U.S. Captives Grow Despite Softening Market

The biggest U.S. domicile said it licensed 29 pure captives last year. Eight new risk retention groups were formed as well as industrial insureds, sponsored, association and branch captives. Gross captive written premium in 2004 is expected to top $10 billion up from $9.4 billion in 2003, he said.

The previous year set a record for Vermont with 77 captives formed a result of the medical malpractice crisis, which he noted has since "waned a little bit."

Mr. Crouse anticipated that even with the softening insurance market, 2005 will be strong for captive growth, even though "group programs slow down in a soft market. They're usually driven by a hard market insurance is expensive and hard to get." Licensing of pure captives, however, "has been steady over the years," he said.

One trend he is seeing with large corporations is the use of existing captives for terrorism coverage. With the Terrorism Risk and Insurance Act due to expire at the end of the year, "we'll see what happens then," he said.

Companies that licensed captives in Vermont in 2004 include Wal-Mart stores, Best Buy Company, John Deere & Company, USA Hockey Inc. and Textron Inc., according to the domicile.

Leslie Jones, insurance director for South Carolina, noted that the domicile has so far issued 118 licenses and has eight inactive captives. Pure captives also are seeing a resurgence, she said.

"We are seeing a lot more pure captives," Ms. Jones noted. "Most of the RRGs are med mal, and I think people who were going to address that issue with a captive have largely done that we're not seeing as much activity in that area."

The domicile has 40 risk retention groups39 percent of the total captives formed. Forty-six percent of those licenses are pure captives.

She added that many of their RRGs also "look a lot like pure captives." An example she gave is a hospital with a Bermuda captive that lost its fronting company. "They needed to form an RRG to replace the front; they needed that [onshore] fronting paper," she said. "So even though we have 40 RRGs active, I would say two-thirds of them look like pure captives."

Ms. Jones noted that although she isn't sure the medical malpractice crisis is over, "we are not seeing as many med mal groups coming in. I don't know if that is because tort reform is taking effect in some states or if people who would use a captive mechanism to fund those risks have done that. We had a big flurry of activity in 2003-2004, and we are definitely seeing less."

A trend South Carolina currently is seeing with captives is securitizations the transfer of insurance risk to the securities market, she said. "Here they are taking insurance risk and isolating it and selling securities to back that insurance risk," she explained. "A lot of our recently licensed captives are special purpose financial captives."

South Carolina also had its first redomestication from Bermuda this year a pure captive with a medical malpractice component, she noted. "I think they wanted to be onshore. They were also doing deductible reimbursement for their workers' comp and some other programs," she said.

Ms. Jones reported that South Carolina does not have any legislative changes in the works. "This year we're trying to keep things simple," she said. "We're trying to get our funding increase so we can properly fund our captives program and become a self-sustaining unit. Right now at least half of our staff is funded by the department."

Craig Watanabe, captive insurance administrator for the State of Hawaii Insurance Division, said 2004 was "another record year for captives. From 1999 we went from $1.5 billion to more than $5 billion in 2004," he said.

Hawaii continues to attract risk managers from Pacific Rim countries, and last year licensed two new Japanese companies. "One is a large pharmaceutical company and the other is Sanyo Electric," he noted. "We are up to about a half-dozen Japanese captives now."

Like Vermont and South Carolina, Hawaii is also seeing a resurgence of pure captives. "The bulk of our captives were pure captives, but we also had quite a few in professional liability for health care providers," he said.

Some of those captives are pure and some are risk retention groups. "The med mal crisis started back East a couple of years ago, but we saw it hitting the West Coast early last spring. By the time late summer came around a lot of them decided to set up a captives," he noted. Those forming captives include hospitals and hospital groups and nursing homes.

Another trend this year, he said, is that some captives "that have been around since 1990 are starting to tinker with their programs." Some are taking higher retentions in the captive and some are adding coverages, covering defense costs, or retaining more risk and reinsuring at a higher level. "So were at the next level where mature captives are being refined to meet the owners' needs."

Mr. Watanabe observed that the marketplace is "unpredictable right now. The Spitzer investigation has made captive owners more diligent. [Captive owners] just want to do the right thing," he said, referring to probes of the insurance industry by New York Attorney General Eliot Spitzer.

At the request of some owners, he noted the department is "unofficially reviewing some transactions between captives and brokers."

He explained that in some instances, direct-writing workers' comp captives are asked to buy reinsurance, "and apparently there is no reinsurance for that that's what the brokers are telling us so they place it with excess carriers."

These captive owners, he noted, "are large employers with about 1,000 employees, and not a particularly high risk. So we have been asking the managers to get the brokers to confirm in writing who they asked for coverage and if they were declined, to make sure the brokers are doing a good job." He added that "most of the captive owners are sophisticated buyers, but we want to help them watch out for themselves."

In Washington, D.C., "we are going very well we have 40 [captives] licensed now and we expect to have another half-dozen in the next month or so, so its moving along nicely," said Insurance Commissioner Lawrence Mirel. "We were sorry to lose Bill White [who left his post as the insurance department's director of captives for a position as senior vice president with Heartland Fidelity Insurance Company last year], but in the meantime we are looking for a replacement for him and everything is humming along."

In Arizona, Rod Morris, Arizona's captive administrator since last July, said the domicile has 39 active captives. "We've got about six active applications and about 12 others interested," he noted. "We have an unusual flurry with respect to recriprocals in a group capacity."

He explained that a reciprocal is similar to a mutual, "where the subscribers are responsible for the formation and capital and surplus. They still need a front if they want to do business outside the home domicile." He noted that Arizona also is beginning to see more activity with large corporations.

Captive owners are drawn to Arizona because there is no premium tax and no income tax, he said. "But if you listen to the managers and owners, they say that helps but is not the overriding issue. They say it's close, relatively inexpensive to get in and out of, and has other attractions like golf and professional sports teams," he noted.

Mr. Morris said that six of the state's captives are Arizona companies, six are from California, five are from Colorado, and four are from Texas.

Changes to the captive law are also in the works, he said, designed to "make sure the statutes are doing exactly what we intended them to do, as well as to keep us competitive with changes in the other domiciles."

Amendments to House Bill 2600, introduced this year in the Arizona legislature, include:

Giving the department of insurance discretion to allow credit for reinsurance.

Clarifying that licensing and renewal fees paid by captive insurers are in lieu of taxes.

Permitting pure captive insurers to cede to and assume from pooling arrangements.

Eliminating the requirement that business relationships with support professionals do business at a location in Arizona.

Flag: Bermuda Update

Head:

Bermuda is still the biggest captive haven by far, with 1,330 facilities nearly double that of Vermont, the biggest U.S. domicile. Bermuda Insurance Management Association President J. Oliver Heyliger said trends in captives for 2005 on his island include:

? A continued use of captives for primary casualty, workers' compensation and general liability retentions fueled by a growth of middle-market company captives.

? Slow growth of Central and South American sourced captives.

? Agencies having difficulty finding market capacity are using captives as the central platform of their overall programs to help obtain fronting and reinsurance capacity. In the past, use of a captive would have been a secondary consideration, he noted.

? More uses of segregated cell rent-a-captives for life business as well as property-casualty.

? Continued use of captives to front difficult risks into the reinsurance market, such as directors and officers liability.

Reproduced from National Underwriter Edition, March 4, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.