Captives in the US are seeing an increase in numbers and use in reaction to the hardening market.
Conventional wisdom has it that when the re/insurance market hardens, captive formation and the use of existing captive facilities increases. Recent experience would tend to bear out this contention, with captive managers in many jurisdictions reporting an increase in captive numbers and premium volumes.
Whether the increasingly thorny issue of taxation will make a difference to the more established captive domiciles of the Caribbean remains to be seen, despite the green light from the OECD's investigation of recent years. With the post-Enron fallout, and in particular moves on Capitol Hill to prevent US corporations moving operations offshore in an effort to reduce their tax bills, there is still uncertainty as to whether the spotlight will eventually fall on the captive community.
The catastrophic events of 2001 have had a profound affect on organisations' risk management activities. Even if the headline rates did not surge as much as some thought at the year-end renewals, exclusions and sky-high deductibles led risk managers to re-evaluate the use of their captives, and the forthcoming renewals could further push their value to corporations.
In particular, those business sectors which have seen a wholesale removal of re/insurance capacity are actively looking at captives to solve their coverage problems. One such proposal is Equitime, a risk-retention group being mooted by US airlines currently unable to purchase terrorism cover from the conventional market, but equally concerned that the US government will not provide a terrorism back-up facility indefinitely. Together with broker Marsh, the Air Transport Association (ATA), based in Washington, DC, is looking at setting up a Vermont-based risk retention group for its members. In February, Leonard Crouse, director of the captive insurance sector in the Vermont department of banking, insurance, securities and healthcare administration, confirmed there had been talks with the ATA, and Scott Russell of Marsh said there was a second quarter target for forming the captive.
Although Vermont is thought to be just one of the domiciles under consideration for the risk retention group, it would be a fairly logical choice as a location. During the course of 2001, the domicile attracted 38 new captives to its borders, with premium volumes nearing the $5bn mark. Vermont is the largest captive domicile in the US, with 527 now established over the 20 years it has been a captive option. "There is strong activity for first quarter 2002," said Mr Crouse. "We have been extremely busy meeting with some very quality companies and we continue to see an even greater level of interest than in previous years."
Among the 37 pure captives licensed and one sponsored captive launched during the course of last year, household names such as the Pepsi Bottling Group, Goldman Sachs Group, Wendy's International and Rotary International entered the jurisdiction, as well as the Roman Catholic Diocese of Brooklyn, which was the 500th to set up in the state.
This tally takes Vermont way ahead of the next-largest onshore captive jurisdiction in the US. Nevertheless, in number two position, Hawaii also reached a milestone last year by licensing its 100th captive, a Japanese watch company. This achievement came close on the heels of the first incorporation and licensing of a captive directly owned by a Japanese corporation and insuring Japan-domiciled risks. Heiwa Insurance Inc, owned by amusement game manufacturer Heiwa Corp of Japan, incorporated in March last year, was seen as the start of a new push east, to tap into a large market where many domiciles have, so far, merely scratched the surface. At the time, Governor Benjamin Cayetano commented, "The licensing of Heiwa Insurance Inc represents the unique opportunities that Hawaii's captive insurance industry offers. This is the first foreign owner that is taking direct advantage of Hawaii's favourable regulatory and US investment environments to finance insurance risks abroad while at the same time optimising its home country taxes."
Heiwa Insurance president Kazuyoshi Horie said at the announcement of the captive, "We have been examining the use of a captive insurance company for several years and decided to set up a captive in Hawaii because of several advantages to our parent company in Japan. Hawaii's prudent yet flexible regulatory environment, ease of access, related business interests and beneficial differential tax rates between the US and Japan are the more important issues that made a difference for us."
Hawaii's insurance commissioner was equally bullish about the domicile's status and prospects. "We anticipate continued growth in Hawaii's captive insurance industry," said Wayne Metcalfe. "Rising prices in the national and international insurance markets and increasing demand for more innovative ways to efficiently finance losses are some of the underlying reasons."
And other states, not wanting to miss out on prospective business, have geared themselves up for captive business. Over the course of last year, three states - Arizona, Arkansas and Montana - enacted regulation to allow the formation of captives within their borders, while Washington, DC, which set itself up for accepting captives in 2000, is particularly bullish about the future captive community.
