11 August 2016Law & regulation

Operating in plain sight

The US captive industry continues to prosper in 2016 despite a number of challenges, some ongoing, some new. As I’ve written before, as a mature industry we now operate in plain sight in a regulatory world. No longer do captives ‘fly under the radar’. That doesn’t, however, mean that captives are well understood. They are not.

Traditionally, captives were the ‘ying’ to the commercial market’s ‘yang’. They were an alternative to what was available in the commercial market or—more accurately—they were a response to what was not available at a reasonable price in the commercial market. But now captives are a strategic tool. No longer do we regard a captive as something that is a response to a hard insurance market (although a hard market—however far off it may be—would certainly boost the utilisation and creation of captives).

I once heard John Huff, the Missouri Insurance director and current president of the National Association of Insurance Commissioners (NAIC), describe captives as a chassis, not a vehicle. You can build whatever kind of vehicle you want on that chassis—as long as it’s roadworthy. The traditional captive industry got used to seeing single parent vehicles, group captive vehicles, agency captive vehicles, and cell captive vehicles.

In recent years we’ve seen behemoth XXX and AXXX life insurance/annuity captives built on that chassis. At the other end of the spectrum we have the 831(b) microcaptives being built on the same chassis! And with the increase in the allowable premiums moving up to $2.2 million at the beginning of 2017, these ‘microcaptives’ will be more properly characterised as ‘small captives’—a term that the Captive Insurance Companies Association (CICA) has decided to use.

Looking ahead

What does 2016 hold in store for the captive industry? In many respects, it is more of the same: a mature industry navigating a regulatory world.

The challenges continue to come from the usual sources: the Internal Revenue Service (does ‘The Dirty Dozen’ ring a bell?), the NAIC, the Federal Insurance Office (FIO), the Department of the Treasury, etc.

Sometimes the challenge comes out of left field, such as the Federal Housing Authority and its decision to prohibit captives from being members of the Federal Home Loan Bank. Although not much legislation is being enacted by Congress, it occasionally leaps into action with little or no notice, such as the Senate Finance Committee’s surprise legislation to amend the 831(b) criteria for small insurance companies.

"CICA - along with most other experienced and skilled service providers to the captive industry - advocates a 'do it right or don't do it at all' approach." Dennis Harkwick

Over the decades, I’ve developed an explanation of what I call the ‘regulatory imperative’—the underlying dynamic and motivation of regulators. First and foremost, they live in terror of being accused of failing to protect consumers in whatever industry they are regulating. Second, they want everything and everybody they regulate to fit into a single template.

Unfortunately, captives—by nature and definition—tend not to fit within that regulatory dynamic. As the saying goes, ‘When you’ve seen one captive, you’ve seen one captive.’ They don’t usually fit into a template. They are a chassis upon which is built a unique vehicle. Also, the consumer protection element is vastly reduced by the fact that the ‘consumers’ actually build and own the vehicle.

In my opinion, most of the reputational danger to the captive industry comes from promoters of a ‘one-size-fits-all’ captive—usually with the pitch that captives are a wealth transfer or tax reduction vehicle. CICA—along with most other experienced and skilled service providers to the captive industry—advocates a ‘do it right or don’t do it at all’ approach. There must be a legitimate insurance purpose for forming the captive, with real risk shifting and risk transfer, along with all the characteristics of a real insurance company.

Judicially, this has been a positive year for captives with wins in Rent-A-Center v Commissioner and Securitas Holdings v Commissioner. At the time of writing, we are waiting for the decision in Avrahami v Commissioner that will shape the future of small captives under the 831(b) election.

In closing, I want to emphasise that despite all the challenges discussed above, the utilisation of captives is still a vibrant and growing industry. At captive conferences and in articles we tend to focus on the negative aspects—as we should in order to equip our members and colleagues with the tools they need to meet those challenges.

But we must remember what a success story captives are and how they have grown from a desperate response to failures in the commercial market to an innovative, strategic risk management tool with a bright future.

Welcome to the world of captives.

Dennis P. Harwick is president of the Captive Insurance Companies Association. He can be contacted at: