By DAVE LENCKUS, who has covered the captive insurance industry for more than two decades.
Captive insurance experts have been predicting for a few years that small and midsize insurance buyers will fuel the next round of growth in captive insurer formations.
With the advent of the series-limited-liability-company captive structure, smaller risks now have a captive insurance option that is more advantageous than not only pure and group captives but also the protected cell structure of rent-a-captives, said experts who are familiar with the industry.
Among those advantages, a series captive is a cheaper and quicker way to get into and run a captive insurance operation, experts said. A series, which resembles the protected cell structure, also is designed to shield an insured against the liabilities of other series facility members, experts said.
There just are not many captive managers or regulators who claim to fully understand the series structure. Several large captive managers would not comment about it for this article because they never have assisted a client set up such a captive or join such a facility.
Some regulators say they are beginning to study the structure, as well as consider the regulatory approach they would take if would-be captive sponsors wanted to form series captives. As a result, series captives to date have formed only in Delaware.
The general unfamiliarity with the series structure is a function of how new it is to the captive insurance scene.
Only nine U.S. jurisdictions have granted series legal corporate structure status. Seven are captive insurance domiciles: Delaware, Illinois, Nevada, Tennessee, Utah, Puerto Rico and the District of Columbia. Iowa's and Oklahoma's corporations laws also permit series.
Delaware's insurance regulators approved the world's first series captive in January 2010, shortly after the state's captive law was amended to recognize series. The structure, however, has been legal in Delaware since 1996, following an amendment to the state's corporations law, making the first state the first one in the nation to recognize the structure.
In the past 18 months, Delaware has approved a dozen more, said Steve Kinion, director of the Bureau of Captive and Financial Insurance Products with the Delaware Department of Insurance. The state's 13 series captives have a total of 42 participants, known as series business units.
Captive managers describe the business units as small and midsize enterprises, ranging from professional firms to manufacturers.
Series captive sponsors can open their facilities to risks from various industries or limit participation to homogenous risks, experts said.
Like a protected cell facility, a series is established by a sponsoring organization, which must meet a captive domicile's capitalization requirements. In both types of facilities, a protected cell captive and a series captive, each participant also has to meet the regulating domicile's capitalization requirements.
But captive members in both cases would not incur the various costs they would face if they had formed single parents for themselves or joined together to form a group captive.
Startup costs for a series business unit owner likely are no more than half the cost of forming a pure captive, estimated broker Robert C. Bates III, president and chief financial officer of Amplitude Reinsurance Co. of Delaware, the nation's first series captive.
Bates, who is a broker, is the owner and managing director of Dallas-based Transpac Managers Inc., which designs specialized insurance programs. Amplitude Re is managed by Strategic Risk Solutions Inc.
Participants in both series and protected cell facilities also operate independently from each other. That means each member of both types of facilities is responsible only for its own premiums and losses. Unlike with a group captive, no series business unit or protected cell can be held responsible for the losses sustained by another member of its facility.
Not even a facility's core capital would be at risk if a facility member fails, experts said.
Under insurance statutes, that normally is not possible, said Joel Pina, chief financial officer of Conshohocken, Pa.-based captive manager Keystone Risk Partners LLC, a subsidiary of Keystone Insurers Group Inc., which has represented series business units in Delaware.
But series facilities in Delaware are formed under the captive law's special-purpose captive provisions, which give insurance regulators the flexibility to protect a series' core capital if a business unit fails, Pina said.
However, a series captive's business units can join together to form and capitalize a separate series business unit that provides reinsurance to one another, said attorney Matthew J. O'Toole, who co-authored both the Delaware corporations law and captive law provisions that recognize the structure.
O'Toole said that the advantage of a reinsurance unit is that, if necessary, it strengthens the series business unit owners' case with the IRS that they are engaged in true risk-sharing and risk distribution, making their premiums tax deductible.
For state captive regulatory purposes, series business units are considered silos, or independent subdivisions of a single entity, said O'Toole, a shareholder and director with Stevens & Lee P.C. in Wilmington, Del. This is an important difference from how state captive insurance regulators treat a protected cell facility and its individual cells, all of which are considered separate entities.
Because series business units are treated as parts of a single entity, none is subject to either an annual premium tax or an annual fee in domiciles like Utah that do not levy premium taxes. Only the mother series entity is subject to a minimum premium tax or annual fee.
Depending on a series captive's business plan, its sponsor could divvy up that single tax or fee among the facility's various business units, experts said.
In contrast, every protected cell in a rent-a-captive--except in Vermont--faces a minimum premium tax or annual fee.
In Vermont, a recent amendment to the captive law extends to protected cell captives the same premium tax advantage that series captives have in Delaware and presumably would have in other captive domiciles, said Burlington, Vt.-based Derick White, president of captive manager SRS (Vt.) Ltd., a unit of Strategic Risk Solutions. Vermont currently does not recognize the series structure.
Those familiar with the series structure point to other advantages it has over alternatives:
-- Because a series is considered a single entity for state regulatory purposes, series business units need not individually retain various vendors to help them meet various state insurance regulatory requirements. Instead, they can rely on the auditor and tax service the parent series retains.
-- Adding or withdrawing a business unit from a series facility requires only relatively easy-to-make revisions to the facility's operating agreement and business plan.
-- Each business unit is governed by its own board. In contrast, a central board oversees all the cells in a protected cell facility.
O'Toole said that the only disadvantage with a series is one it shares with the protected cell structure--"a degree of uncertainty" over whether a bankruptcy judge would treat series business units or cells "in the right way" if a fellow facility member fails.
A judge who understands the structure of series and protected cell captives should not shift a failed business unit's or cell's liabilities to others in its facility, O'Toole said. But because of a dearth of legal precedent on handling insolvencies within these types of facilities, judges potentially could err, he said.
Owners of series business units in Delaware, though, have "an additional layer of comfort" to make sure that the problem would not occur.
The state's amended captive law underscores that Delaware insurance regulators recognize the total segregation of each business unit's liabilities and assets, O'Toole said.
Not everyone is sold on the merits of the series captive. Ross Elliott, captive insurance director for the Utah Insurance Department, for example, has a few concerns.
The drawbacks, however, will not deter Utah from entertaining proposals to form series captives, and Ross said he is evaluating at least five series captive applications, including two by already-licensed pure captives.
August 23, 2011
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