The captive industry may be mature but its boom is far from over, finds Ronald Gift Mullins

The captive insurance industry has been described as a "mature market", but it doesn't mean growth has levelled off or that the entrepreneurial spirit has diminished. Rather, it is mature in the sense that it has survived for almost 40 years, has prospered; has become an essential part of the insurance scene: It is here to stay.

Though the idea of a "captive insurer" goes back hundreds of years, the modern era began in the 1960s when a captive was formed in Bermuda. Having little competition, and an environment conducive to captive formation, Bermuda quickly attracted additional captives as well as reinsurers and insurers and fast became the leading domicile for captives. Other offshore domiciles - Cayman Islands, Barbados and British Virgin Islands - followed suit and began acquiring captives.

But about 20 years ago, several US states eyeing the millions of dollars in fees and taxes paid by captives and the additional employment required to service these captives began actively promoting their state as the ideal domicile for a captive. In 2005, the total number of captives in the US was 1,098, which for the first time topped Bermuda's 987 as the domicile with the most captives. The Cayman Islands had 733 captives, Vermont, 542, British Virgin Islands, 383, Guernsey 82 and Barbados 301. That individual US states have begun aggressive marketing programmes to pull in captives can be seen by the explosive growth in Nevada (39 to 58 from 2004 to 2005) and in Utah (2 to 15).

As of 2006, 18 states and the District of Columbia have enabling legislation for captive formation. New Jersey may soon join the ranks as a bill has been introduced to allow captives to be formed there. With so many domiciles in the US, it is likely that considerable competition will develop within the captive market which could offer taxation, and administrative benefits to captives.

Worldwide premiums for the captive industry can only be estimated at about $62bn per year, with surplus hovering around $175bn, but growing each year. From 2000 to 2004, net premiums written by 150 captive insurers followed by AM Best had growth of about 56%, but in 2004, the increase was only 3.6%. This slowing may have been an early indication of a softening of the traditional market and companies spreading risk away from the company rather than holding it in their captives.

Growth will continue

"The number of captives in the world will continue to grow," said Jim Swanke, managing principal, Tillinghast business of Tower Perrins. "In ten years there will be 10,000 captives in the world. The concept of a captive is generally accepted and is here to stay." He does think that Bermuda will continue to be the dominant captive domicile of the world, "it has an extensive captive infrastructure that is highly desirable for organisations wanting to form a captive."

One reason he believes captives will continue to prosper is that there are fewer commercial insurance companies that are available to the Fortune 500 companies to spread their risk. This is especially true of reinsurance companies. "So, there is no alternative except to form and promote captives," he explains. "The other factor is that captives are more efficient in terms of keeping expenses down for underwriting and administration than commercial insurers."

Kate Westover, vice president at Innovative Captive Strategies and author of several books on captives, believes the captive industry is mature and "as long as brokers, captive managers and actuaries/consultants make money with captives," she said, "they will promote them and this means more are formed, for smaller and smaller insureds." She mentions the growth in cell companies and member-owned group captives, both of which are being sold to middle market insureds that are not large enough to have their own captives. "Additionally, you have more domiciles, and each domicile has a financial interest in growing captives," she adds, "so the captive industry is likely to remain strong."

"I know captives are a mature market in the sense that they are recognised as an important alterative risk market," said Nancy Gray, executive director, Aon Insurance Managers. "It does not mean that there is no future growth. What captives are good at is responding to current market needs."

New risk for captives

In the decades since captives were first created, besides the pure captive which does business only as a reinsurer or as a direct writer and association or risk retention groups, a variety of captives have been developed - rent-a-captive, agency captives, cell (sponsored) captives, group captives and others. Captives insure everything from the mundane liability risk to the exotic, such as animal feed contamination. Increasingly, domestic captives have issued terrorism insurance policies for their parents. These captives have legal standing with the Terrorism Risk Insurance Act. Fortuitously, because captives have seldom been used to insure property, the tally of record catastrophe losses from the 2005 hurricane season showed captives had few measurable losses.

