MARKETING
Captives and other alternatives have become extremely popular
By Len Strazewski
"Captive insurance companies have been viable risk funding devices for a long time, but lately, as agents and clients struggle to control their costs, they have become the technique of choice."
--Greg Dobrowolski, Universal Insurance Services
For nearly 10 years, the work was easy, but the compensation was slim. Insurers were cutting rates with every renewal and aggressively pursuing market share--and agents and brokers were almost always the bearers of good news for their clients while their own commissions were falling.
In 2001, when the property/casualty insurance market shifted, so did the fortunes of agents and brokers. Increased rates and premiums yielded higher agency commissions--but only when producers could place or replace coverage in an increasingly hard market.
When agents couldn't place coverage at acceptable rates, they turned to the alternative risk market--captive insurance companies, risk retention groups or other programs that allow agents and corporate clients to set their own rates based on their loss experience. And as the hard market continues into 2003, the alternative risk market is still the place to be for many agents and brokers and their clients.
"The alternative risk business has been extremely popular in the last year or two," says Greg Dobrowolski, director of captive insurance for Universal Insurance Services in Grand Rapids, Michigan. "Captive insurance companies have been viable risk funding devices for a long time, of course; but lately, as agents and clients struggle to control their costs, they have become the technique of choice."
Universal has about 12 corporate clients involved in group captives--companies formed specifically to allow homogeneous client companies to share their risks--and formed eight of the programs in the last year, he says.
Captives allow clients with good, consistent loss experience to smooth out the ups and downs of the property/casualty insurance cycles. By retaining some predictable, fundable level of risk in an insurance company created for that purpose and reinsuring high levels of catastrophic or less predictable risks, clients can underwrite their own exposure and fund their predictable losses without the administrative costs or profit requirements associated with commercial insurance companies, he explains.
"If clients can individually or as a group control risk within their organizations, they are excellent candidates for the alternative risk market," Dobrowolski says.
Kevin J. Doyle, president of Gallagher Captive Services, a subsidiary of Arthur J. Gallagher & Co., Inc., in Itasca, Illinois, says the management company has been flooded with requests from its own brokers, independent agents and their corporate clients for feasibility studies and captive application processing.
Workers compensation, general liability and automobile liability insurance are the cornerstones of most captive programs, as well as the often difficult-to-place medical malpractice and other professional liability coverages, he says.
The management company can form single parent captives for individual client companies with $1 million or more in premium volume in those lines of coverage or place smaller risks of $250,000 to $1 million in rent-a-captive or protected cell structures--risk management accounts within insurance companies created for that purpose.
Arthur J. Gallagher & Co. owns two Bermuda insurers, Artex Insurance Co. and Protected Insurance Co. that offer rent-a-captive and protected cell services to agents, brokers and their clients.
"What the agents and client get from the alternative risk solution is control," notes David McManus, president of Artex Insurance Co. "There is no reason why agents should be buffeted by the changes in property/casualty market cycles--subject to the commercial insurance market's alternating demands for market share and profitability.
"Captives allow their participants to capture the profit that is built into the insurance process. If a risk can be underwritten successfully, yielding either an underwriting or investment income profit, that profitability can be retained within the captive for use by a single parent or to be distributed as dividends to participants."
Agents can also share in the profitability of their best client risks by creating and funding captive insurers for high-quality individual risks or groups of smaller client companies with exceptional loss histories, he says. Many group captives evolved from books of business developed by agents with unique expertise in difficult risk categories.
"The profitability accrues to whoever provides initial capital or collateral to fund the risk," McManus says. "In some situations, an agency has an opportunity to provide that capital for its best clients and establish an additional way to retain profit from its expertise."
Captive insurers can be formed in a wide range of domestic and offshore domiciles that provide special tax advantages and rules of incorporation. According to preliminary totals reported to A.M. Best Co. in Oldwick, New Jersey, the largest of the captive domiciles--including Bermuda, Cayman Islands and Vermont--experienced more than 50% growth in new captives compared to 2001.
"New formations are going gangbusters, but that's really no surprise, considering the hard commercial insurance market," explains Carol M. Pierce, assistant vice president and director of Best's Captive Insurance Directory. Overall, Pierce estimates an average of about 35% growth in new formations for all offshore, domestic and European captive domiciles. However, she also estimates little or no growth in the total number of captives worldwide as liquidations also continued at a high rate last year.
"The domiciles are still reporting a lot of liquidations and mergers; and acquisitions of the past years are finally resolving, leading to the combinations of risk management programs and the consolidations of captives," she says.
The Captive Insurance Directory reported 932 total captives worldwide in 2001. Pierce expects 2002 totals to remain less than 1,000.
