In the world of risk management, captive insurers have taken on a major role for companies of all sizes. Their value for insuring difficult-to-place risks and the added control they offer for insurance programs are widely recognized. While formation of captives has traditionally peaked after major events, such as Hurricane Katrina in 2005, their growth has continued during both hard and soft markets.
“Despite volatility in the financial sector, global economies, and the emergence of new risks, captives continue to thrive, providing affirmation of their efficacy, flexibility and stability,” Marsh stated in its benchmarking report The World of Captives: Growth and Opportunities Without Borders. “The growth of captives in 2014 was no exception.”
As the captive market has become more mainstream, differentiating between domiciles is often an exercise in comparing financial data. Nevertheless, some larger trends have emerged that indicate where captives could be headed in the future.
In Vermont, the largest U.S. domicile and third-largest worldwide, 16 new captives were licensed in 2014, comprising 10 pure captives, two sponsored, two special purpose financial insurers, one association and one risk retention group. So far, 2015 is looking even better, with 10 new captives licensed, according to Sandra Bigglestone, director of captive insurance in the captive division of the Vermont Department of Banking, Insurance, Securities & Health Care Administration. “I don’t think we were even close this time last year,” she said. “We also have a healthy pipeline. We have had conversations and we expect applications to come in this month. It’s been a good year so far.”
Vermont also saw two redomestications last year, and Bigglestone expects to see this trend continue throughout the market. “In particular, there is chatter about risk retention groups (RRGs) seeking to move,” she said. The top reason given is examination costs, which can be “pretty brutal on RRGs.”
This is because a number of domiciles use contract examiners, adding another layer of costs as the state captive department then has to supervise the contract firms and the examiners they are using. “Vermont may not be completely unique, but a majority of our staff—25 people—are dedicated to analysis and examinations of our captives, which helps control the costs,” Bigglestone explained, adding that examination costs for an RRG can exceed $100,000 every three to five years, depending on state law. “Our average cost for RRGs so far in 2015 is $43,000,” she said, noting that the state’s three-year average for 43 RRG exams is $37,640.
Another development in the captive market is an increased interest in health care captives, especially by medium-size companies. “Group captives in the health care space are definitely growing,” said Gary Osborne, president at captive management firm USA Risk Group. “There are new variations of ‘skinny’ plans and these are being run through captives as well.” Skinny plans, or preventative and wellness plans, are mini-medical plans that cover preventive services such as doctor visits and generic drugs.
Construction captives are also seeing a resurgence as the construction industry continues to rebound in the wake of the financial crisis. “Those that weathered the downturn are coming back stronger,” said Sanford Saito, deputy commissioner and captive insurance administrator for the state of Hawaii. While business slowed for these firms during the downturn, they continued to use existing captives for coverage needed for ongoing projects. “They slowed down on the construction side, but they already had legacy risks on the books, at least for their captive, and they went into a runoff period,” he said. In runoff, the captives continued to pay claims, adjudicate any claims in process and keep the insurance intact.
Saito has also noticed a trend in captives being formed by tech startup companies in Silicon Valley and the San Francisco Bay Area. “We have noticed that a lot of the established high-tech companies’ personnel are being poached by up-and-coming companies,” he said. “So they might have a CFO or CIO from Microsoft or IBM, and those companies may have had a captive. As a result, these people understand what a captive can do, so when they land at their new startup, they bring an almost ready-made comfort level in exploring the captive concept and bringing it up with their insurance brokers.” Tech companies are using captives for product liability, general lines, property, and errors and omissions coverages, he noted.
Hawaii is also attracting captive formations for cyber coverage. “They may not be able to cover the entire breach, but when they went into the market to look for it, they were flabbergasted at the cost,” he said. “They are either adding it as a new retention because they didn’t have the coverage already, or they are working with their current insurer to take a deductible at the bottom and participate at the higher levels, rather than the traditional way of insuring.”
New and Emerging Markets
While companies from the Pacific Rim have been forming captives in Hawaii for years, their numbers are increasing. “We have noticed that continuing to spread the gospel in Asia about captives, specifically in Japan, is finally bearing fruit,” Saito said, noting that traditional Japanese corporations were previously hesitant to form a captive out of a sense of consideration for their business contacts and relationships with large Japanese insurers. “The captive concept sort of implies that you are taking away business from a valued business partner,” he said. “More and more, however, large Japanese insurers are taking a second look at the captive concept and how it might help their large customers.”
Currently, more Japanese companies are moving beyond exploring feasibility and are actively forming captives. “In 2014, we had six new captives that had ties to Japan,” he said. “I have noticed that the U.S. subsidiaries of Japanese companies embrace the captive concept before their Japanese counterparts. I think they see the benefits of using a captive for mitigating their risks and taking ownership in that fashion.”
In Bermuda, the world’s largest domicile, Shelby Weldon, director of licensing and authorizations at the Bermuda Monetary Authority, said they are still seeing considerable interest from Latin America, noting that 25% of the new captives incorporated there in 2014 have a Latin American focus.
“Emerging markets like Latin America are finding that a captive can be part of an entire enterprise risk management framework, which they might not even have,” he said. “Rather than going out and buying coverage because it is cheap, a captive can put a program in place.”
There is also renewed interest in formations from Canadian companies. Bermuda’s government entered into a tax treaty with Canada several years ago, “allowing the governments to share information and also providing Canadian companies looking to do business in Bermuda with a tax advantage,” he explained. “This puts Bermuda on a level playing field with Barbados, where Canadians have traditionally formed captives.”
In Alberta and other parts of Canada, Weldon said that a number of large energy companies are also finding they can use a captive to insure their property risks, including their plants, transport vehicles and commodities.
Lately, some of the biggest news in the captive market has been about the smallest captives. For a number of years, many thought that overall formations of captive insurers would dwindle because there were only so many companies large enough to form them. Instead, growth in the number of domiciles in the United States has driven competition, expanded the concept of captives and inspired creative new ways to attract them.
Small captives—any captive that writes less than $1.2 million, according to Marsh—were introduced to appeal to mid-size and small businesses, allowing them to insure difficult risks or take larger deductions with their insurers to keep coverage costs down. Now they can take advantage of captives the way large corporations have since these risk transfer vehicles first became popular in the 1980s.
Of the captives it managed last year, Marsh reported that small captives grew more than 100%, with the majority of these captives owned by companies in the middle market. “The fact that small-sized captives are the largest group in the distribution effectively demonstrates our theory that captives are no longer exclusive to Fortune 500 companies,” Marsh said. The top five industries using small captives were construction; transportation; communications, media and technology; sports, entertainment and events; and financial institutions.
While Vermont is known for large single-parent captives, small captives, including sponsored and cell, have also been a success story there. On May 7, Vermont Gov. Peter Shumlin signed into law changes to captive legislation that reduce the minimum capital requirement for sponsored captives from $500,000 to $250,000. “Over the years, we have licensed 25 sponsored captives and, at the end of 2014, there were 104 cells and 78 of those are active,” Bigglestone said.
She noted that the types of businesses in individual cells are not required to be similar, like in some other cell arrangements, and that the number of cells within a sponsored captive are unlimited. Sponsored cell captives have another advantage in that they can also serve as incubators. “At any point, if they feel their program is large enough, they can turn it into a single-parent captive,” she said.
Another small captive that has become increasingly popular in some domiciles is the 831(b), which offers tax advantages. Because they have often been formed for financial planning purposes rather than to address insurable risk, however, they have gotten the attention of the IRS, which this year added captives to its “Dirty Dozen” list of abusive tax scams and announced plans to target “unscrupulous promoters” of small captives.
Because of the fear of attracting negative attention from the IRS, a number of captive managers have been hesitant about forming them. “With 831(b) captives, we have always been cautious,” Osborne said. “We will do them, but we see that they have third-party risk. We only do it if it makes sense and we’re really comfortable with what they are doing.”
He sees the largest number of these captives being used for risks in the property area, especially to cover windstorm, earthquake and flood catastrophe exposures. “Where they have a high deductible, it’s very attractive for them to be able to put a million dollars aside and let that build for years until something happens,” he said. “That’s been the driver behind the ones we have done.”
While there is still a lot of interest in 831(b) captives, Osborne said, “we are not doing it with the wealth-advisor community. Our approach is to look at their risk profile, the issues that cause problems and their current coverage to see if this might make sense.”
This way, he added, “when we do get challenged, we have a strong position to argue that this is done for risk reasons and the tax is the icing on the cake—not the driver.”