At the first conference organised by the Captive Insurance Council (CIC) of the District of Columbia, which took place in March, CIC chairman Ed Armstrong predicted, strong growth in association business as part of DC's economic development. More than 6,000 associations are based in DC, constituting the third-largest industry in the area, and Lawrence Mirel, commissioner for DC's insurance and securities regulation, was confident that the district could tap into that huge potential market. Two captives are already up and running in DC - American Captive Corp and Columbia Group Insurance Inc - and Mr Mirel said there were several license applications currently in the pipeline.
Increasing captive numbers appear to be a current characteristic of most domiciles. During February's World Insurance Forum in Bermuda, a panel of captive professionals discussed the growing use of such devices, though they recognised that there could be increasing investigation of such devices being used as tax-avoidance tools. As more risk is being retained by corporations - either out of choice or, more likely, as a result of the much harder re/insurance market - more weight is being brought to bear in the cause of the captive. Even so, the hardening reinsurance market is still creating problems since captives traditionally are large purchasers of reinsurance cover. At the same time, fronting arrangements are becoming more difficult to put together.
A recent survey by the Captive Insurance Companies Association identified fronting fees representing between 6% and 8% of captives' premium volume. The survey sample reported fronting costs ranging between an average of $572,000 for single parent captives to $738,000 for group captives and risk retention groups. During 2001, most saw fronting fees remain at the previous year's levels, though 42% reported an increase, and the 3% balance said the fees had reduced. But as the number of insurers providing fronting facilities falls, either out of choice or, as in the case of Reliance and Frontier because the insurers are no longer trading, inevitably there will be an increase in fees, on top of much higher costs of reinsurance capacity out the back of the captive.
Despite these problems, captive owners are seeing a wider choice for the location of their captives. Over recent years, the number of US states offering captive facilities has increased dramatically (see box page 25). At the beginning of this year, the state of Montana announced its first captive, with the formation of ALPS Reinsurance of Missoula, a captive formed by the Attorneys Liability Protection Society. Speaking at the announcement, Montana's commissioner of insurance John Morrison said, "We are pleased to license ALPS Reinsurance as the first captive insurance company in Montana. This is a Montana company that until this year, had to be domiciled in Vermont." Legislation passed in Montana last year allowed captives into the state for the first time, requiring Montana-based captives to locate their headquarters in Montana, and Mr Morrison said he hoped to license several more over the course of this year. "I am hopeful that this will be a stimulus for economic growth in Montana," he said. "We will be holding informational meetings around the state and will be working with the governor's office to promote this industry."
Captive model preference
Organisations in lines of business which are having a hard time finding traditional capacity also are turning to the captive model. In particular, the US healthcare sector is looking at the option in the light of premium rate increases of up to 500% for hospitals and nursing homes. Speaking at the Captive Insurance Council conference in Washington, DC, in March, Kathleen Nilles said that several healthcare organisations have been looking anew at the captive solution. Ms Nilles, an attorney with Gardner Carton and Douglas, commented that some medical practitioners are finding it impossible to find liability coverage, or that premiums are too high to be viable. In fact, a new joint venture, National Capital Risk Services, has been formed by medical professional liability insurer NCRIC Group, and Risk Service LLC, to serve this market.
R Ray Pate Jr, president and CEO of NCRIC Group, commented, "With this joint venture, we are positioned to offer healthcare providers across the country access to various alternative risk financing vehicles. This fills a critical need for healthcare providers, given the current lack of traditional insurance products that are either affordable or, in some instances, available."
Other, more established captives are looking at ways to improve the systems within their business. Recently, Dorinco, the captive owned by Dow Chemical Co, has been working on a new software system, to be provided by Eurobase International. As well as providing insurance services for its parent, Dorinco writes reinsurance business for third party clients, and had total gross premiums of $257m in 2000.
The new system, to go live in September, will replace Dorinco's mainframe system, streamlining the underwriting, claims, reinsurance, accounting and management reporting processes.
"We evaluated several systems at the start of the process but chose Synergy because it gave us more of what we needed for our bucks" says Frank Gonzalez, Dorinco's information systems manager. "As the development has progressed it has proved to be the right decision for our needs, even though we have had to accommodate major differences in areas such as accounting practice between the UK and the US."