While the financial market crisis and the deepening recession are being blamed for a drop in captive insurer formations in some domiciles, the captive business is far from dormant, with at least two domiciles actively licensing more facilities and others hoping a hardening commercial insurance market might spur more alternative risk-transfer activity.

Nancy Gray, executive director for North America at Aon Insurance Managers, predicted that 2009 will be similar to 2008, with "continued new formations, but along the same trends of expanding the captive use and also the number of new formations."

In particular, she noted, "we're seeing signs of the market hardening in some lines--that will have an impact on captives."

However, with the economy in such dire shape, corporate insurance buyers are more focused on the costs of operating a captive.

"There's more involved in setting up a captive," she said. "The period of time from when a risk manager decides they want a captive to the point of getting approval is much longer than what we've seen in the past."

This trend, she said, started after the fall of Enron and implementation of Sarbanes-Oxley disclosure mandates for public companies. "The days of risk managers being able to make that decision [to form a captive] on their own, I think, are gone," she said, adding that corporate boards are much more involved with such strategic moves.

When selecting a domicile, Ms. Gray said, cost is a factor as well as the infrastructure of the domicile--how well established it is and the reputation of the regulators. She said there is more focus on location, because more than ever, companies are looking for convenience.

The following is an overview of the latest news and trends in U.S. captive domiciles:

One domicile that has seen phenomenal growth is Kentucky, which began licensing captives in 2000 and has formed most of its facilities within the last two years.

Russell Coy II, captive coordinator in thefinancial standards and examination division for the Kentucky Office of Insurance, said the state currently has 76 active captives. According to information supplied by Kentucky, the state licensed 37 captives in 2008, compared to 21 captives in 2007.

"Our growth last year was up drastically," he said. "Our story is a little different. We passed our law in 2000 and nobody came for three years."

Because the state wanted to become a successful domicile, he said, "we started asking ourselves why. We started going to the Captive Insurance Companies Association meetings to find out what people wanted in a domicile--that's when we got serious."

Since 2003, he said, the domicile has grown from nine to 76 captives. Kentucky also had a dormant captive association, which has taken on new members and now holds an annual one-day conference.

The Kentucky Captive Association's president, Stewart Ferguson, is with a captive management company, The Underwriters Group, which he said manages 13 captives--all in Kentucky.

Mr. Coy said most of the captives are pure captives, covering a broad spectrum of industries and coverages. "We are seeing a lot of business interruption type coverages--supplemental to their standard commercial policy," he said.

Another part of the domicile's growth is due to repatriation and re-domestications from offshore domiciles, he noted. "Part of that is the economy. It's more convenient, cheaper [to be onshore]. Its' probably harder to justify that trip to Cayman or Bermuda and other locations."

Utah, which also experienced slow growth initially, has seen a growth spurt--even with the financial markets downturn.

Donnie Spann, captive insurance director with the Utah Insurance Department, said that as of year-end 2008, Utah has a total of 122 captives--adding 31 companies in 2008, with one dissolution. Of the 122 companies, he said, all are pure captives, except for one risk retention group and one special-purpose financial captive.

Utah adopted its captive act in 2003 and licensed one captive that year, and one in 2004. The turning point was when the domicile abolished the premium tax in 2005--since then, the number of captives increased to 12. Now a company pays a licensing fee and an annual renewal fee totaling $5,252, Mr. Spann noted.

So far in 2009, he said, five applications are pending. Industries he's seeing are "across the board. We continue to see interest in all lines of coverage--about 25 percent of the total is either real estate construction or manufacturing."

Geographically, Mr. Spann added, 86 percent of Utah's captive business is located in Western states, 11 percent are from the Midwest and 3 percent are from the Southeast.

Delaware is another domicile that surged forward, adding 22 captives in 2008, compared to 10 in 2007, said William P. White, administrator of the state's captive program.

"We were at 40 captives at the end of 2008," Mr. White noted. "Not bad, considering I got here in 2006." He said the 22 licensed last year were a mix of pure captives, a number of special purpose companies and groups forming cell structures.

Mr. White surmised Delaware will continue to see growth in group captives, especially those using cell structures. "And I think we'll see growth in smaller pure captives," he said. "Smaller businesses are looking for ways to initiate their own risk-transfer program, or they're trying to protect assets and have more control."

Delaware hasn't had much activity with RRGs--an area that has been "very quiet recently," he noted. "We've always been in favor of RRGs, but if legislation had gone through last year, we'd have a clearer view now of Congress' intent and what RRGs are supposed to look like, and some of these issues would have been resolved."

He added, however, that "because of the economic crisis, that got shoved to the back burner."

Mr. White said that businesses concerned about the capital and credit markets and those with balance sheets under pressure will look to the alternative risk-transfer market for coverage solutions. "This has always been the market that comes up with a response," he noted.

Meanwhile, in Vermont--the largest U.S. captive insurance domicile and second-largest worldwide in terms of gross written premium (with $15.2 billion in 2007), 16 new captives were licensed in 2008, about half the number of 2007.

David Provost, Vermont's deputy commissioner of captive insurance, said 2008 was "a slower year for captive growth due to economic conditions." However, he added, "we continue to see interest in forming quality captives, with activity across all lines of business."

The soft market, uncertainty created by proposed, financially burdensome IRS regulations (since withdrawn--see page 26)), and current economic conditions were the drivers that slowed formations in 2008, Vermont officials said.

