticut Foundation Solutions Indemnity Company, was an example of a captive pushing innovation in a way commercial insurers are not.

“If a hurricane hits, a new Sandy, damaging thousands of homes, they should look at what we did in Connecticut, where captives achieved much more, and much cheaper, than the commercial insurance industry could have,” he said. “We should take pride in our innovation, and also learn from it.”

Innovate now
An eagerness to embrace innovation was evident among speakers and attendees alike. In an electronic poll of attendees, 31 percent said their captives had achieved some measurable success in their innovation strategies, while the same number said it was too early to say that, but at least indicated they are embarking on the early stages of their innovative journeys.

That is not to say innovation is easy. Just over a quarter of those asked what the main blockage to innovation in their institution was cited a knowledge barrier, while just under a quarter said organisational culture presented the biggest obstacle.

Cyber risk was of course another recurring theme. Timothy Padovese, CEO of the Ophthalmic Mutual Insurance Company (OMIC), an RRG, stressed that all captives, no matter how small they felt when set against the giants of the insurance industry, should be under no illusions that they are targets.

Steven Bauman, head of global programmes and captive practice for North America at AXA XL, said captives and reinsurers should work together to tackle cyber risk. “Captives have always been about emerging risks and emerging regions, but reinsurance plays a big part in that,” he said.

Edward Koral, a specialist leader at Deloitte Consulting, told attendees to be patient with cyber coverage, a line that remains in its infancy. As it builds up a history of claims data pricing and coverage will improve, he said, as it did in the employment practice liability product over the first decades of its existence.

Christine Brown, director of captive insurance at the State of Vermont department of financial regulation, said state governments wanted to act on cyber regulation themselves before the Federal government did.

Some states have already implemented a National Association of Insurance Commissioners (NAIC) model law, and Vermont is currently looking at it, confirmed Brown. But the model law is not an accreditation standard and Vermont did not want to rush into implementing anything that may be onerous for its captive community, she said. “We want to ensure our response is proportional,” she added.

Among the other regulatory issues to be discussed was the thorny issue of 831bs, although this is a relatively minor component of the business done in Vermont itself, and as such the issue was never front and centre. But a number of sessions went into considerable technical detail about how captives can ensure they satisfy IRS requirements demonstrating they are bona fide insurance companies, rather than elaborate tax dodges.

Inconsistent treatment
Of more immediate concern to Vermont’s considerable risk return group community are the less headline-grabbing, but still insidious, attempts by US states where they are not domiciled to make them register and pay fees. The Liability Risk Retention Act is clear that these attempts have no legal basis.

“Risk retention groups have had enough” of inconsistent treatment from states where they are not domiciled, said Bigglestone.

She assured the audience that NAIC’s RRG task force is looking to resolve the situation by updating the registration forms RRGs are required to complete in their state of domicile and developing FAQ page to educate state regulators on the registration process for RRGs.

The less obvious, but equally significant concern over the long term, is how the captives industry will replace the most experienced and aging members of its community as they approach retirement age.

According to the College Board database, there are 1935 accountancy programs for students looking for a career in accountancy, and a slightly more modest 799 finance programs for those interested in a career in that area. But for those interested in getting into a career in risk management or insurance there are a mere 82 programs.

The concern is that these programs may not be producing enough graduates to replace those leaving the industry. “Every baby boomer is having to be replaced by half a gen x’er,” said Zachary Finn, professor and director at Butler University.

Finn said events in recent decades like 9/11, Fukushima and mass shootings in the US meant there had never been such an acute need for people with risk management expertise. Yet somehow this need is not being met.

Finn called for a dramatic increase in the number of insurance and risk management programs, which would give more people the skills needed to allow small and medium sized companies to create captives.

Even if company managers are convinced of the financial advantages available by creating a captive, they do not have the skills within their workforce to do it, he said.