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The future of U.S. captives Will future legislation interrupt growth? By Michael J. Moody, MBA, ARM In the past, the growth of the captive insurance market was directly tied to affordability and availability issues in the traditional insurance market. Many found that the cyclical nature of the traditional market was tailor-made for forming new captives. However, over the past 10 to 15 years, another trend has emerged. This trend is that captive formations continue regardless of the point in the pricing cycle. The reasons for this new trend are numerous. First and foremost is that corpora-tions have finally come to understand the strategic value of captive insurance companies. They are no longer viewed as simply antidotes for hard market conditions. As a result, today many captive owners are exploring many unique ways to utilize their captives. Whether it is for first-party property coverage, terrorism coverage, or even employee benefits, captives can provide their owners with a competitive advantage when structured properly. Another major reason for captive growth has been the acceptance of captives by the traditional insurance market. Insurers/reinsurers and brokers have been more willing to deal with captive insurance companies. As a matter of fact, most national property and casualty insurance carriers and international brokers have developed products and services specifically for the captive insurance market. Today, captives have become an accepted risk financing method. Long-term view While the current softening insurance market will have an effect on captive formations, most industry experts agree that the captive movement will continue despite the softening of rates. And the number of states passing captive enabling legislation continues to grow. Obviously, this speaks well for the growth of U.S.-based captives, right? Not so, according to Ernst N. Csiszar, past insurance commissioner of South Carolina, past president of the NAIC and past president of Property Casualty Insurers Association of America (PCI). Csiszar stunned a crowded session at a recent Captive Insurance Company Association (CICA) in Tucson, Arizona, when he said that the majority of growth for captives will be offshore, rather than domestic. He based this conclusion in large part on the serious threat to domestic captives that will come from changes to the U.S. insurance regulatory environment. Csiszar stated that the current issues facing insurance regulators will require some change that will ultimately challenge the flexibility that is enjoyed by captive insurance companies. He stated that he believed that some type of federal regulation would be very hazardous to the health of U.S. captives. And while he did note that there were options on the table with regard to the state regulations, he held out little hope of improvements or reforms to the current state regulatory system. As a result, Csiszar indicated that the next few years would see a growing trend within the captive industry of movement to offshore domiciles. An opposing view There is another, different view on the growth prospects for the captive insurance industry—one that favors U.S. domiciles. Some believe that at least for publicly owned, U.S.-based companies, domestically based captives will be the suggested method for formation. There are four basic reasons for this view: • Sarbanes-Oxley compliance-related issues • Expense management as captives begin to maximize their return on investments associated with a closer home domicile • Employee benefits requirement for a U.S. domicile, and • Offshoring concerns on the parent’s reputation and/or patriotism Many people do believe that there will, however, be significant use of non-U.S. captive domiciles by foreign-owned, global companies. This will be due in large part to a more “direct writing” approach in European Economic Community (EEC) territories in an attempt to better manage fronting costs for non-U.S. risks. This is believed to be even more possible due to the expanded number of European domiciles and the broad growth of the number of countries that are now a party to the EEC Directive. Current situation Clearly, the United States does have a major problem with regard to its insurance regulations. Traditionally, the regulation of the insurance industry has been done by individual states. However, most industry insiders agree that state regulation has outlived its usefulness as currently practiced. Critics of the current regulatory environment say it is overly complex, anticompetitive and unduly burdensome, and results in increased cost of compliance and delays in bringing products to market. Currently, Congress, through various committees and subcommittees, is reviewing many aspects of the insurance regulations. At this point, there are basically two distinct approaches that are emerging from the Hill. One of the approaches is a dual federal/state chartering methodology and the other is more of a modernization of the current state system. Some within the industry believe that the states have a historical right to regulate the insurance business. They point out that states have been involved with insurance regulation for 100 years, but that is also part of the problem. It should be remembered that 100 years ago, the individual states regulated the railroads, the utilities and most other forms of commerce with minimal federal involvement. It was also a time when most of the insurance industry was made up of small mutual insurance companies that insured the property risks of local families and business owners. Today’s insurance environment is quite different because much of it is being done internationally, with many of the largest insurers headquartered outside the United States. Conclusion It appears that the growth of captives will continue over the next few years. What remains cloudy is the issue of onshore vs. offshore. This is an issue that is critically important to all participants of the captive insurance community. But it isn’t just the captive insurance industry that is concerned about offshore vs. on-shore issues. The entire insurance industry will feel the effects of any changes made in Congress. With so much riding on the results of the state vs. federal regulation issue, it is important that the participants of the captive industry take a much more active role in the direction of this legislation. Whether Csiszar is correct, and captives begin to lose much of the flexibility that they have enjoyed or not is really up to Congress. However, it is not too late to help design a better mousetrap for insurance regulations. And now is the time to get involved. * The Author |
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