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By DAN REYNOLDS, senior editor of Risk & Insurance®

It was a bunch of taxi drivers in tourism-dependent Hawaii who, back in the mid-1980s, first gave their approval to the formation of a captive to house certain of their liabilities, according to the state's Insurance Commissioner J.P. Schmidt.

"But over the years, obviously, we have gained a lot of experience and knowledge in what will work and what won't work," Schmidt says.

True enough, if statistics can be believed. The latest calculations aren't complete, but Hawaii looks to have had 165 active captives at the end of 2008. That places it, depending on what resource you use, in either ninth or 10th place in the world in terms of number of captives.

But in terms of combined assets, Schmidt asserts, the captive domicile ranks fifth in the world.

"If you measure with a different metric and look at the domiciles with the largest combined capital assets, Hawaii is the fifth largest captive domicile in the world, and that is because some of the other captives in the top 10 have a lot of smaller captives," Schmidt says.

"We have a lot of very large, sophisticated corporations that have set up here. We have Nike and Clorox, eBay and Intel, as well as large healthcare entities such as Stanford Hospital and the University of Washington Hospital," says Schmidt.

"And because of the expertise that we have and our ability to work with these captive owners, the captive structure really works well for them to achieve their goals."

DISCOVERING JAPAN

The presence in Hawaii of such Silicon Valley-based giants as Intel and eBay, and the Beaverton, Ore.-based Nike Corp., also gives a clue to what is one of the most important advantages Hawaii has as a captive domicile. And that is its geographic location.

There are sizable captive domiciles in the Western states of Nevada, Arizona and Utah, but those domiciles, which had a combined 315 captives at year-end 2007, do not have the mid-Pacific location of Hawaii, with its proximity to Japan and other Asian nations.

There are larger domiciles of course; Bermuda being the largest in the world and Vermont being the largest U.S.-based domicile. But in the Pacific Rim, there really isn't a whole lot of viable competition.

There's Singapore, which had approximately 62 captives at year-end 2007. But in the eyes of a crucial Pacific economy, Japan, Singapore is classified as a tax haven under Japan's tax laws and as such isn't looked on as a viable domicile by many Japanese-based companies, according to Emi Swaim, a vice president in the Honolulu offices of Marsh Inc.

"So a lot of captives opt to set it up at places other than Singapore," Swaim says. Japanese giant Yazaki Corp. is a case in point.

"I know that Japanese companies usually look at Bermuda because Bermuda is the leading captive domicile, and they do think that Bermuda is a great domicile with the access to the reinsurance market and so forth," Swaim says.

But, she says, Bermuda's presence in the Eastern Time Zone makes it difficult for Japanese-based businesses that wish to operate a captive to conduct any voice-to-voice business there.

"Basically, they would have to send out an e-mail and then they would have to wait for the response until the following day, so there is some time loss," Swaim says.

"Where in Hawaii, we can talk on the phone in the morning Japan time, which is the afternoon our time, we have a good three or four hours that we can do business," Swaim says.

What also works in Hawaii's favor, according to Schmidt, is the attitude of another significant Pacific Rim economy, the state of California.

It seems officials in California don't look too kindly on the idea of risk retention groups, Schmidt says.

"There are a number of states in the West that may not have a positive view of captives and risk retention groups, such as California, where because they don't really have their hands on a regulatory authority, they are somewhat skeptical and often attempt to place a number of requirements on risk retention groups or captives that do business there," Schmidt says.

Schmidt says that over the years, though, regulators in Western states have come to recognize Hawaii as a legitimate domicile that fairly, ethically and strictly regulates its captive industry.

"And because of that, we have developed a very good relationship with California and some of the other states in the West, where they understand that we do a very good job of regulating captives and risk retention groups," Schmidt says.

"If the risk retention group was set up in Hawaii, they know that it's got a good business plan, it's got a good financial structure and so they are comfortable with it. In fact, California has recommended some companies come to Hawaii to set up their captive, which we take as a compliment," he says.

"So, a part of it is the fact that it really benefits captive owners who want to do business in the Western states that they know that the regulator in those states is going to treat them well because they are set up in Hawaii," Schmidt says.

The commissioner adds that his department has done a good enough job in educating Hawaii's lawmakers on that, and that he has been able to pass some legislation helpful to the industry in the past few years.

In the past two years, Schmidt has championed and seen passed an annual taxation cap on captives of $200,000 and the approval of a special-purpose financial vehicle, a captive that can be used to securitize insurance products.

Of course, given what's going on in the investment world these days, that sort of captive isn't getting a lot of play at the moment.

"Now obviously with the financial problems ... there is not much action in the area of securitizations. However, I think as things begin to turn, insurance-linked securities will be one of the first areas where securitization will start growing again," Schmidt says.

REPLACING WATANABE

For the short-term future, Schmidt and other state officials have set in motion the mechanism to replace Craig Watanabe, who had been the deputy insurance commissioner and captive insurance administrator for the Hawaii Insurance Division for the past five years.

In this, Schmidt admits he's got his hands full. Watanabe, who was seen as one of the department's greatest assets, got a lot of the credit for improving Hawaii's regulatory environment for captive insurance companies.

"Well, frankly, I think that Craig Watanabe is one of those people that is irreplaceable," Schmidt says.

"He was really highly regarded not only around the nation but around the world for his expertise in the captive area."

But in replacing Watanabe, who left the state for a position as chief financial officer with DTRIC Insurance Co., an underwriter of automobile, home, general liability and workers' compensation coverage, Hawaii is at the moment in a better position than Arizona, for example, which for budgetary reasons hasn't been able to replace a captive administrator it lost more than a year ago.

"We have got the government approvals already and will be proceeding to advertise the position soon. In government you always have to go through the personnel process, which you know can be quite daunting, but we have gotten the approval and can move ahead," Schmidt says.

March 3, 2009

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