Traditionally dominated by tropical offshore domiciles such as Bermuda and the Cayman Islands, the captives industry in recent years has been shifting its focus to U.S. shores—a trend that is expected to continue and perhaps accelerate in 2013 as more companies recognize some of the distinct advantages of domiciling domestically.
“There has been a re-balancing between onshore and offshore captive domiciles as these risk-transfer mechanisms become more mainstream,” says Richard S. Smith, president of the Vermont Captive Insurance Association. “The cost, tax and expertise advantages to domiciling your captive offshore have disappeared and given way to healthy competition among U.S. domiciles.”
On the savings front, domestic captives present lower operating costs by, for one, eliminating the need to travel overseas for board meetings.
“With companies taking a hard look at expenses, it’s hard to justify a trip to a tropical island for a board meeting when it can be done in the U.S.,” says Richard Klumpp, president and CEO of brokerage Wilmington Trust and president of the Delaware Captive Insurance Association (DCIA). “Between travel expenses, hiring service providers and the cost of regulation, I’d venture that a company can save at least 20 percent [annually] through re-domestication.”
“At present, the differences between onshore and offshore domicile offerings are becoming narrower, so if all other factors are equal, the cost savings and convenience of doing business locally can come into play,” adds Julie Boucher, head of the Vermont office of Marsh Management Service Inc. and Marsh’s U.S. Captive Solutions practice leader.
PROGRAM FOR SUCCESS
But cost savings are hardly the only consideration behind the move to domicile domestically.
“Advantages to coming onshore are often program-related,” says Boucher. “For example, U.S. captives can write TRIA [Terrorism Risk Insurance Act] coverage backed by the federal government” whereas this option is unavailable to captives located offshore.
Captives can also provide Benefits coverage on a reinsurance basis with the approval of the Department of Labor, if it is a U.S-based captive or branch, Boucher adds.
Among other attractive qualities, onshore captives also permit a greater variety of alternative risk-transfer mechanisms that may not be available in foreign domiciles. These include rent-a-captives, in which a captive insurer “rents” its financial services to an outside organization without requiring the financial commitments of a self-owned captive; protected-cell companies that segregate their assets and liabilities by class share within their portfolio; and risk retention groups (RRGs) in which each policyholder is also a stockholder of the captive.
“Onshore [captives], business is driven by risk-retention groups and terrorism risk,” says Sean B. Rider, senior vice president and managing director of sales and consulting for the Willis Global Captive Practice.
Domestically, Rider adds, “there is also a more expansive scope of coverage than what is otherwise available [offshore]: Contingent Business Interruption; Nuclear/Biological/Chemical/Radiological cover for those involved in urban real estate and public spaces; and alternative risk transfer.”
Some U.S.-domiciling decisions are based on tax regulations. States such as Vermont and Connecticut tax captives on a graduated scale, meaning the rate starts low and gets higher as the company grows.
Other domiciles appeal to smaller companies by offering flat tax rates, such as Delaware’s 0.2 percent rate on direct written premium; offering tax holidays (as Vermont does); or reducing their premium tax to zero, as Arizona has, according to Richard Klumpp of the DCIA.
While large corporations still represent the lion’s share of captive business, tax and cost-savings initiatives have allowed other, middle-market entities (those with revenues ranging between $50 million and $1 billion), including manufacturers and transportation companies, to engage in self-insurance.
Another factor contributing to American corporations’ move back onshore is the uncertainty surrounding how Solvency II regulations will impact captives abroad.
Solvency II seeks to review capital adequacy for European insurance companies and establish new capital requirements and risk-management standards starting in 2014, with the goal of making sure insurers have sufficient capital to survive not just the losses they incur, but also financial-system shocks.
No one yet knows how the regulation will impact captives outside of Bermuda (which will not be applying Solvency II requirements); whether they will have to use the new standard formula to calculate minimum capital solvency; or whether they will be allowed to use their own internal models. But the prospect of greater regulation has some E.U. captive players worried.
“Solvency II is a big deal because a lot of major U.S. corporations that are captive owners have European exposures and E.U.-based captives,” says Willis’ Rider.
OFFSHORE STILL A LURE
Still, for every company that decides to re-domesticate its captives business onshore, many are content to stay in Bermuda or the Caymans.
“I have found that clients with over five years of experience in the insurance industry are very comfortable with offshore captives and often prefer to go that route,” says Jeremy Huish, director of captive-advisory firm Artex Tribeca.
Clete Thompson, vice president of marketing and business development at Capstone Associated, a captive-insurance planner for the middle market, notes that the U.S. economic crisis has caused some states to withdraw funds from captive bureaus, lengthening the bureaus’ response time due to reduced resources.
“Those active in the captives arena understand that a captive is a living, breathing insurance company with ongoing issues,” says Thompson. “The captive needs to have responsive regulators in place that can make timely decisions regarding ongoing issues involved in their management. States that are short on staff have made operating in these domiciles very difficult.”