Thomas FX Hodson outlines the factors that should be considered when selecting a US captive domicile.

Captive insurance companies, or more simply, captives, are one of several alternatives to traditional insurance coverage. A captive can be defined as an insurance company, organized and owned by one or several owners, whose purpose is to insure the risks of the owners. The captive marketplace has grown over the last several years at a rate of 4.5%-5.5% per year, and the formation of new captives is expected to increase at a rate of more than 5% per year through 20051.

Location, location, location
Captives can be domiciled (chartered) onshore (in the US) or offshore. In the past, when corporations were deciding where to set up a captive, they were frequently asked: "Do you like to golf or ski?" This referred to Hawaii and Vermont, two of only a handful of onshore captive domiciles until recently. Since 2000 however, the US has seen considerable growth in the enactment of legislation designed to encourage the formation of captives2. During this time, many states, including Arizona, Arkansas, Montana, South Carolina and Washington DC, have launched efforts to attract captives. Why? Certainly, one reason is each state's desire to share in this billion-dollar industry. In Vermont, for example, the leading captive domicile in the US, more than 500 captives generate over $12.6m in premium taxes for the state. Moreover, states believe captives are a "non-polluting, revenue generating, non-invasive industry."3 Consequently, with the increasing number of US domiciles (growing from seven in 1997 to 19 in 2001), a penchant for golf or skiing is no longer the deciding factor when choosing where to establish a captive4. Instead, such a decision requires the consideration of several other factors.

Issues to consider
With so many onshore domiciles, choosing the right location can be a difficult task, especially given the number of domiciles that have recently enacted captive enabling legislation. Therefore, when doing so, a few basic points must be considered.

Regulatory setting. Is the domicile's captive legislation stable? A captive must be comfortable that the domicile's laws on the books today will be there in the future5. For example, Vermont's success is due in part to consistent captive legislation. This is, in large measure, a result of an active trade group vigorously advocating on behalf of Vermont's captive industry. The Vermont Captive Insurance Association (VCIA) educates, communicates, and advocates on behalf of the Vermont-domiciled captive industry thereby ensuring a favorable legislative and regulatory environment for captive insurance. Similarly, Hawaii's Captive Insurance Council Corporation works with Hawaii's State legislators to make sure that Hawaii's captive law stays current with international trends in the insurance market so that Hawaii remains an attractive captive insurance domicile. It is evident that active trade groups such as these provide a strong voice for the captive industry in their respective states. As dedicated advocates for captives, their access to legislators and regulators significantly enhances the stability of captive legislation.

Infrastructure. Are the domicile's regulators experienced in regulating captives? This is one of the most important factors to consider. It is critical to the development of a captive industry that a domicile has knowledgeable regulators dedicated to the industry. In addition, if the domicile has a poor reputation in this area it can be catastrophic for a captive seeking to attract reinsurers or fronting companies6. The frustration caused by inexperienced and/or unprofessional regulators can be taxing. Vermont created an independent division, focussing entirely on captives, within its Department of Banking, Insurance, Securities and Health Care Administration. Having the largest governmental staff of captive insurance professionals in the world has clearly contributed to Vermont's success. Hawaii, South Carolina, Washington DC and others have followed suit. Further, does the domicile have the support of outside service providers? "Well managed captives need the support of professional, outside service providers, such as captive management companies, domiciliary legal counsel, banking, etc. The popular domiciles all have these services in abundance. While most domiciles require that these services be performed locally, a few will allow them to be provided from another location."7

Tax treatment. Does the domicile provide favorable tax treatment to its domestic captives? All US domiciles charge a premium tax, which can be significantly less than the normal premium tax that commercial insurers are charged.8 Most US domiciles impose premium taxes of 0.25% on all premiums written for pure captives and 1% for association captives and risk retention groups. Some states, including Colorado, Hawaii, Rhode Island and Tennessee, have provisions that give credit to captives domiciled in those states for premiums taxes paid to other states.9 Thus, if a captive is formed in one of the states, but insured operations are all outside the state, it is unlikely that a premium tax would be paid.10 The Illinois tax scheme takes this favourable treatment a step further. In Illinois there are no corporate franchise taxes, no premium taxes for captives that maintain their principal office in Illinois, no premium or income tax on risks located in other states, and no taxation by local units of government.11

Capital requirements. Are the domicile's capital requirements too restrictive? In Vermont, a captive's capital requirements are: $250,000 for a pure captive; $500,000 for a risk retention group; $750,000 for an association captive; and $1m for a sponsored captive.12 Hawaii's capital requirements are at the discretion of the regulator, but the guideline requirements are similar to those of Vermont's.13 The same can be said for South Carolina's requirements, with the exception of an association captive requiring $100,000 less than in Vermont.14 Washington DC and South Dakota allow for less restrictive capital requirements, which may be attractive to smaller single parent captives.

