Regulatory élan
With around 35 US states currently having captive legislation on their books, it doesn’t seem impossible to imagine that in a few years’ time all 50 states will have enacted some form of captive regulation. North Carolina, Oregon and Texas have all got in on the act in recent months, so it is apparent that no slowing of the momentum is encouraging states to consider developing a captive industry as they look to emulate the successes achieved by the likes of Hawaii, South Carolina and Vermont.
The issue is whether new entrants, or those states that are re-emphasising a push into the captive space, can deliver on the regulatory rigour and excellence that is necessary to bring out the best in the captive insurance industry.
As Richard Smith, president of the Vermont Captive Insurance Association outlined, regulatory strength is “incredibly important” for the sector and for each individual domicile. Any weakness in regulation has the potential to result in captives being formed with weak or inadequate business plans in place, he said, and “the last thing we want is captives going through insolvency and potentially creating a black eye for the industry in the US”.
Les Boughner, managing director of Willis’ captive and consulting practice, added that while captive managers don’t seek to influence the domicile decision of the captives they manage “the regulatory depth of the domicile is a key discussion point when comparing domiciles—it is a differentiator”. He added that Willis is not interested in working any state where there is a concern regarding the degree of regulation. Regulation is a key consideration, he said.
What is essential is a regulator that is capable, experienced and consistent. David Snowball, captive division director at the Utah Insurance Department, said that outstanding captive domiciles set themselves apart by a “consistent, responsive approach, while retaining a strong regulatory presence”.
Smith concurred, arguing that three factors set the best domiciles apart from the competition: captive experience, the approachability of the regulator and the flexibility of the regulator’s application of captive insurance regulation. He said that in this regard Vermont has been able to establish a recognised reputation thanks to its bench of expertise and its years of experience, and that he worries about the bench strength and staying power of some of the newer and less experienced domiciles.
Smith said that while some states get very excited about the captive concept, many “later run out of steam”, due to changes of personnel or when the returns to the state aren’t what had been hoped. What captives owners need is continuity, he said.
Snowball added that it is essential to maintain staff who are knowledgeable about captives, particularly as entities grow in number and sophistication. Part of this will involve training people up from within, but it will also involve picking up best practice from other more mature domiciles.
“One of the biggest issues for the sector is being able to train regulatory staff fast enough,” he said. This is a particular issue for some of the newer domiciles, Snowball added. In fact such issues have been behind the slowing of captive growth in a number of domiciles, he explained, with their growth potential being constrained by a lack of necessary experience and expertise.
Boughner added that captive growth in certain states has slowed as their “appreciation of what it takes to regulate a captive has grown”.
Smith said that question marks remain regarding the regulatory capabilities of some of the new states, particularly those that are looking to rely on expertise brought in from the commercial arena to regulate their captive sector. As he explained, this may lead to regulators treating captive as they would traditional insurance companies, or domiciles licensing captives whose business plans are weak.
Boughner concurred that questions are apparent regarding the motivations behind the involvement of certain states in the captive space. “With some states you really wonder what they were thinking when they passed captive legislation, because there is simply no regulatory depth,” he said. Without that depth, the regulatory proposition is weakened, opening the captive—and the wider captive industry—up to all sorts of issues.
Examiners needed
One of the key areas that regulators need to attend to—and one highlighted by Boughner as particularly important—is state examiners. Some states still lack local examiners and are obliged to sub-contract examinations out to other domiciles, he said. This makes oversight more expensive and takes it outside the state. Snowball agreed that examiners are an important component of a state’s captive capabilities. He said that Utah law allows for the use of an audit in lieu of an examination for those captives that are compliant and solvent, but explained that such oversight is an essential component of a strongly regulated domicile.
Smith said that in Vermont’s case all examinations are done in-house by people who have come up through the system and understand the captive industry well, while benefiting from oversight from highly experienced regulators. He concurred that hiring contract examiners has significant cost implications for captives in domiciles unable to conduct their examinations in-house.
Nevertheless, Boughner said, he has never come across a state that is not concerned about the reputational risk of any regulatory shortcoming. Instead they are looking to pick up best practice from the best and most experienced domiciles. Addressing captive legislation, Boughner said: “If you did a word-matching algorithm to the Vermont code, I think you would see a strong correlation in many of the other states’ legislations.”
And it is apparent that many states are also willing to share their knowledge and experience with fledgling states. “There is a real willingness to provide guidance and information,” said Smith.
“Dave Provost [deputy commissioner of captive insurance in Vermont] has consistently shared his expertise with other regulators. Although other states may be considered ‘the competition’, Vermont feels it is valuable to share best practice with them,” he explained. By doing so, Vermont can help to raise standards right across the industry and create opportunities for all states as the attractions and maturity of the industry deepens.
Snowball spoke in a similar vein, adding that Utah has worked diligently to help new domiciles including North Carolina, Oregon and Texas build their captive capabilities. “There is enough business out there for us all; the question is about keeping the industry strong,” added Snowball.
He said that education is an important consideration for the industry. Much of this education will come from examinations—another reason to keep them in-state—adding that new domiciles can at times seem naïve. “They learn with time how best to regulate and oversee their captives. It’s a learning curve”—one that the more mature regulators can help with.
Looking ahead, it is apparent that there is continued appetite to develop captive legislation in the remaining 15 states. Boughner, for his part, was bullish about the prospects of more states entering the fray. “I would be happy if all 50 states had captive legislation and we had offices in every jurisdiction.”
Smith sounded a note of caution, however. He said that while further entrants would give captive owners more options, the concern is whether it is backed by strong regulation and continuity. “There are few industries where owners want strong regulation, but this is one of them. This is their money at risk and they appreciate the feedback and oversight afforded by a strong and capable regulatory authority.” Demand for strong regulatory teams and oversight is likely to be sustained.