10 August 2015Actuarial & underwriting

A winner in the domiciles sweepstake

How do you view the proliferation of onshore domiciles in the US, and how do you think things will shake out over the next five to 10 years?

If you look at the proliferation of states in the US that have passed captive-enabling legislation within the past five or six years and ask yourself how many of those states are likely to achieve something like critical mass, it’s very difficult to see how most of them will, for a number of reasons.

For one thing, it takes time and a sustained investment approach on the part of any state that aspires to ‘play home’ to an appreciable number of captives and appeal to a broad range of prospective captive owners—in other words, to build a solid portfolio.

The economics of state government do not support the build-up of regulatory resources on anything other than a piecemeal basis. By regulatory resources I mean a staff fully dedicated to the captive sector with a proper understanding of its distinctive dynamics.

Beyond that, the economics of the captive management business model will simply not support the concentration of resources at offices in more than a handful of states—certainly not in this age of electronic record-keeping, flexible delegations and workload balancing, and the widespread use of remote working arrangements. The bulk of captive management work will be done in those locations where it makes most sense in the context of the particular captive manager’s operations.

So I think that most of the relative newcomers to what I sometimes refer to as the ‘domiciles sweepstakes’ will struggle to project a compelling value proposition that will allow them to differentiate themselves and build critical mass. And I certainly don’t see any plausible or realistic scenario for the emergence of a thriving captive programme and captive business sector in dozens of different states within the next decade.

Do you regard this proliferation phenomenon as a positive or a negative for the captive movement overall? Does it raise any particular concerns for you?

I don’t think it necessarily has to be viewed as either a positive or a negative. As I have often said, choice is a good thing, and to the extent that captive owners have more choices, that is good for them. However, I also think that a number of regulators and practitioners share a concern that in their drive to license more and more captives, some domiciles may apply a lower degree of scrutiny both at the licensing stage and as a matter of ongoing solvency and compliance monitoring.

"Facilitating the creation and build-up of value for captive owners over time is the bottom line rationale, the 

raison d’être

 of our whole sector."

Should that trend manifest itself over time in captives with solvency problems, unsound business plans, patterns of troubled operations and sloppy compliance and the like—especially in domiciles with minimal capital and surplus requirements, token filing requirements, and the absence of financial condition examinations—then you can expect to hear charges that captive regulators are indulging in a ‘race to the bottom’.

There will be louder calls for more stringent and more uniform regulation of the whole captive sector, and perhaps even efforts to subject captives to the kinds of requirements that are more appropriate to the traditional insurance sector, but which are wholly inappropriate to captives and not at all in keeping with the ‘principle of proportionality’ embraced by the International Association of Insurance Supervisors (IAIS).

My view is that if market forces are allowed to dictate the direction and results of this proliferation trend without regulatory overreaction by forces at either the National Association of Insurance Commissioners (NAIC) or the federal level (forces that are likely to have little understanding of the captive sector and may even be hostile to it) then the captive sector will be just fine.

Captive parents will make the choices that further their own interests and managers will do the same. Some captives will go ‘belly-up’, as undoubtedly they should, just as others will be shut down because they no longer meet the changing needs of their parents.

The pendulum having swung too far in the direction of proliferation, it will sooner or later swing back in the direction of consolidation. Some states’ programmes will become dormant or moribund—I am not rash enough to predict which ones—especially as overall economic conditions continue to improve in those states.

What was it about South Carolina that attracted you to take your current assignment?

When I arrived in South Carolina in November 2013, I found two assets of inestimable importance to the state’s position and prospects as a domicile. The first was a dedicated captive team within the department built over the near decade-and-a-half since the inception of our programme in 2000. That team includes seasoned captive professionals with a strong background in the industry working alongside exceptionally talented financial analysts, all focused exclusively on the 250 or so captives that had been established in our state up to that time.

Clearly, the Palmetto state had long since achieved critical mass in numbers of captives licensed and in acquiring and developing captive expertise within the department.

The second source of strength was a high concentration of professional captive service providers resident within South Carolina. Charleston in particular has developed into a real captive hub. Virtually all the global captive management firms have professionally staffed offices in Charleston from which they provide management services to captives domiciled not only in South Carolina but also in Delaware, the District of Columbia, North Carolina, Tennessee and states outside the south east region.

In almost every case, the individuals who run their firms’ captive management offices in South Carolina have transferred in from other long-established captive domiciles such as Bermuda, Cayman, and Vermont, and have brought with them a wealth of practical experience and captive-specific know-how gained from years of working elsewhere in the captive sector.

During 2014 four new captive management firms opened offices in Charleston and moved experienced personnel into the state to run those offices: Willis, JLT Towner, Somers Risk Consulting, and R&Q joined the ranks of other prominent management firms with a long-standing presence in the state—companies such as Marsh, Aon, SRS (Strategic Risk Services) and USA Risk Group. This is what critical mass really looks like—not just the sheer number of captive licences issued.

These moves represent very real investments in South Carolina by these individuals and their families, as well as by their employers, all to the benefit and betterment of our whole captive programme. The result is a cluster of professional captive service providers—a genuine captive community resident within the state—largely concentrated in Charleston, but to a lesser extent also in Columbia, and Greenville, South Carolina. This is a tremendous asset to our domicile and sets us apart from every other onshore domicile with the exception of Vermont.

The bottom line is that South Carolina had all the ingredients to consolidate a position alongside Vermont, and perhaps one or two others, in the top echelon of onshore domiciles. It just needed a new approach to some old issues and challenges—new ideas, a sustained dose of high energy and an insistence that our policies, practices, and procedures all need to make sense.

What changes and accomplishments can you point to during your tenure to date?

In my first few months on the job, we mapped and critiqued each step of all our internal processes with particular focus on the application and licensing process, which we totally revamped to eliminate redundancies and needless red tape. These process improvements are, and will continue to be, ongoing. We also started to pay more attention to staff development and undertook a range of new marketing initiatives.

All these steps were preceded by sitting with captive managers during my first week on the job to hear about their perceptions of the domicile, their experiences in dealing with the department, their frustrations, challenges and opportunities. These sessions yielded invaluable insights as well as practical information of great use in identifying and addressing internal and external issues.

I saw right away that there was no shortage of opportunities to make big improvements fast and to see them bear fruit. By moving forward quickly on multiple fronts, we were able to attract and license 20 new captives in 2014, compared with only three during 2013. Importantly, we did so without lowering our prudential standards. Four of those 20 new captives were established pursuant to enhancing legislation passed in June 2014, which allowed the formation of a wider range of cell company structures on either an incorporated or an unincorporated basis.

Is there a regulatory philosophy or set of values that you would like to be identified with as chief regulator of and advocate for the South Carolina captive programme?

Absolutely. It boils down to four things. The first is professionalism across the board and closely allied to that is the second, which is consistency of execution. Both of those relate to the internal workings of the department. The third is the quality of our portfolio of captives—we don’t want to be licensing rubbish. Quality trumps numbers of licences on our scale of values. And if companies do get into trouble with their solvency or any other aspect of their operations we need to find out why and take appropriate steps to put them on the path toward full compliance in terms of financial and operational soundness, or be prepared to do whatever else the statutory regime calls for under given circumstances.

The fourth and final thing is probably the most fundamental and most easily overlooked, and that is to emphasise the element of owner choice and owner value. In essence, none of this activity takes place if the captive service providers—the captive managers, the consultants, the legal and other advisers—as well as the regulators, aren’t about providing prospective and actual captive owners with smarter, more sophisticated and individually tailored ways to help manage and finance risk. Captives cater to that need.

As we each play our respective roles in the process, we should not lose sight of the fact that what we are really doing or should be doing is facilitating the creation of something of value that hopefully will be sustainable. Facilitating the creation and build-up of value for captive owners over time is the bottom line rationale, the raison d’être of our whole sector, and I don’t hear other people out there articulating that particular message. It seems to be taken for granted at some level, but I don’t think that we can afford to do that. That element underpins everything that we do and we shouldn’t allow ourselves to forget it.

Anyone can say ‘we’re a business-friendly’ or a ‘captive-friendly’ state and mean it, but it takes a lot more than that in order to be a credible captive domicile. You have to let people know that you have an understanding of the business itself and the reasons that companies form captives in the first place. I believe that regulators would do well to (a) acknowledge and respect the financial and risk management imperatives that drive business owners and executives to establish these insurance subsidiaries, and (b) to adopt a regulatory approach that is commensurate with the nature, scale, and complexity of the activities and risk profile of each individual captive.

Jay Branum is South Carolina’s director of captives. He can be contacted at: