By JACK ROBERTS, who consults with insurance brokers, carriers, risk managers and media companies
With 42 of the Fortune 100 companies sponsoring captives domiciled in Vermont, it's no wonder that Vermont has the reputation as the Big Captive State.
But those statistics may obscure the profile of most of the individual insurance captives domiciled in Vermont. More than half of the Vermont captives are small or midsize captives and about 25 percent have less than $1 million in gross written premiums, said Daniel D. Towle, director of financial services for the Vermont Department of Economic Development. Towle markets Vermont as a captive domicile.
For many captives, gross premium dollars were flat or declined for the past few years reflecting the soft insurance market with its lower premium prices. David Provost, deputy commissioner of Vermont's Department of Banking, Insurance, Securities and Health Care Administration, said a number of captives have become "dormant" awaiting an improving economy and a better insurance market.
Those captives, and captives now being formed, will be in a far better position as an effective alternative risk mechanism when the market turns.
Christina Mancini, CEO of Captive.com, which tracks domestic and offshore captive formations, said that captive growth for the past two years has been flat or declining, although she began to see increases in 2010. "There are certainly new, smaller captives coming," she said.
In 2010, only 21 Vermont captives "dissolved"--a turnaround from 36 in 2009. "Certainly, in 2009 we saw a number of captives go away," said Richard Smith, president of the Vermont Captive Insurance Association. But the trend changed in 2010.
"Some of this could have been attributed to the economy, but it's a relatively short timeframe," Smith said. Smaller companies and organizations are looking more closely at alternative risk options and captives, Smith said. "Smaller organizations see the benefits," he said. "Previously, I think, captives were perceived as one of those financial instruments that seemed better suited to large companies." But today, he said, with the maturity and growth of the captive industry, "the tangible benefit to small companies is clear."
Nancy Gray, regional managing director for Aon Risk Solutions, said she advises any organization seeking to form a captive to do an analysis of the total cost of its risk.
"We look at the alternative risk options relative to other risk transfer options, including self-insurance and the commercial markets," she said. "Often we find that with small captives, especially group captives, our clients can reduce their cost of risk."
Gary Osborne, president of USA Risk
Group, said he has talked with risk managers and insurance brokers who think that Vermont will be too expensive for a new captive, especially a smaller captive.
However, he said, "Comparing government fees, Vermont may be less expensive than an offshore domicile." A captive can be formed for $45,000 to $60,000 depending upon what it plans to do, Osborne said. That cost differential is relatively small among domestic domiciles and is probably less than the total formation costs in many offshore domiciles.
Richard McCarthy, who manages the Land Title Assurance Company, a risk retention group based in Vermont, said his midsize captive, with about $7.5 million in gross written premiums, was formed in June 1987 by American Land Title Association, to provide its members, title agents and abstracters, with errors and omissions coverage.
"It's not that expensive to set up or operate a smaller or midsize captive in Vermont," he said. "The cost is marginal. Today, it's the best domicile. In the early days, it was the only state with a real captive infrastructure."
As a former chairman of the VCIA, McCarthy, who works from Washington, D.C., has had the opportunity to network and learn from his peers. "I sit on the VCIA board and meet with huge captive owners. I might be sitting across from the guy from Exxon or Janice Abraham, who heads up United Educators, one of the largest risk retention group with more than $100 million in gross premiums, he said.
"Whenever I go to any Vermont meeting, I learn something," McCarthy said.
Like many captives, McCarthy said Land Title Assurance Company was formed when his members-- title agents--simply "couldn't get insurance."
Because the title insurance business is generally tied to the fortunes of the housing market, the ability to get insurance in the commercial markets ebbs and flows.
Today, with the prolonged housing crisis, errors and omissions liability coverage for title insurance agents can be expensive or very difficult to place.
"For 23 years, we have offered stability. We may not be the cheapest, but we offer the best policy," McCarthy said.
Availability of insurance is a common issue for smaller risks, Aon's Gray said.
"Even in this soft market, there are a number of companies that find it difficult to find insurance coverage because of their type of risk," she said. "For certain kinds of product liability risks, for example, the commercial insurance markets might not offer coverage at all--or coverage at an affordable price.
"The traditional market might be as responsive to a client with a small premium," Gray said.
Last year, Vermont provided newly formed captives a one-time premium tax credit, which expired on Dec. 31, 2010. "The tax credit expired and the state has agreed to talk about making it permanent," VCIA's Smith said. "That sends just the right message to a smaller business interested in starting a captive."
USA Risk Group's Osborne said there are some strong advantages for businesses with smaller risks to start a captive. He points out an example of a small hotel owner who may have only one or two hotel properties. In this case, the hotel could have an exceptional loss record, perhaps going for years without any claims.
"In effect, that owner is paying in the commercial market for losses that he just isn't going to see," Osborne said. If the hotel goes for five years in a captive without any losses, the cost of its formation will be covered by the profits from the captive. Even better, Osborne said, if the good loss record continues, the owner should be able to cover his insurance costs solely out of the captive.
Some of the new captives, Osborne said, may also be motivated by estate and tax planning issues. Under the federal tax provisions known as 831(b), certain small insurance companies, including captives, can shelter certain profits from federal taxes. The provision only applies to insurance companies with ceded premiums less than $1.2 million.
In the past, the predecessor provision was abused. It came under criticism because tax consultants used the option to shift millions into the entities just to defer taxes. These strategies really didn't have any legitimate risk transfer or risk management function. The 831(b) provisions sought to stop those kinds of excesses.
Vermont's Provost said that he assumed that some captives in Vermont qualify for the 831(b) tax treatment, but that Vermont regulators evaluate a proposed captive based on its business plan as an insurance company. "Certainly we look at the tax impact of a captive, but we look at it in terms of the impact on the financial statements of the captive itself," he said.
"We don't get many applications for captives that are blatantly motivated by tax issues," Provost said. Nor does Vermont market the 831(b) provisions to potential captive sponsors, although some other domiciles do.
Aon's Gray said that Vermont will license a captive that qualifies for 831(b), "but only providing it makes economic sense. If it works as an insurance business, then it can be approved."
She acknowledged that "captives are being formed for estate planning purposes, and to benefit from the 831(b) tax provisions." But, she warned, "These kinds of issues should not be the driver of the captive. You need to have the proper business plan and real risk management reasons for forming a captive. Tax benefits may be important, but they should not be the driving factor."
The fundamental reason for a small or midsize captive to be domiciled in Vermont isn't any different than the reason many very large captives are based in Vermont: regulation.
McCarthy, for example, said that his risk retention group "wanted to be regulated properly" and Vermont listens to our needs, "but certainly isn't a rubber stamp."
Equally important to McCarthy is that as the captive community has grown in Vermont, the governor and the state legislature have supported the captive insurance division.
"As the number of captives in Vermont increases, even when the budget was being cut back in other places, the department's budget increased and it was able to hire additional staff," he said.
Another plus is small captive owners will be better positioned for a hard market. Provost said, "Companies that form captives in a soft market tend to be forward looking and know that the soft market won't last forever." These owners will be ready, he said. "They will have their reinsurance in place. They will have the needed relationships in place. They will be able to adjust retentions and take advantage of better pricing in the captive than in the market."
And, Provost said, "When the market turns we will get a lot of people who want to form a captive in a hurry." Those in place today will be far better prepared.
May 1, 2011
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