A decade captured in the blink of an eye
A decade is a long time in any industry. Fashions change, people move on, new concepts arise, old ones evolve.
The captive insurance market in the US has been no different. It has seen extraordinary growth over the past 10 years in every sense.
As Dennis Harwick, president of the Captive Insurance Companies Association (CICA)—for the past decade as it happens—stresses, it is and always has been difficult to assess numbers of captives. He estimates, however, that the number of captives has more than doubled in the past decade from around 1,000 in 2003 to somewhere around 2,600 in 2013—the most recent years for which figures are available, although this is likely to have increased again since then.
He also makes the point that this growth has been steady and seemingly immune to the cyclical nature of rates in the traditional insurance markets. It was once thought that captives were more likely to be formed when rates were hard in traditional insurance, forcing risk managers and CFOs to explore alternative and more cost-effective methods of risk transfer.
But this logic seems not to have applied in recent years. Harwick attributes this, in part, to the increasingly innovative and flexible nature of the way captives may be used—driven by a mixture of captives managers and regulatory changes opening up new business in new vehicles.
These have ranged from the large XXX/AXXX life insurance/annuity reinsurance vehicles to micro-captives utilising the 831(b) tax election. He also notes that protected cell legislation and serial captive vehicles have also driven growth in some sectors while also making the numbers of captives harder to count.
“The industry changes quickly and Vermont has kept ahead of it, maintaining the strategy that has made us successful since the beginning." Dan Towle
In tandem with this growth in the numbers of captives across the US, the number of states that have embraced this form of risk transfer have also increased greatly. State after state in the US has accepted the virtues of captives. Harwick estimates that 37 or 38 states now have legislation enabling the use of captives.
One thing that has not changed since the start of the decade is that Vermont remains the leading state by captives domiciled, a position it’s held from the very start.
Dan Towle, director of financial services of the State of Vermont, attributes the growth partly to a deeper acceptance in the US of the use of this form of risk transfer—Vermont has ensured it has maintained pace with these changes.
Towle describes the industry as having transitioned from being an “alternative risk transfer” mechanism to being a mainstream insurance tool. To put the sector’s growth in perspective, in Vermont, gross written premium volume has grown from $10.9 billion in 2004 to $25.5 billion in 2014.
“The industry changes quickly and Vermont has kept ahead of it, maintaining the strategy that has made us successful since the beginning. We find quality companies and regulate them in a manner consistent with their risk profile,” says Towle.
Such evolution is not unexpected given the way that the insurance market has changed. The past decade has seen a wide range of crises ranging from natural disasters, to cyclical changes, to regulatory revamps. And yet the growth of the market continues unabated.
“Over the last 10 years the trajectory of the US captive market has been like that of a shooting star,” says Arthur Perschetz, principal at insurance law firm Arthur D. Perschetz and a veteran of the captive industry.
“People started to notice them when many states started reporting that they had them, such as Vermont and South Carolina,” he explains.
“Other domiciles started to see the benefits of captive insurance entities providing the opportunity for the business entity to provide insurance within their jurisdiction. They’re seen as a big plus—if it’s not going to their jurisdiction it will go to another one.”
"The states that joined after the captive train left the station are coming back and looking at what they can do to attract more captive business in their domiciles." Arthur Perschetz
Perschetz says he expects this growth to continue; any initial reluctance to captives is now long gone. There are a significant number of people now within the industry who are very well known and have an expertise in dealing in the captive arena.
More and more uses
Captives are here to stay and will be used more and more as companies are able to get involved with smaller captives in those states that have tax advantages for small captives. Even some of the larger entities are going in and forming their own risk management programmes.
“As people go on with onshore/offshore reinsurance I think they are seeing a multitude of uses and ways that they can craft a captive that can be a little bit more flexible than a traditional company insuring itself,” Perschetz says.
“It’s now a very vibrant market—the states that were the initial leaders have done exceptionally well and the states that joined after the captive train left the station are coming back and looking at what they can do to attract more captive business in their domiciles.
“The US economy is in quite a good state now and people are suddenly realising what self-insurance is. The traditional market has been a bit on the rigid side and people are starting to realise that if they have sufficient capital, it’s a good deal for them to be able to manage their own risk by forming a captive.
“States like Vermont and South Carolina have excellent captive operations. It puts these domiciles generally in a better light for being a good place to do business, which can flow over from captive to captive within the domicile.