Length of licensing process. How long does it take to properly prepare and package the domicile's application filing for a captive? Requiring six months to a year to properly file the application may be burdensome, particularly for a corporation looking to form a captive without delay.15 States like New York and Vermont boast a streamlined licensing process with a quick turnaround on applications.

License fees. Are the domicile's licensing fees overly burdensome? For example, Hawaii charges a $1,000 application fee, a $300 registration fee, and outside application review fees ranging from $3,500 to $7,500.16 On the other hand, South Carolina has a $200 application fee and a $300 annual fee.17

Ease of Access. Is the domicile easily accessible? Distance and time zones are always a factor when a corporation is selecting a captive domicile. If the captive's owner wants to have a voice regarding the management of its captive, the domicile must be readily accessible. If the captive, or its manager, is half a world away, communication can be taxing. Furthermore, most domiciles require the board of directors of the captive to hold annual meetings in the state. Executives do not always have the luxury of time to fly across the country for meetings, particularly in a slow economy. For example, if the corporation is based on the East Coast, it may not want to set up a captive in Hawaii. Similarly, Vermont is not easy to reach by plane. On the other hand, domiciles such as Nevada, New York, and Washington DC are readily accessible.

The right fit. Does the domicile fit the company's image? A final consideration is whether the domicile matches the image of the company. For example, a company may not want to form a captive in a domicile that is regarded as a vacation destination. Shareholders may not appreciate an image of their company's officers and directors sitting poolside, playing 18 holes, or placing a bet at the poker table. In other words, the company may wish to avoid the perception that it is more concerned with leisure and less concerned with critical business matters. Thus, finding a domicile with an image akin to that of the company's may be a crucial consideration in the selection process.

Vermont leads the pack
As indicated above, with over 500 captives, Vermont leads the pack of onshore captive domiciles. In addition to the issues identified earlier, VCIA lists the following as reasons contributing to Vermont's popularity as a captive domicile:

  • single parent, association and group captives permitted;

  • reasonable capitalisation requirements that may be met with a letter of credit;

  • coverage includes nearly all commercial lines, including excess workers' compensation, directors' and officers' liability, and property and casualty insurance;

  • no approval of rates and forms required;

  • no minimum premiums required;

  • no investment restrictions for pure captives and group captives; and

  • Favorable premium tax structure.

    So, does Vermont feel threatened by the recent growth of captive domiciles? Not so, says Dan Towle, director of Financial Services of Vermont's Department of Economic Development. According to Towle in a recent VCIA press release: "...even though there are more choices than ever, Vermont's stable regulatory environment, accessible government officials and world-class professional support services make it the premier onshore domicile of choice."

    In sum, picking an onshore captive domicile is no longer as easy as deciding whether you prefer being on the golf course or the ski slope. With at least 19 domiciles to choose from, a corporation looking to form an onshore captive must carefully consider many factors.

    1 Lynn Goch, "Courting Captives", Page 27, Best's Review, March 2001.
    2 Id.
    3 Id.
    4 Id. at 26.
    5 Id.
    6 Donn P McVeigh and Ted O. Hall, The Captive Insurance Manual, I-4, NILS Publishing Company, 2002.
    7 Id. at I-5.
    8 Id. at I-4.
    9 Id.
    10 Id.
    11 Id. at IL-iv.
    12 Vt. Stat. Ann. tit. 8 § 6004(a) (2002).
    13 Haw. Rev. Stat. § 431: 19-104 (2002).
    14 SC Code Ann. § 38-90-40 (Law. Co-op 2002).
    15 McVeigh & Hall, supra note 7 at CO-iii.
    16 Haw. Admin. Rules § 16-17-6 (2002).
    17 SC Code Ann. § 38-90-20 (Law. Co-op 2002).

    By Thomas FX Hodson
    Attorney, Thomas FX Hodson is Counsel in the insurance and reinsurance practice group of Edwards & Angell, LLP, a 300-lawyer national law firm focussing on financial services, private equity and technology. He may be reached at:
    thodson@ealaw.com .