2012 Vermont Captive Insurance Association Special Section

Continued captive growth expected

An annual review of legislation keeps Vermont on the cutting edge

By Michael J. Moody, MBA, ARM

The captive insurance industry continues to defy logic by growing during the midst of one of the longest soft insurance markets in history. Conventional wisdom pretty much held that captives had their place in the insurance market, but that place was as a solution to the hard market. Many industry observers felt that there was some direct relationship between the insurance market conditions and captive formations. And traditionally this was true. Captive formations hit their zenith in the midst of hard insurance markets and, when things turned soft, so did interest in formations of captives.

This pattern became well established and many large management consulting firms made a living taking advantage of this natural ebb and flow of the insurance marketplace.

Over time, the commercial insurance market became aware of how to stop the flow of good business into the ART market. It was simple really—just begin reducing premiums. But a funny thing happened during the current soft market: lowering premiums was not sufficient to stem the tide of lost business. Commercial insurance buyers had finally had enough. They were determined to maintain control of their own insurance costs and many of them turned to captives to do so. It started with large, multinational companies, but quickly spread to mid-sized corporations.

Based on the evidence today, it would appear that captives have become a permanent fixture within the commercial insurance landscape. No longer just a hard market antidote, they have become a focal point for many corporations' strategic risk management efforts. As buyers gained confidence in their risk management programs, more and more began to see the advantages a captive could bring them, regardless of the state of the traditional insurance market.

A natural outgrowth of captive formations was the growth in captive domiciles. As of today, two-thirds of the states have passed legislation that fosters captive formations. While each domicile has its specific selling points, for the most part they are following the lead of Vermont, the largest domestic domicile. According to Dan Towle, Vermont's director of financial services, the state currently has 590 active captives, including 41 new captives licensed in 2011. And 2012 is also off to a good start, according to Towle, who notes that eight new captives were licensed during the first quarter of 2012.

Reviewing the legislation—an annual tradition

Most captive domiciles will periodically review the legislation that allows captives to operate in their state. In Vermont, Towle says, "It's an annual tradition for us." He adds: "We try hard to make changes that have been suggested by captive owners." For example, "the most recent changes deal with a number of clarifying language issues particularly with regard to sponsor captives." The largest change, however, involved the issue of collateral. New changes now allow captive owners to "consider the use of a trust as an option for capital and surplus. Whether companies will take advantage of this is still unknown," says Towle. But a number of captive owners had expressed interest in this option.

Towle notes the importance placed on this annual process. "It's essential that we remain responsive to our captive owners." He also suggests that this may be a reason why Vermont continues to attract captive owners who decide to re-domicile. "While we have never been satisfied to rest on our laurels," he says, most companies know what they're getting into when they come to Vermont. He points out that "we have experienced personnel in the insurance department and more importantly we have a proven track record."

"We definitely listen to our captive owners," adds Dave Provost, deputy commissioner of captive insurance for Vermont, "but our annual 'housekeeping bill' is also an opportunity for us to respond to potential changes brought to light from other sources, including service providers and other regulators from around the world. It's our chance as regulators to implement best practices from the regulator's point of view."

Earlier trends continue

Over the past few years, Vermont has confirmed several key trends, which appear to be continuing. The majority of Vermont captive business still comes from single-parent captives. Towle notes that about 70% to 80% of the current captives in Vermont are single-parent captives. However, that's not to say that Vermont is not involved with multi-owner captives as well. He points out that the state licensed six new risk retention groups last year. Towle also acknowledges that most group programs take longer to come to fruition, particularly in the soft insurance market, so growth is slower.

Re-domiciling is another trend that continues in Vermont. "We have always seen a fair amount of interest and activity in this area." While Vermont has seen interest from both onshore and offshore domiciles, Towle points out that more recently they are getting frequent interest from onshore domicile captives. Part of this is undoubtedly the result of so many new domiciles being introduced. Once formed in one of the newer domiciles, Towle opines, captive owners soon see the advantages of an established domicile like Vermont.

Interest in employee benefits is yet another growing trend. Towle indicates that "they had more interest in this area last year than prior years." Specifically, he says "companies that are forming captives for the first time have indicated that one of their key reasons for forming a captive was to include employee benefits." Additionally, Towle says, "the uncertainty in the health care market has many companies reviewing their available options." A captive insurance company is frequently cited as one potential solution for these issues.

Conclusion

The captive movement continues to gain participants, and support from the commercial insurance/reinsurance markets remains strong. Additionally, third-party service providers are growing in number and in sophistication. At this point, there is little doubt about the virtues of captive insurance ownership even for smaller companies. Towle notes: "As more and more companies begin looking into the future, they realize that a captive may be one of the few options to control their cost of risk." Further, he points out, "If you have not had someone come in and analyze this option, you might be missing a fantastic opportunity."

Risk management is playing an ever-increasing role at most corporations regardless of size. The key is "they want to control their cost and better manage their risk," says Towle. And they've found "one of the best ways to do that is by forming a captive insurance company." A number of mid-sized agents and brokers have already found the competitive advantages of being able to offer captive alternatives. This has grown to the point that, if you are not offering your clients a captive option, competitive pressures may endanger your agency's continued involvement with the larger accounts in your client base. And today this could as easily come from another mid-sized broker down the street as from a large international broker.

Clearly, as the market hardens, mid-sized brokers that have yet to develop a viable strategy to assist clients with the whole array of alternative market options will be at a significant competitive disadvantage. It's not too late to consider how best to take advantage of ART solutions for your larger clients.