The Fast and the Furious – Competition for Captives Soars

In 1955, when Fred Reiss, a former fire protection engineer turned insurance agent, secured his first captive insurance client in Ohio, the event at the time could hardly be akin to “the shot heard ‘round the world”, a famous line attributed to the beginning of the Revolutionary War. However, Mr. Reiss felt very enthusiastic about the captive concept and secured seven more captive insurance clients in the US.

The US insurance laws at the time did not recognize the difference between captives and traditional insurance companies, so Mr. Reiss searched for place outside the US that had an accounting and financial infrastructure and would help him promote his “new” captive concept. After searching in several places, including Switzerland, Bermuda was chosen.

While the acceptance of captives, and later an entire industry referred to as “alternative risk transfer” was slow, today it represents over $50 billion in premiums, including 5,000+ captives worldwide. Bermuda, because of its risk taking investment in the captive model, is clearly the domicile most often associated with captives and its economy has been forever changed as a result. According to a Government report on employment in Bermuda, the international business sector has become the island's leading employer for the first time.

Other early adopters including Cayman, Guernsey and Vermont, all of whom passed captive insurance legislation or had the necessary infrastructure to accommodate captive entities, have also enjoyed the notable increase in their economic situation as a result of providing a serious and progressive business climate for captives, and in some cases, RRG’s. Vermont’s captive industry in 2003, for example, represents 1100 jobs and produces over $14 million in taxes for that state’s economy. When Vermont passed captive insurance legislation 1981, it was primarily known for its timber industry. Hawaii’s captive industry’s contribution to the state’s economy is $17 million.

The success of these domiciles in the captive market has motivated many other countries, territories, and states, to enact their own form of captive legislation in the hope of augmenting their own economy, notably through employment, hospitality, or taxes. To attract business to their domicile, some will leverage their location, infrastructure, tax, or captive statutes to entice you. The choices can be overwhelming.

If you are looking for a place to set up your captive, you will find no shortage of domiciles from which to choose. In the last few years, there has been such a significant increase in the number of captive domiciles in the world, that I have a hard time keeping up. My last count was over 80, of which about 30 states are in the US. New Jersey is the latest state to enact captive insurance legislation in 2011 and more are expected to enact similar legislation. (Note to Ohio: What's the hold up? Ohio can claim "birthplace of the modern captive" and Youngstown, OH can be the "heart of it all").

The increasing choices in domiciles are both good and bad news for captive owners and corporate insurance buyers. The good news is more selection, less travel, and competitive pricing and taxation. The bad news is a thinning of experienced regulators or supervisory bodies in the captive domicile or insufficient accounting and professional support services to manage your captive. These considerations apply to both onshore and offshore domiciles. Both are critical components of managing any alternative risk entity.

In any event, because of the competition among the growing number of domiciles to obtain your premium dollar, - despite a softening of premiums (for now) in most lines of insurance - buyers can look forward to increasing innovation in the use of captives and alternative risk strategies, speed to market and eventually, I believe, domiciles segmenting the marketplace to attract a certain type of captive owner or size.

Let’s take innovation. There are so many advances and augmentations since the days of Fred Reiss and the single parent captive, it’s dizzying. But one innovation that was created in Bermuda in the 1970’s that has the chance to create another wave of captive users is the rent-a-captive.

There are several versions as to how the rent-a-captive started, but I suggest that it was motivated by a need to write third party business by single parent captives and the demand by some who wanted the benefits of a captive but could not or did not want to start one themselves. Ultimately, this led to the creation of an investor-owned captive that sought middle market business. Each client was accounted for separately as the captive itself was more or less a pure captive. Bermuda, at that time, you see, did not pass formal insurance regulations until 1978, so while a governing supervisory body approved each business plan, there were no classifications of a captive.

Quite like the single parent captive model in the 1960’s, the 1970’s rent-a-captive concept did not gain immediate acceptance. Nevertheless, in 1997, Guernsey, an offshore captive domicile and part of the Channel Islands, passed its version, “Protected Cell Companies” which improved upon the original model by “statutorily segregating” each client on a cell-by-cell basis. Most of the large offshore domiciles followed, including Vermont in 1999, each passing their own version, thus preserving their respective competitive positions (and their economy) and hopefully stopping any flow of business from their domiciles to another because of laws that are more favourable.

By 2006, Jersey, a sister island of Guernsey, but managing only a fraction of the number of captives that Guernsey does, passed an updated version of Guernsey PCC, called “Incorporated Cell Companies”. This allowed individual cells not only statutory segregation, but allowed each cell to become a legal identity as well as other attributes different from the PCC. In response, Guernsey passed ICC legislation within weeks of Jersey’s version. In the US, the domicile of Washington, DC, could be the first to pass its version of the ICC concept, while most US domiciles have already passed Vermont’s versions, called a “sponsored captive”.

Historically, while most captive innovations are readily accepted, some can supersede the ability for some regulators to accept them, either because they do not intend to regulate that type of captive business or wish to focus their efforts on a segment in the marketplace. Some buyers may rebel against this type of selective acceptance of the progress of captives – and RRG’s – but in the end it should provide them with an advantage to intelligently choose their captive or RRG domicile.

In an increasingly fragmented captive marketplace, it is becoming difficult for a domicile to differentiate itself from the rest of its competition. Long gone are the days where one went to Bermuda or Cayman for offshore reasons or to Vermont or Hawaii for a US-based captive. And, if you wish to implement an RRG solution, there only one country to go – the US, but to which state?

One successful strategy often used in business competing in a fragmented market is to identify the market you choose to compete in, based upon what your core competencies are and specifically focus your efforts to obtain that business. For a domicile seeking to preserve its position or to increase its business, this may mean the loss of opportunities to write all kinds of captives and RRG’s in the short term, but in the long term it will establish a “brand” in the industry segment it wishes to attract.

Buyers are already the beneficiaries of this marketing strategy. Cayman, for example, has become almost synonymous with healthcare captives, yet it allows most type of captives and industries to domicile there. Bermuda, originally known for captives, is increasingly known for excess liability capacity and property reinsurance. Vermont, arguably the most well known US captive domiciles, attracts large captive clients partly because of strong brand image. Other examples include DC for its speed to market regarding captive legislation thus giving its clients access to new risk transfer technology, and perhaps Arizona for its “no tax” position on captives, quite a unique feature since most captive domiciles rely o some sort of tax to sustain their supervisory operations.

I will add one more strategy that may be effective as well, specifically for the US domiciles – regionalization. As more and more states enact generic captive legislation, the only differentiation between their competitors will be location. Location for some buyers is very important as their time cannot be used to travel to and from their captive domicile yet wish all the benefits. For them, innovation, taxes, or progressive captive legislation is not as important as their time.

As a direct result of increased competition for captive business, corporate insurance buyers, captive and RRG owners, and risk manager, are being ushered into a new phase of risk transfer strategies and an environment that will be more easily accessible, competively priced and progressively updated. These changes have happened quite rapidly and mostly within the last few years. The face of insurance is being unalterably changed and you get to be a part of it. Good luck in finding your edge.

Will Japan's catastrophe(s) quicken cycle turn?

Captives popular with insurance agency owners

I just came back from a conference for program administrators (PAs) in Arizona last month. Attendees included agency owners, MGAs, wholesalers and many carriers. A workshop on captives for agency owners was very well attended.

That leads me to believe that despite the softnes of the current insurance marketplace, the savvy captive candidate is still interested in how to make more revenue for his firm as well as for his employees and clients.