Companies and organisations form captives to lower costs, and to gain greater control, broader coverage and better cash flow. Remarkably, captives have responded with coverage of difficult risks when the regular insurance and reinsurance market has found them uninsurable or quoted coverage at very high rates. In 2001, when medical malpractice became almost impossible to insure, the risk retention groups were able to cover the liability for hospitals so they could remain in business. Because catastrophe property coverage following the losses from Hurricane Katrina and others may be difficult to find or be expensive, especially along the Atlantic and Gulf coasts, some companies have begun placing property catastrophe cover in their captives or have created new ones.

The latest type of captive, employee benefits funding, may become increasingly used by corporations to fund their employee benefits programmes. Last year, several companies were given permission by the US Department of Labor to fund employee benefits through their captives. Companies benefit by lowering costs and from the investment income.

Within the past few years, the growth of captives can be attributed to smaller companies forming captives, usually rent-a-captive, a cell or one of their own. "It is true that captives are being marketed to smaller companies and industry organisations," said Geoffrey Etherington, partner, Edwards Angell Palmer & Dodge. "Obviously those who provide infrastructure have an interest and so do regulators in the captive states. But company management still has to be convinced that setting up a captive in whatever form, is worth the cost and time to organise one."

Westover said that captives provide greater control and capacity for a company, and there is no question that they provide risk managers additional means to solve problems. She continued, "The question is why do they grow the way that they do? It is because of the presence of the promoters. The majority of captives are formed for financial purposes, mostly as the result of captive management and servicing firms visiting with insureds to convince them of the advantages of forming a captive."

It is true that captives are being marketed at increasingly smaller companies and industry organisations, agreed Aon's Gray, "and obviously those who provide infrastructure have an inherent interest in creating more captive-type entities, as do regulators in the captive states, but business people have to be convinced it is worth the expense of setting up a captive before they will go ahead."

Offshore or onshore?

A factor that may have a subtle influence on the slowing of captive growth in Bermuda and other offshore domiciles is the Sarbanes Oxley Act which requires greater transparency among companies and more governance over ethical concerns. Some companies would rather not have to declare they have set up a captive offshore, raising perceptions among directors and shareholders of being unpatriotic or attempting to hide something. "I think it is more a matter of perception than a reality," Gray said. Nevertheless, with so many states wanting captives, it is easier for US corporations to stay onshore rather than explain to a board of directors why it was necessary to set up a captive in Barbados, the Caymans, or in Bermuda. Because of this perception, I think these offshore domiciles will not see the same level of growth that they did a few years ago."

"There is a pleasing appeal for companies to stay in the US," Swanke of Tillinghast said. "Certainly there are some companies that will say 'We do not want to even create an appearance that we are going offshore no matter how ethical or economically valid the reason, so we will stay here'."

Regulation to increase?

For the most part, captives have not been regulated or scrutinised as rigorously as primary insurers and reinsurers. But the investigations began by the New York attorney general in 2004 which spawned other assessments by state and federal officials may result in increased attention paid to onshore and offshore captives and their parents. Currently captives owned by publicly-held companies must comply with regulatory compliance and governance requirements within the Sarbanes Oxley Act.

One group of captives that may be more closely regulated are Risk Retention Groups (RRGs). As of now, they are not regulated by each individual state in which they operate. Rather the federal Liability Risk Retention Act allows RRGs to insure policyholders in any state after meeting the licensing requirements of only one state. A report issued in late 2005 by the General Accountability Office recommended that Congress should consider setting corporate governance standards for RRGs and requiring policyholders to make a financial contribution to the group's capital and surplus.

The captive market is mature, meaning it has a secure place in risk transfer; but it is also continually creatively evolving to meet fresh challenges, which guarantees it a place in the future of risk management.

- Ronald Gift Mullins is an insurance journalist based in New York City.