These are interesting times for the insurance industry. A global recession, an unpredictable market and the possibility of increased regulation have created an unprecedented climate of uncertainty. In many organizations, it has become a time of survival. For risk managers tasked with helping their organizations develop strategies to finance risk and meet the demands of this economic environment, one solution is to explore the many options afforded by today's captive marketplace. Opportunities abound and choices are plenty.
Captives remain as important as ever, allowing organizations of any size and in any industry to take their risks from the mainstream insurance market into an alternative venue where pricing, capacity and claims costs can all be controlled with greater precision. The tax breaks from operating a captive are, as always, another major incentive. And while increasing competition has always made this market compelling, there are other developments at hand that make the world of captives even more unpredictable than usual.
The first and most important factor affecting the captive arena is a soft insurance market that has given mixed signals as to when it might begin to harden. Traditionally, just as hard markets are a boon to the alternative risk financing market, soft markets give risk managers incentives to return to the mainstream. The captive market has not been immune to this. Many of the domiciles featured in this year's review have suffered slower rates of growth in new company registrations, if not net losses in their total number of captives.
At the same time, U.S. regulatory issues cast a shadow on the entire captive industry. "The President fully supports the Stop Tax Haven Abuse Act and will not tolerate the offshore tax abuses that drain $100 billion a year from the U.S. Treasury," said a senior Obama administration representative during a congressional hearing earlier this year.
This sentiment, coupled with the act itself and the administration's recent actions to curtail Swiss banking secrecy, points to potentially serious regulatory developments in the coming year. And lest anyone forget, the IRS did try to push through new captive insurance tax measures last year but was stopped by opposition from the industry in an unprecedented display of solidarity. A repeat of such a measure is always possible.
That said, captive insurance seems less likely to be targeted by Washington than it does of becoming collateral damage to overly broad legislation. Lawmakers may not intend to affect the captive industry but might anyway, thanks to imprecise wording or overzealous intentions to rein in other offshore corporate arrangements.
Historically, few captive domiciles have been "blacklisted" as legally dubious jurisdictions, but in today's new regulatory environment where offshore business may be seen as shady by default, the smart domicile might want to aspire to become "whitelisted" as an internationally compliant and transparent jurisdiction by the Organization for Economic Co-Operation and Development.
So far, few captive domiciles have actually earned this distinction, but those that have are making sure that regulators know all about it. This could prove a winning strategy for domiciles seeking to keep jittery U.S. companies from "redomiciling" stateside and convince them that it is safe to set up shop offshore.
As we have mentioned in past years, established domiciles such as Bermuda, the Cayman Islands, Vermont, Guernsey and the British Virgin Islands are facing the challenge of holding their position in an increasingly competitive market. While Bermuda remains the world's leading captive domicile with nearly 1,000 active captives, its supremacy is facing its greatest challenge yet. Bermuda is surpassed in total captive activity by the Caribbean (whose domiciles host more than 1,700 captives total), the United States (where more than half of all states are now captive domiciles and are home to more than 1,500 captives combined) and by mainland Europe (which hosts more than 1,050 captives between about a dozen different jurisdictions).
Asia remains a relatively quiet section of the captive market, with a total of around 140 captives. Some of its domiciles are growing, however, giving the region the potential to expand as the global economy improves, the insurance market hardens and Asian operations improve their insurance performance. Interesting standouts are New Zealand and Vanuatu, which have both grown noticeably over the last year, perhaps in response to reports that the Australian insurance market is still smarting from the 2001 demise of HIH Insurance, the country's second largest insurance company and its largest corporate collapse, and, as such, offers a most unwelcome regulatory climate for captive development.
The Middle East remains virtually inactive, although the burgeoning world of Islamic finance and insurance continues to provide a huge opportunity for those savvy enough to take advantage. Dubai, Bahrain and Qatar are all taking steps to establish captive marketplaces. Progress is slow, however, as the market waits for local and regional players to see the need for risk transfer and financing.
Outside of the Gulf, Malaysia's special offshore business zone on Labuan remains an active domicile, as does Singapore. Both are well positioned to address any captive needs that the world of Muslim finance might have.
Overall, as businesses look for more conservative ways to protect their wealth, captives remain an attractive option. Perhaps Renée Lewis, head of captive insurance at HSBC Bank of Bermuda, put it best by noting that captives are, by nature, conservative in their investment policies and, in an uncertain market, continue to focus on the preservation of capital. That being the case, the need for each and every domicile to distinguish itself from the competition has never been greater.
1 Bermuda
Active Captives: 960
The captive insurance industry as we know it began in Bermuda, so it figures that this posh island in the mid-Atlantic would remain the world's premier domicile. Strategically located within a few hours' flight of any major city on the East Coast and most European capitals, the island is also home to a huge concentration of top-notch captive experts, services and support. The government remains ever-vigilant of global regulatory trends, and its responsive legislature ensures that Bermuda remains an attractive destination in terms of taxation.
That said, Bermuda does have exacting "know your captive" standards for starting and maintaining a captive, and complaints of onerous red tape and high costs (life on the island is not cheap and real estate is in high demand but short supply) have slightly dulled the domicile's competitive luster. Still, Bermuda is Bermuda, and no other single domicile seems likely (or even able) to match its numbers any time soon.
2 Cayman Islands
Active Captives: 787
The Cayman Islands boasts a deep and mature financial services industry of which captive insurance is just one part. The Caymans is also home to many banks, investment houses and ancillary financial services, giving this location an attractive local talent pool. Regulatory and taxation conditions are extremely favorable for captive formation, but concern over the nation's status as a tax haven has spurred it to adopt a number of strict new measures that should fast-track the location into the ranks of those countries that meet UN-backed financial reporting standards. Nearly 90% of all captives in the Caymans are for U.S. companies, which makes this domicile vulnerable to economic conditions stateside, and as such, it has suffered a slower rate of captive formations since last year's market meltdown.
The domicile remains competitive, however, especially in the health care sector; nearly 36% of all Cayman Island captives are health care captives, which themselves account for nearly half of all captives worldwide. The domicile is also home to a large amount of workers comp and property businesses, and is working to create a local reinsurance market as well. The first domestic reinsurer was founded within the last year, which is a major step for the Caymans' plans to become a one-stop shopping destination for any organization's offshore insurance needs.
3 Vermont
Active Captives: 553
The largest U.S. domicile and the third largest in the world, Vermont remains dominant in the domestic captive market. Like the other leading domiciles, it offers favorable taxes, legislation, regulation and enough local talent to aid captive formation and management. Nearly 80% of Vermont's captives are pure captives while risk retention groups make up another 14%, and association captives and industrial insureds account for the remainder.
At the moment, Vermont enjoys a major edge over its offshore competitors in that it is stateside at a time when the entire captive industry is unsure of how to gauge Washington's crackdown on supposed tax havens. The state saw eight new captives form in 2008, which was only half of its 2007 growth total, reflecting the larger economic troubles affecting many other domiciles.
Still, Vermont remains an attractive domicile thanks in part to a flexible legislative environment that values the local captive industry and is willing to adapt to ensure that the state can keep pace with ever-evolving market conditions. Case in point: in May, Governor Jim Douglas signed into law a new measure aimed at recapturing companies that had redomiciled elsewhere. The legislation relaxes certain accounting regulations and establishes a premium tax holiday through 2010.
4 Guernsey
Active Captives: 372
While other domiciles are struggling to maintain their market shares, Europe's leading domicile has had a banner year attracting new business, increasing its number of captives enough to become the world's fourth-largest captive domicile. Guernsey has been a major insurance destination since the 18th century and has allowed captive insurance since 1922. It is also the birthplace of the protected cell company, a structure often used in conjunction with captive formation (there are 344 in the domicile).
On top of strong local resources, a mature market presence, convenient location in the English Channel with ties to the United Kingdom and proximity to the Eurozone, Guernsey is continuing to fine-tune itself. The island is encouraging the formation of other kinds of business, such as reinsurance. It has also recently adopted a 0% tax regime for licensed insurers, updated its corporate governance code and introduced the "own solvency capital assessment" (OSCA). This measure reflects Guernsey's risk-based approach to regulation and provides captives with both the flexibility they desire and a firm supervisory framework.
At the G20 Summit in April, Guernsey was "whitelisted" by the Organization for Economic Co-Operation and Development as an internationally compliant and transparent low-tax jurisdiction. Other than Vermont, no other domicile in the top five spots on this list can claim that distinction.
5 British Virgin Islands
Active Captives: 319
The British Virgin Islands has been a major domicile thanks to its 0% tax rate, low formation costs, convenient Caribbean location and large financial services community.
By our count, however, BVI has lost 55 captives in the last year, signaling a major decline capped by the domicile's drop from fourth place in 2008 to fifth place worldwide. According to industry reports, most of the departed captives redomiciled in Kentucky and Anguilla, but the decline suggests multiple forces at work, not least of which is the generally bad economic environment hurting most offshore domiciles. Regulatory storm clouds from the United States are also undoubtedly hurting the domicile, since there are a number of U.S. domiciles posting big gains this year.
There is also a lingering reputational regulatory issue regarding BVI. Previous insurance regimes have been accused of being unresponsive and bureaucratic, especially in the handling of the Boston Life and Annuity Company scandal in 2007. The fact that BVI has been "greylisted" by the OECD (as a jurisdiction that has agreed to the international tax standard but not yet substantially implemented it) does not help. There is a new insurance regime in effect now, however, and BVI seems committed to strengthening its overall regulatory approach. Hopefully this will help the domicile overcome its current challenges as opportunities continue to grow.
6 Luxembourg
Active Captives: 261
Luxembourg emerged as a major captive center in the 1970s and has never looked back. The financial services sector makes up some 40% of the country's GDP and employs nearly 11% of the total population, so this jurisdiction has clearly committed itself to this market for the long haul.
Featuring an advanced local pool of services and expertise, Luxembourg is strategically located in the heart of Western Europe, which makes it a preferred domicile for EU business. Luxembourg is also the only major domicile where French is the first language.
On the other hand, Luxembourg has been greylisted by the OECD and has not yet fully committed to the internationally agreed tax standard this year. Its capital requirements, corporate tax rate and extensive tax treaties within the Eurozone, however, make it clear this is no tax haven and, as such, it seems unlikely to suffer the sort of regulatory pressures forced on Switzerland's banking industry last year.
7 Anguilla
Active Captives: 178
Anguilla has been a savvy and aggressive financial center in recent years, offering organizations a zero-tax environment with plenty of expertise, support and ancillary services. The island is a British crown dependency, like certain other Caribbean domiciles, and it has promoted a strong, yet flexible local regulatory scheme. It has never been put on any financial watch blacklist and has created its own financial services commission to stay ahead of worldwide regulatory trends.
Currently on the OECD greylist, Anguilla is working hard at getting whitelisted. In the meantime, it offers a number of attractive market innovations, including a flexible, responsive legislature and, perhaps most impressively, its ACORN online business registration system, which enables organizations to open shop in Anguilla entirely online, significantly reducing the time and expense normally associated with this step in captive formation.
8 Turks & Caicos Islands
Active Captives: 173
The success of the Turks & Caicos Islands has mainly rested on its low administrative fees, low capital requirements and flexible regulatory approach, which combine to allow for the formation of companies that might find difficulty operating elsewhere. As a result, the TCI has become a leading domicile for producer-owned reinsurance companies (PORCS), insurance operations typically used by retail outlets that sell financeable wares such as automobiles, furniture and electronics. PORCs are also used commonly by rent-to-own operations as well as certain kinds of lending institutions. The IRS considers PORCs "inherently abusable," from a taxation standpoint, however, and takes special interest in them.
Considering the scrutiny the IRS is placing on offshore business locations and that the TCI is on the OECD greylist, the domicile has its work cut out for itself in order to remove any "tax haven" connotations. That the nation is also the leading domicile for credit life insurance-which pays off one's consumer debt in case he or she dies-does not help. Credit life insurance is roundly criticized by consumer advocates as an unnecessary and, depending on how it is sold, predatory insurance product.