Fueled by the medical professional liability crisis, risk retention groups and purchasing groups--domestic risk pools enabled by federal legislation--are also on the rise. According to the Risk Retention Reporter in Pasadena, California, the number of risk retention groups has grown to 95 and purchasing groups to 718 as of January 1.
Many of the new groups have been launched specifically for hospital and health care practice liability insurance. In January, for example, New York-based Marsh, Inc., a global brokerage and risk management company, announced formation of Community Hospital Alternative for Risk Transfer, a Pennsylvania-based risk retention group, to provide medical malpractice and general liability insurance for 33 rural Pennsylvania hospitals.
This new group was the 21st group formed since 2001 to address the growing demand for hospital liability insurance at affordable rates, the broker says.
Both offshore and domestic captive insurance domiciles are reporting ongoing growth in new captive formations.
In Bermuda, the oldest and largest of the offshore captive domiciles, Pierce estimates at least 52 new formations and about 50% growth in new formations over 2001. She also notes exceptional growth in protected or segregated cell formations--risk-funding accounts for small to medium-sized businesses in established Bermuda insurance companies.
For example, late last year, the Liberty Mutual Group in Bala Cynwyd, Pennsylvania, formed its first Bermuda-based sponsored captive to provide rent-a-captive arrangements and segregated cell accounts to medium-sized employers and their agents and brokers. The company is targeting employers with $500,000 to $5 million in premium volume and special coverage needs.
Bermuda dominates with captives for the energy industries, transportation industries and large manufacturing companies, among other mainstream risks, and Bermuda-based captive managers report continuing interest and a steady flow of new applications.
Cayman Islands, the second largest of the offshore captive domiciles, reported even more explosive growth in 2002, fueled by health industry captives. The domicile licensed 97 new captives in 2002, according to Gordon Rowell, head of insurance supervision, leaving another 25 applications in process for licensing in early 2003.
About half of the new formations were generated by the health industries as a crisis in medical malpractice insurance drove physician groups, hospitals, nursing homes and other institutions into the alternative market.
However, Rowell said the remaining new formations came from a broad range of industries, including retail, construction, hospitality, real estate and transportation and were licensed to underwrite a wide range of coverages, including workers compensation, property insurance and general liability.
Segregated Portfolio Companies (SPOs), insurers that offer segregated cell accounts, increased by more than 45% to 60 total; and active cells doubled to a total of more than 300.
Other offshore domiciles also reported some growth, according to Best's Pierce, but not at a similar accelerated pace.
Dublin continued to be the domicile of choice for European companies and U.S. companies needing a captive facility for European subsidiaries, but the domicile did not report formations to the Captive Insurance Directory in January. Guernsey, a pioneer in protected cell companies, reported some growth in formations, fueled mainly by new protected cell companies, Pierce says.
Gibraltar, despite heavy promotion as a platform for risk management in the European Union, reported only one new captive in 2002, bringing its total to 12.
In the United States, Vermont continued to dominate among onshore domiciles. The state set an all-time record with 70 new licenses, including 55 single parent captives, 10 risk retention groups and several sponsored or association captives, bringing its total up 597. Thirty-two captives were licensed in the fourth quarter alone.
"We have 10 applications in the pipeline," notes Derick White, assistant director of captive insurance. "2003's pace is not slowing down a bit."
Other onshore domiciles posted some growth and significant percentage increases, but not explosive totals. South Carolina continued its aggressive marketing, targeting agents as well as employers, but reported only three formations in 2002.
Hawaii, touted as a perfect location for Pacific Rim companies and United States firms expanding into Asia, recorded "only a couple of new captives," Pierce says.
Will captive growth continue at its present pace?
Smith, Bell & Thompson, Inc. (SB&T), in Burlington, Vermont, formed seven new captives in 18 months after the property/casualty market hardened, including three in the first month of 2003, according to President and Chief Executive Officer Roger Teese.
The pace continues unabated as more and more clients look at their risk-funding options, he says. "I don't see it slowing down for at least another year."
However, captive growth is not without some roadblocks, notes Jeff Kenneson, SB&T captive director. The global hard market has had an impact on the global reinsurance market, causing reinsurers to tighten their underwriting standards and raise their rates--though not at the same catastrophic levels seen in the standard market, he says.
Reinsurance for captive parents that want to retain only a portion of their risk may be difficult to come by--particularly in historically difficult-to-place risks, such as medical malpractice insurance.
Also fronting insurers, admitted carriers that issue policies reinsured by captives, are becoming few and far between. Kemper Insurance Group sold its risk management and fronting accounts to Hartford Insurance Group, and Old Republic Insurance Co. was only the most recent fronting insurer to abandon its business.
Without fronting insurers, captives can't fund risks in many key states, Kenneson notes. *