A new study by A.M. Best affirms what captive domicile regulators are saying, that the alternative risk-transfer market continues to flourish, despite the current soft insurance market--especially in the captive-heavy medical malpractice sector.

In its special report, released in late July--"Medical Malpractice Leads Captives' Premium"--Best found that falling med mal prices led to a 15 percent drop in net premiums written between 2006 and 2007 for a composite of captive insurers, but that captives overall benefited from favorable underwriting trends.

Best analysts told National Underwriter that risk managers have become much more sophisticated in their use of captives. They are holding onto their facilities--even during a market when insurance rates are down--almost across the board.

In fact, captives are thriving, said Best analyst John Andre. He noted that "premium volume is down among the captives that we follow, but the results are still solid...I guess it shows that the experience is still good, even though the volume may be down for whatever reason."

The drop in captive premium volume, he said, may be the result of "competition from the standard market," adding that another possibility is that "a lot of them are taking advantage of some solid reinsurance pricing and getting some protection there."

Another Best analyst, Gail Guerra, observed that even though prices for coverage are soft, many captive owners are choosing to stay the course.

"A lot of them prefer to stick with the captive instead of searching for the lowest [insurance] price, because of all the value-added services, the claims-handling and the risk management," she said. "They prefer to just stay where they are and ride it out."

A group captive, such as a risk retention group, might retain the client but have less premium written with them, "because that group captive may reinsure more of their business," Mr. Andre said. The client might also take a portion in the direct market, leaving another piece of business in the captive, he suggested.

With prices low, captive owners can get creative, he added. They can use the captive for certain lines and access the open market for the rest of their business, he said.

"I think we've noticed the past two or three years, over the last market turn, that captives are not getting up on a shelf like they might have years ago and becoming inactive," he said. "There are more and more being formed, and they're being used very strategically now, versus the last market cycle turn."

The analysts agreed that insurance buyers are becoming much more sophisticated in their knowledge and use of captives. Mr. Andre added that risk managers and brokers are using their captives much more strategically.

A.M. Best said its outlook for the captive industry is stable.

SOUTH CAROLINA

Jeff Kehler, program manager for the South Carolina Insurance Department, agreed with Best's assessment. "The captive industry is a very resilient one," he said. "If you look back all the way to 1950, there have been lots of economic challenges in the states, but every single year has shown a positive net growth in the number of captives."

He added, "So I think they'll continue, and at the end of the day there'll be another positive year this year. Where there's a vacuum in the hazards the traditional companies don't want to cover, the captive always seems to look to find a way to solve that."

In 2007 South Carolina licensed 27 new captive companies, and Mr. Kehler predicted 15 more this year. The state's total number of captives is 163, which he observed is catching up with Hawaii, which has 165. He added that the state is fast approaching its 200th license since the captive act was signed in 2000.

He noted that South Carolina is still doing special purpose financial captives, "but it's slowing down. Some of the other domiciles are doing them now. And let's face it, we've done 25 so far, and the biggest players have already done theirs."

He summed up current market conditions: "The big drivers are the economy and the market conditions. Pricing is pretty darn soft--in fact, when reinsurance pricing along the [hurricane-prone] coast of South Carolina goes down, you know that's some soft market conditions."

WASHINGTON, D.C.

Associate Commissioner Dana Sheppard said the domicile licensed seven captives in 2007, and so far this year has licensed seven more. "I wouldn't be surprised if we got up to 15," he said, noting that "from what I hear, all the domiciles in the U.S. have been slow this year."

He said that last year the District of Columbia may have seen fewer licenses because it was in a transition period. "We started to scrutinize more closely the [risk retention groups] we were willing to license," he said. "As a result, some of the managers have been less active here and taken their business other places."

Mr. Sheppard explained that D.C. "buckled down and said we would do RRGs, but not the ones that aren't motivated by the right prospects. I think over time our decision not to do these will be reinforced."

He added that other companies are starting to take a look at D.C. and its newly amended protected cell law, which is attracting attention. For the time being, he said D.C. has somewhat of an exclusive ability to license protected cell companies in the United States.

"In fact, most of the jurisdictions I've seen, the laws state the opposite--that [cells] cannot be created as a separate legal entity. So that's attractive to some," he said.

HAWAII

Craig Watanabe, Hawaii's captive administrator and deputy commissioner, said that so far this year, four new companies have been licensed. Two are Japanese-based and the other two are Hawaiian companies. Two captives were lost, leaving a total of 165, he noted.

"Nothing from the Mainland," he added, citing two reasons--competition from the soft market, as well as from other domiciles.

Mr. Watanabe noted that last year Hawaii licensed 10 captives, from Japan and the West Coast--several of which were for construction and real estate.

"The smaller, home-related construction captives may slow down, but most of these are very large, with government infrastructure projects, not as affected by the real estate market," he said.

Hawaii has some "pretty good-sized risks, and they're okay," he said. "But we've got some smaller ones, too, and that's where the downturn in the economy, the subprime [crisis], the housing market, really is affecting some of them."

He added that Hawaii will "probably lose at least one or two of them this year. The owners may take the risk back to the parent level and dissolve the captive or put it in a dormant status."

Mr. Watanabe said he recently attended a captive conference in Singapore, and found the region of Southeast Asia becoming much more interested in forming captives.

DELAWARE

William P. White, Delaware's captive administrator, said that "given that it's a slow market across the board, we've seen some sporadic activity with group captives."

He added, however, that "we haven't seen a lot of activity in the areas we're most interested in, and that's the special purpose financial captives and some of the more sophisticated captives used to access the capital markets--but that's for obvious reasons."

The domicile is seeing activity with larger group captives. Last year 12 were licensed and so far this year just one--for a total of 18 overall, he said.

"It's a soft market and the IRS issue slowed things down," he said, referring to an abandoned initiative to negatively alter the tax treatment for self-insurance vehicles. As a result, those interested in forming a captive are having to "reconfigure, restructure, rethink what they're going to do," he noted.

As for inquiries, he said, "a lot of it is very different, and it's what gives rise to this idea that a lot of groups are rethinking what it is they need to do. We've had inquiries of interest in doing types of cell captives for a variety of exposures, some concerns about TRIA, some concerns about doing some 'unwrapped' SPFC deals--guarantors are in trouble right now."

A number of discussions have centered around the domicile's flexibility with regard to "RRGs and other group captives," he noted. "There I'm talking about segregated account structures and sponsored captive-type structures," which would include all of that, meaning protected cells and incorporated cell companies.

MICHIGAN & CONNECTICUT

Michigan Gov. Jennifer M. Granholm in March signed into law captive legislation, adding the state to the list of about 30 U.S. captive domiciles.

Diane Bissell, administrative law assistant with the Department of Labor & Economic Growth, Office of Financial and Insurance Regulation, said the bill "has been on the fast track. We're a state in a serious economic situation."

Captive legislation was requested by Jackson National Life Insurance Company, headquartered in Lansing, Mich., she noted.

John Brown, vice president of government relations for Jackson National Life, said, "We're gratified the governor signed the bill, and we're looking forward to its implementation here in Michigan."

Meanwhile, Connecticut on June 2 enacted captive legislation but won't be funding the operation for months or hiring a captive administrator anytime soon, according to Debra Korta, state legislative program manager, who noted the law becomes effective Jan. 1, 2009.

Ms. Korta said funding for the captive division--allowing for three positions--will become effective Oct. 1, 2009.

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