9 Barbados
Active Captives: 164
Barbados maintains its position as a leading domicile with low fees and reserving requirements, a zero-tax regime and a business environment that is both welcoming and highly capable. The only Caribbean domicile to make it onto the OECD whitelist, Barbados has become a model for proactive and market-savvy regulation. It offers an extremely stable political environment (the third-oldest legislature in the British Commonwealth, after Britain and Bermuda) and it has the third-highest United Nations Human Development ranking in the Americas, after the United States and Canada. As a captive domicile, Barbados has extensive taxation treaties with other jurisdictions. Its treaties with Canada, in particular, make this the most popular domicile for Canadian companies.
10 Hawai'i
Active Captives: 162
The Aloha State has capitalized on a number of strengths to maintain its very solid standing as the Pacific Rim's leading captive insurance domicile, including a strategic location between the U.S. mainland and Pacific Asia, strong regulatory credentials, a sophisticated international business environment and an entrepreneurial approach to supporting captive insurers already located within the state. Hawai'i works to keep the domicile as up-to-date with market trends as possible, which has afforded it some interesting opportunities. For example, it is the only domicile in the world that specifically allows for not-for-profit captives.
11 South Carolina
Active Captives: 156
South Carolina was one of the first states to enter the captive insurance market after Vermont, and it has always remained one of the most viable markets. The state boasts favorable tax rates, flexible legislation, strong regulatory credentials and a generally favorable business climate. It is within easy traveling distance of North Carolina, Georgia, Florida and the eastern Gulf Coast. It also has an unusually strong and well-connected trade group, the South Carolina Captive Insurance Association, which provides a great deal of support to any company considering the Palmetto State as a captive destination. Its relatively close location to Kentucky could put additional competitive pressure on South Carolina in the coming years, however, forcing prospective captives to compare the two domiciles more closely during the feasibility stage of formation.
12 Ireland
Active Captives: 131
The global recession and other competitive pressures have hit Ireland especially hard in the last year, resulting in the net loss of 74 captives. Although Ireland has been and continues to be an extremely competitive marketplace with a great deal of expertise at its disposal, many of the innovations that made Ireland such a breakout domicile throughout much of the last decade have been imitated by competing domiciles such as Luxembourg, making it more difficult for Ireland to distinguish itself. Furthermore, the cost of living in Dublin is no longer at a competitive level; it is simply more cost effective for many businesses to establish their captive elsewhere. That said, Ireland is one of the few OECD whitelisted domiciles, maintains impeccable credentials and has always been at the forefront of Solvency II compliance and market innovation.
13 Nevada
Active Captives: 124
The western United States has become an interesting regional captives market, and at the top of it is Nevada, which has gained a healthy amount of captive business through a zero premium tax regime, a very responsive and business-friendly legislature (which, by the way, is constitutionally required to balance its budgets and stay in session no more than 120 days biannually). Health care, construction general liability, professional liability and workers comp are the most common risks addressed through captives here, but the state does have a fight on its hands. Neighboring Utah has become a real competitor in very little time, and Arizona is not far behind. Nevada will have to use every resource at its disposal to ensure that its jurisdiction remains as alluring to outside business as it has thus far.
14 Utah
Active Captives: 122
It is hard to believe that this domicile only opened its doors in 2003, but since that time, it has established itself as a powerhouse in the western U.S. captives market. Much of the domicile's success is owed to the unrelenting support of the state insurance department, which established a captive insurance director in 2006 and is constantly seeking new ways to update state insurance law to make for a more inviting captive environment. This all follows Utah's larger success as a general business location; the Corporation for Enterprise Development recently named Utah one of the top eight states in the United States in terms of economic performance, business vitality and development capacity. Something must be working-the state added 22 captives to its roll last year alone.
15 Isle of Man
Active Captives: 116
Located conveniently between Ireland and Britain, the Isle of Man has long been a center for financial services. Although independent from the United Kingdom, the Isle of Man enjoys British law and operates in pounds sterling while remaining outside of Eurozone regulation. Captive insurance is just one leg of the island's diversified offerings, and a robust regulatory environment has led to the Isle's whitelisting by the OECD. It recently began admitting protected cell companies and thanks to its zero-tax regime, low administrative fees, low reserving requirements, deep pool of local talent and a reputation for being a highly cost-effective place to run a captive, its numbers have remained strong despite challenging economic times.
