CAPTIVES: 2019 AND BEYOND

Opportunities abound for mid-market agents and brokers

By Michael J. Moody, MBA, ARM

Recent years have seen a renewed interest in captive insurance company formations. Despite a continuing soft commercial insurance market, captive formations continue to increase. To be sure, this risk financing alternative has been in use for decades. Historically captives were used by Fortune 500-type corporations. This began to change in the late 1970s in response to significant market displacement. The commercial insurance sector became so dysfunctional that in 1986 Congress passed the Risk Retention Act. The act enabled the formation of group captives and smaller single-parent captives. Broker/consultant Marsh points out in a recent issue of The Captive Landscape that although captives were “once the domain of large, multinational companies, today they are an important risk financing tool for organizations of all sizes.”

Today the strongest interest in captive formation comes from mid-sized corporations that are searching for a more effective method of risk financing. Initially these companies were directed to an approach that took advantage of section 831(b) of the Internal Revenue Code. That approach, however, has come under intense scrutiny by the IRS, which has prevailed in several challenges in tax court. The captive community has received little clarification of the rules that apply to 831(b) captives, and experts agree that the IRS needs to issue guidance on the use of this structure.

Agents and brokers who understand the relationship between captives and enterprise risk management and can successfully convey it to their clients and prospects will thrive in the future. Those who don’t are destined to remain commission-driven insurance salespeople.

An emerging trend in the captive arena is strongly supported by brokers like Robert Phelan, president and chief executive officer of TriPoint. He indicates that captive owners are beginning to see their captives as core pieces of a broader enterprise risk management program. He says this approach, which he refers to as “performance-based insurance” and highlights in his book, The Cost of Ignorance, provides a way for companies to realize the advantages of captive ownership.

Opportunities abound for middle market agents and brokers, according to Phelan; and, contrary to what some believe, the captive market is far from being saturated. “Worldwide there are probably fewer than 6,000 captives today. We have just started to scratch the surface as performance-based insurance begins to be incorporated into enterprise risk management.”

Corporations need to focus more intently on developing a strong safety culture. Today’s workforce is much more interested in employers that provide a safe working environment, Phelan observes. “Safety can no longerbe viewed as a ‘nice to have’ extra that is provided only if it’s convenient.” It must become a core strategic initiative.

Many middle market agents and brokers hesitate to enter the captive arena because they lack understanding of the operational aspects of captives. Dan Towle, president of the Captive Insurance Companies Association (www.cicaworld.com), says he realizes that some agents and brokers “may be resistant to the captive concept, but that trend is changing.”

Further, he says, “Captives are more mainstream than ever, and agents and brokers need to be educated on the benefits of captives to be able to appropriately advise their clients.”

Although most captive domiciles have annual educational offerings, basic information should be provided by an objective source. As a domicile-neutral organization, CICA can present an unbiased overview of the captive movement. Towle points out that CICA’s annual conference provides educational offerings at all levels of learning. Another balanced learning experience is offered by the International Center for Captive Insurance Education (www.iccie.org).

It’s easy to turn your back on current trends in the captive market; 831(b) captives certainly have their detractors, and not everyone is on board with the whole enterprise risk management approach. As Phelan points out in his book, however, “What do you think would happen if all the good companies jumped out of the traditional insurance market, leaving only the bad companies? You got it. The system would get very expensive for all those remaining insureds.” Although the current soft market has prevented this trend from manifesting, if the market turns it will become obvious that poorly performing accounts will be placed in assigned risk facilities.

Where does this leave us with regard to captive trends for 2019 and beyond? Despite uncertainty in the commercial insurance market and potential additional IRS challenges, it appears that growth in the captive sector, particularly enterprise captives, will continue into the foreseeable future. This should be great news for middle market agents and brokers because, as Phelan has noted, “The key, of course, is that the captive needs to be established as the core of a corporation’s overall risk management program.”

Agents and brokers who understand this relationship and can successfully convey it to their clients and prospects will thrive in the future. Those who don’t are destined to remain commission-driven insurance salespeople.

The author

Michael J. Moody, MBA, ARM, is the retired managing director of Strategic Risk Financing, Inc. (SuRF), which was established to provide consulting services to captives and other alternative risk transfer mechanisms. As a contributor, he continues to promote the benefits of the ART market by providing current, objective information about the market, the structures being used, and the players involved.