New captive formations included 11 pure captives, two special-purpose financial captives, one risk retention group, one sponsored captive and one branch captive--bringing the total number of licenses issued in Vermont to 839, according to figures from the Vermont Department of Banking, Insurance, Securities and Health Care Administration.

Some of the companies licensing facilities in 2008 include: Darden Restaurants, Microsoft, Swiss Re, Thermo Fisher Scientific, Wells Fargo and Winthrop University Hospital.

The state said it is continuing its promotion of and innovation in the captive industry, proposing several new initiatives:

o A Premium Tax Holiday--amounting to a $7,500 reduction in premium taxes for captives licensed in 2009 and 2010.

o Increasing the special funds budget to support captives.

o Several technical amendments that affect sponsored captives, letters of credit and accounting standards.

Dana Sheppard, associate commissioner of the Risk Finance Bureau for the Department of Insurance Securities and Banking, reported 13 new companies in 2008 and six incorporated cell captives--which, he noted, are "unique to D.C." and a product of its incorporated cell law, amended in 2006. "We were happy with our year," he said. "We reached our 100th mark last year."

The District rebounded last year after licensing just seven captives in 2007. "We were in a transition period, we slowed down with RRGs, and our numbers dropped," explained Mr. Sheppard. "Other managers checked us out and came back this year."

So far this year, he said the domicile has "several applications pending and a few on the way, so it looks like the first quarter will be better than last year. We're seeing a variety--a lot of single-parent coverages."

Included in the count were three health care RRGs. Captives formed this year were for terrorism coverage, property risks and employee benefits--"a variety," he said.

While D.C. is not seeing a real impact in its captive sector from the financial market meltdown, Mr. Sheppard said it is experiencing other related challenges.

"A lot of companies tend to have their investments in one bank," he explained, noting that "one moved money out of IndyMac before its failure" in July 2008.

Because of concern over bank solvency, he said, "we've notified our companies to look at concentration issues and decide whether to move their money into multiple institutions."

D.C. also has observed that some RRGs have "letters of credit, and some banks are electing not to extend them for another 12 months when they come up for expiration. Some banks also have pulled out of their LOCs," he said.

Mr. Sheppard added that D.C. has "made some inroads in a controversial area--we allow self-management." Although not well-publicized, he said, some captives need to be managed, "and we require them to retain captive managers, and others are qualified [for self-management]. We handle this on a case-by-case basis at their request."

Not all domiciles saw captive growth. South Carolina dropped to 11 new formations in 2008, compared with 27 in 2007, noted Jeff Kehler, the state's program manager for alternative risk-transfer services. "Let's face it, the economy and the financial markets have had a serious impact on the industry," he said.

Of those 11 companies, he said he was surprised that four were in the construction industry--a sector hard-hit by the troubled real estate market.

He added that he was pleasantly surprised by a few developments. "If you talk to [risk managers] about why they're doing this, it's very clear they have their fingers on the pulse of their own business. They knew this [economic downturn] was coming, and they planned for it and they funded for it."

These companies also had plans for how to use their captives "down the road. You can tell they had already thought it through," Mr. Kehler observed. "These are very interesting times because of the nature of the parent companies."

Steve Matthews, captive coordinator and chief financial examiner in Montana, said the domicile licensed eight in 2008 and lost two--compared with 10 licensed in 2007. Eight were formed in 2006, and three in 2005. Of their 36, 11 are RRGs.

Mr. Matthews said he is not sure what effect the financial market crisis has had on his domicile. "So far, managers we've talked to seem optimistic--they're going to form some new captives this year--so we're going to wait and see what happens."

In 2009, he said, "two have been licensed, one is about ready to go and a couple of applications are coming, so we're off to a normal start for us."

A few changes are in the works, which have passed the state House and will go to the Senate:

o Surety and marine lines added.

o An ability to waive the risk-based capital reports on RRGs.

o A prorated minimum premium tax by quarter.

o A change in investment laws, which lets RRGs hold up to 10 percent in a money market fund if they have less than $5 million in total assets.

Hawaii Insurance Commissioner J.P. Schmidt said that in 2008, Hawaii licensed eight captives and deleted six, compared with 10 licensed in 2007. Hawaii has 165 active captives, he noted, and since the passage of its captive laws in 1986 has licensed 220 captives.

"We're continuing to have positive growth, though slower than a few years back," he said. "We're continuing to see strong interest in captives from companies in Japan, and we have a mix of captives from the Western U.S. as well as other parts of the U.S."

Mr. Schmidt noted the loss of its former captive administrator, Craig Watanabe, who joined personal and commercial lines insurer DTRIC as its chief financial officer. "He did a fantastic job in building the captive industry, but we're happy for his new prospects," he said.

One of Mr. Watanabe's accomplishments, he said, was in building "a solid team here. We think we'll continue without missing a beat." Judy Nako, who has been with the department for a number of years, is serving as interim captive administrator.

Mr. Schmidt said the captive division has seen the effects of the financial crisis, which has hit some of the large-tract home construction companies in particular. He added there is still a strong interest in health care captives, as well as in the use of captives for estate planning--especially for high-income individuals and owners of family businesses.

Special Reports /

Captive Formations Steady, Despite Shaky Financial Markets

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