16 Arizona
Active Captives: 104
Arizona picked up an additional eight captives in the last year, continuing its steady growth despite strong competition from neighboring Nevada and Utah. Arizona has been a center for alternative risk finance since the 1970s, so when it became a player in the captives market, it already had a mature infrastructure to leverage. Arizona's population and business environment has skyrocketed in recent years (it is the second fastest-growing state in the United States), enabling the state to employ a zero-tax regime towards captives while maintaining a strong and flexible regulatory environment.
17 District of Columbia
Active Captives: 89
The District of Columbia added 19 captives to its roster in the last year and it rose one spot in our survey, adding it to the ranks of U.S. domiciles that have grown noticeably while their offshore competition has either leveled off or contracted. The District of Columbia has fresh tax incentives, a speedy application process and allows for the formation of every commonly used type of captive. Like New York, it is within easy travel distance of most of the eastern seaboard, and it also offers unparalleled local access to the U.S. federal government, which might be an even greater enticement should federal regulation of offshore business take an interesting turn in the coming year.
18 Kentucky
Active Captives: 76
Kentucky has only been on the captive scene for a short while, but it has experienced explosive growth, adding 37 companies to its rosters in the last year alone, largely by capitalizing on redomiciliations from the BVI. The state allows for single parent, consortium and sponsored captives as well as risk retention groups, and a wide variety of coverages are present among companies currently domiciled there. Low organizational fees, a convenient location in the eastern United States with a major airport hub, and an ongoing influx of business from other states all point to continued expansion for this domicile. In 2007, the insurance commissioner also created a "captive coordinator" office that makes the process for setting up shop in the Bluegrass State even easier.
19 Nevis
Active Captives: 64
Nevis lost almost 66% of its total captives count from last year (down 96 captives) and slipped six spots in this survey's ranking. It joins the British Virgin Islands as a domicile with some serious market concerns. Although it was taken off the blacklist in 2002, it remains on the OECD greylist despite considerable effort. It is also a leading domicile for PORCs, which is undoubtedly making captive companies skittish about the jurisdiction's regulatory future. Ongoing concerns over the island's union with neighboring St. Kitts, which is also seeking to establish itself as a captive domicile, all adds up to a place where the future is murky, and future attrition seems likely.
20 Singapore
Active Captives: 62
Singapore is the largest captive domicile located in Asia, and is the second largest domicile servicing the Pacific Rim. As a major center for international shipping, manufacturing and refining, Singapore has been hit hard by global economic woes, a fact that ripples into its captive sector, as many of the companies domiciled here are Japanese. With Japan suffering a deeper recession than both the United States and the Eurozone, captive formation has leveled off, ending several years of successive growth.
Singapore remains a highly cosmopolitan, world-class business environment, however, and is capable of competing with any other major city. Its proximity to Malaysia and Indonesia make it an ideal area to enter Islamic finance, a market that nearby Labuan has had some success in.
21 (tie) New York
Active Captives: 50
New York provides a fairly straightforward package of incentives for potential captives, as well as access to Wall Street and Midtown Manhattan, two of the world's top business environments. The financial meltdown of the last year has been unkind to the Big Apple, however, with some parts of Wall Street looking more like a ghost town than a boom town. High costs of operating (New York is one of the most expensive cities in the world) are also a concern. The sheer amount of business in Manhattan alone, however, makes for a huge pool of potential captive business. Case in point: the domicile added another six companies to its rolls in the last year.
21 (tie) Sweden
Active Captives: 50
Sweden's captive market has been quietly humming along for the last two decades, home to mainly Swedish companies that write direct line business such as business interruption and other short-term risks. The reserving requirements in Sweden make for a favorable domestic captive environment. As a Scandinavian country, Sweden is part of a robust regional captives market that bears watching; Denmark has an additional 16 captives that mainly write workers comp and other long-tail risks, and Norway has another 15 captives that can write directly into the European Union.