“Captives are relatively new but they get larger and larger, and they can become quite sophisticated. Some hospital systems in the US have assumed the risk rather than buying insurance from the commercial market. They’re forming their own captives, where they have a much better way of managing the risk and the loss expense side of it.”
Reluctance and regulation
Not everything has been easy for this industry in the past decade. Regulation has also changed over this period with the amount of regulatory oversight increasing and deepening for a wide range of reasons that include the crippling financial crisis of 2008–2009, which shook the US and the wider financial industry deeply.
Harwick at the CICA points out that 10 years ago, captive owners needed to worry only about legislation in their home state. Now, a whole plethora of different bodies take an active interest in the activities of captives including the Internal Revenue Service, National Association of Insurance Commissions (NAIC), the Federal Insurance Office (FIO), the International Association of Insurance Supervisors (IAIS) and even the Organization for Economic Cooperation and Development (OECD).
A number of states have resisted the implementation of legislation to enable the formation of captives.
“Some states are not interested in attracting captives. Those states think there’s too much captive infrastructure to build and there’s a lack of expertise among the people at work within the state insurance arena,” Perschetz believes.
“Captive insurers can become quite sophisticated, more than your typical insurance company. Some state officials who approve insurance companies just might not recognise the need or make the effort to attract captives.
“They might not understand, or they might think that it’s a bit too risky—and they have to have some internal employees who are capable of dealing with regulating captives.
“A lot depends on where the state is and how sophisticated it is—some of them might think that it’s an extra burden that they have to deal with, whereas others see opportunities to create additional jobs and make the insurance department a little bit more important than it had been before.”
Experience is paramount in terms of captives and state regulators. It’s fair to say that over the wide spectrum of states that are now captive domiciles there are some that are doing things right—and some that are doing it wrong. What differentiates these from each other?
Perschetz says: “The states that have been more successful than others are the ones that have very good captive laws, they have more experienced staff within the insurance arena who are committed to dealing with captives and the people that are coming into the state to form captives.
“It’s a challenge that they relish, going into a whole new area like captives, which can be more sophisticated than the traditional market. They get to work more effectively and closely with the captive owners.
“The states that are getting it wrong are the ones that are not welcoming captives into their domiciles. There are people who are looking at it as just one more thing that they have to work with. In the beginning some of them looked at captives as something that was unique and a little bit off-base for the traditional market and the traditional regulators.
“The states that got it right—Vermont, the District of Columbia, Delaware and South Carolina—were the leading states that initially got their feet wet in the water of captives. Some states like Montana have seen what’s happening with those leading states, and have seen the benefits of having a captive domicile and are getting involved as well.”
South Carolina certainly takes the regulatory approach very seriously. Asked about the path that the state has taken since he started working there two-and-a-half years ago, Jay Branum, director of captives at South Carolina Department of Insurance, says building a bespoke regulatory framework suited to captives is the key.
“As a starting point for the development of a captive regulatory policy, I take it as a matter of principle that the captive sector is a discrete sector with its own characteristics which regulators should be prepared to acknowledge, understand, and respect as quite different from the traditional re/insurance sector,” Branum says.
“Some captive regulators refer to themselves as ‘firm but fair’, and I would certainly be pleased if our regulatory approach in South Carolina were recognised for those qualities. Two other attributes I would also like us to be associated with are ‘pragmatic and balanced’.
“By pragmatic, I mean reasonable, practical, and business-minded. By balanced, I mean trying to strike the right balance between being responsive to the business needs of captive stakeholders on the one hand, and being true to our overarching mandate as solvency regulators on the other.
“Getting that balance right is something we strive to do every day. We take very seriously our responsibility to safeguard South Carolina’s reputation as a respectable and attractive place for world class companies to establish subsidiaries and conduct business.”
At the moment approximately 38 US states are captive domiciles—some with just a few on the books, some with hundreds. As the market grows still further knowledge of these insurers continues to spread. Who knows how many the market will have after another decade?
It would be fair to say that many more state insurance departments will have heard of them, will have adjusted local legislation to try and attract them and will be trying to build on past progress.
The next 10 years will be interesting to watch. As Harwick says, captives have not only survived the challenges of the past 10 years, they have thrived—and there is every reason to imagine that the next decade will be even better.