Captive Insurance and expanding choices in US Market January, 2014 BLOG POST
Captive are established to meet the risk management needs of owners A captive is an insurance company created and wholly owned by one or more non-insurance companies to insure the risk of its owner (or owners). The purpose of the establishment of a captive is to meet the risk-management needs of the owners or members. The International Association of Insurance Commissioners (IAIS) defines a captive as “an insurance or reinsurance entity created and owned, directly or indirectly, by one or more industrial, commercial or financial entities, other than an insurance or reinsurance group entity, the purpose of which is to provide insurance or reinsurance cover for risks of the entity or entities to which it belongs, or for entities connected to those entities, and only a small part if any of its risk exposure is related to providing insurance or reinsurance to other parties.” Many prominent companies have long been using captives to manage their insurance risks. While the captive concept has existed for centuries, it has gained widespread acceptance only in the past few decades.
How does it work? Who forms it? The type of entity forming a captive varies from a major multinational corporation to a nonprofit organization. Finance, real estate, construction and manufacturing are the sectors with the greatest number of captives, but over the years, there has been substantial growth in health care, property development and securitization for life insurers. Typically the formation of captives is done as a subsidiary of the parent company. Most captive parent companies which belong to non insurance sector hire an outside firm, often an insurance company or captive manager, to manage the captive for them.
Types of Captives and Risks underwritten by them Majority of the captives insure only the risks of its parent or owner, but over the years, companies have explored new and innovative ways to use captives depending on their needs. In future, it is expected that the types of captives in use would evolve and proliferate to address the growing need for alternative risk transfer. The most common types of captives are listed below: •
Single-Parent Captive or Pure captive – A pure captive is generally defined as an insurer that insures only the risks of the company’s affiliates and controlled unaffiliated businesses. The majority of captives are formed as pure captives
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An association (or group) captive- A Group captive insures the risks of the member organizations of the association and their affiliated companies
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Alien captive – An insurance company formed to write insurance business for its parents and affiliates and licensed pursuant to the laws of an alien jurisdiction that imposes statutory or regulatory standards in a form acceptable to the superintendent on companies transacting the business of insurance in the alien jurisdiction
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Branch captive – A captive insurance company that is domiciled in an alien jurisdiction and has been issued a certificate of authority to transact insurance through a business unit with a principal place of business in the state
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Rental captive - A captive owned by an outside organization and open to participants for a fee. Members “rent” licenses and capital from the rent-a-captive owner. A rent-a-captive, or rental captive, is often used by entities that prefer not to form their own dedicated captive or for a program that is too small to justify incorporating its own captive
The above list is not exhaustive. In addition to these types of captives, there are agency captives, protected cell captives, incorporated cell captive, sponsored captive and risk retention groups (RRGs). In addition to these more traditional types of captives formed by non-insurance companies, commercial insurers also create captives for reinsurance, securitization or reserve financing purposes. These captives are often referred to as special purpose vehicles (SPVs). Special purpose financial captives are limited to issue only special purpose financial captive insurer contracts to provide reinsurance protection and facilitate the securitization as a means of accessing alternative sources of capital and achieving the benefits of securitization. Captives are formed to cover a wide range of risks; practically every risk underwritten by a commercial insurer. They provide all traditional P&C insurance coverage like workers’ compensation, director and officer (D&O) liability, auto liability and professional liability (e.g., medical malpractice). They can also provide specialized coverage for nontraditional and specialized coverage like terrorism risk, pollution liability especially for oil and gas companies, credit risk, equipment maintenance warranty and employee benefit risks, including medical benefits and personal accident.
Captive growth in US Today if a company wants to set up a captive it will be spoilt for choices in the US. There are mature domiciles like Vermont, Hawaii and South Carolina and rising stars such as Arizona and Missouri and nascent captive jurisdictions such as Florida, New Jersey and Oregon. It seems that every state is getting in on the act, with the US captive landscape proving a decidedly crowded field. There are currently more than 30 states with captive laws in US. Vermont is one of the oldest states to enact captive legislation in 1981 and has been the most successful in terms of total number of licensed captives; it has 590 licensed captives at the end of 2012. In a process similar to the private sector, other states started emulating Vermont’s success and also tried to carve out a niche in a particular business area like flexible corporate structures or catering to specific industries. The key growth drivers for captive industry are new regulations like Nonadmitted and Reinsurance Reform Act (NRRA) and Patient Protection and Affordable Care Act (PPACA) and increased traction among SMEs. With the passing of NRRA it seems that SMEs are the major growth area for the captive sector as home state advantage is likely to be a key driving factor for SMEs, who cannot afford to take their captive enterprise further afield. Similarly PPACA may fuel the growth for healthcare captives.
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Typically, companies tend to form captives in the hardening market when prices in the commercial insurance market are on the rise, the main driving force for forming captives is saving cost and mange risk more efficiently. The ongoing soft cycle in the commercial market is hardly conducive to growth for captive industry, but new and alternative ways of using captives are increasingly becoming mainstream and states with specialized focus can certainly avoid the insurance life cycle. Captive structures like RRGs and 831(b) captive which is designed for small businesses are few of the examples which can provide opportunities even during the soft insurance cycle. However, with this growth in more and more states passing legislation the challenge for new states is to differentiate their offerings from such experienced competition. One way to overcome this challenge is to focus on one’s strength like the specific case of Missouri which has become a hub for life reinsurance, with two of the state’s domestic players writing 40% of life reinsurance in the US. Hawaii has achieved reasonable success attracting captives from West Coast organizations. Washington D.C. competes with flexible regulation. Utah has developed a niche for micro-captives. States which will focus on their strengths and build those strengths into the legislation can certainly carve a niche that would be difficult to duplicate.
Regulations impacting the US captive industry The Patient Protection and Affordable Care Act (PPACA) has the potential to change the US healthcare landscape dramatically. The captive industry is watching the developments closely, with new medical institutions offering the potential for significant new entrants. It encourages more consolidation which will create larger healthcare institutions. These large organizations are more likely to self insure their risk which may provide greater control of their cost and increased oversight of their financial and clinical risk. Nonadmitted and Reinsurance Reform Act (NRRA) as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act sets forth a framework under which states may tax and regulate insurance placed with non-admitted insurers. However, it is still unclear if this category only includes surplus lines insurers or captives will also fall under it. After the enactment of NRRA, many captives found themselves wondering whether the benefits of being domiciled in a state other than their parent’s home state exposed the company to paying more in taxes via a self-procurement tax collected by the home state under the NRRA, plus a premium tax charged by the state where the captive is domiciled. NRRA and its implications are still uncertain for captives and only time will tell if it provides any opportunities for states and captives.
Source: NAIC, Property Casualty 360, CICA (Captive Insurance Companies Association), International Association of Insurance Commissioners (IAIS)
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