21 (tie) Switzerland
Active Captives: 50
Switzerland is an unusual domicile compared to its rivals in that it has not enacted laws specifically allowing for captives; all a captive needs to do is meet the country's standing requirements for any commercial re/insurer in order to begin operations. It also does not provide much of a tax incentive, hitting captives with a 1% stamp tax, a 8.5% corporate tax and additional canton and municipal taxes. These factors have resulted in a flat market where the number of captives has not changed in recent years. For most operations, the big incentive to domiciling in Switzerland is to take advantage of its world-renowned banking and financial services industry, which speaks for itself in terms of services, expertise and support. But the IRS-led assault on Swiss banking laws last year, in addition to global financial chaos, has rattled the Swiss financial services industry as well as Swiss lawmakers.
24 Delaware
Active Captives: 40
Delaware has been a pre-eminent U.S. business location for many years, but only came into the captives game recently and has been working to make up lost ground with captive-friendly legislation and insurance oversight. The well-established financial services community here makes for a very welcoming environment in which to set up a captive, especially for operations that value holding professional meetings in person. Delaware added 22 new companies in the last year, showing some serious competitive potential. The domicile also has one of the most strategic locations in the United States, being within a three-hour drive of Washington, D.C., Baltimore, Philadelphia and New York, and a short commuter flight to Boston or Chicago.
25 Montana
Active Captives: 35
In the seven years since Montana became a captive domicile, the state has aggressively marketed itself, offering competitive regulatory standards and tax rates with other domiciles as well as allowing the formation of specialty captives such as branch captives, risk retention groups, reciprocals, sponsored protected cells and association/group captives. It added eight captives in 2008, which is consistent with the domicile's steady growth. Industries currently taking advantage of the Montana domicile include health care, commercial trucking, construction and the legal profession.
Bill Coffin is publisher of Risk Management.
AN OVERVIEW OF CAPTIVE OPTIONS
by Rick Stasi
There are many kinds of captive arrangements. To secure the greatest benefits, it is important to understand the marketplace and determine which option will best meet the needs and limitations of your organization. The following is a look at the major types of captives and the opportunities of each.
Single-parent captive insurer. This traditional, single-owner approach is often taken by large, multinational parent companies to consolidate their insurance programs. It provides consistent pricing and coverage for all of the company's operations around the world, not to mention unbundled claims and loss control services.
Group captive. This is generally the most appropriate option for middle-market companies or larger accounts. The risk-sharing members of group or "multi-owner" captives are shareholders of the captive insurance company and are often tied together as an industry group. When structured correctly, this type of captive arrangement can provide cost advantages. It also offers control over claims and loss control services.
Association captive. This type of captive is generally used for a group of homogeneous businesses with a trade association owner. An association captive is usually formed to stabilize insurance costs for its members.
Agency captive. In this arrangement, the captive is owned and funded by an insurance agency, which in turn benefits from an exclusive insurance program and profits from the program's positive loss experience. The captive's members benefit by having access to better insurance coverage and more effective claims and loss control services.
Rent-a-captive. A rent-a-captive company "rents" its capital, surplus and legal capacity to the insured party that wants the benefits of a captive without actually participating in ownership or management. This option requires lower start-up costs, as the participants avoid having to invest the capital normally required to form a captive. Entry and exit are therefore much easier. Rent-a-captive fees are based on a percentage of premium ceded to the captive. This allows a more predictable expense ratio relative to the size of the program and can be beneficial for start-ups and smaller programs. In addition, a rent-a-captive can be a viable option when program premiums are uncertain and when the fixed cost of owning a captive will end up with higher than normal expense ratios.
Captive for franchisees. Providing a specialized captive insurance program for a group of franchisees can add franchise value for the franchisor as well as increase the bottom lines of franchisees. For example, a captive program for an association representing a national restaurant franchise has returned an average of 45% of premiums to the association over the past three years. In the first year alone 61% of premiums were returned. To equal the same profit as the insurance program, the association members would have to sell almost five million more meals at $5 each (assuming 10% profit on meals).
Rick Stasi is the chief operating officer responsible for the overall operations of alternative risk programs for Avizent where he handles the administration, marketing and claim services of captives and fronted insured programs.