Roger Crombie

In the world of captive insurance, a number of jurisdictions use the Bermuda model. Now, as captive insurance again bubbles to the top of the corporate agenda, Bermuda should feel flattered as other players are actively growing their captive franchises. More than 70 national and state jurisdictions now offer captive services or plan to start doing so soon. The Cayman Islands and Vermont models have been added to the mix.

A.M. Best reports that over the five-year period ending Dec. 31, 2003, net premiums written by the captive industry grew by 45 percent and admitted assets by nearly 29 percent. In that time, surplus increased by only 2 percent. Growth in risk underwritten by captives has therefore come at the cost of increasing leverage.

Around the world, Fred Reiss' 1960s notion of companies insuring their parent or group's activities is finding fertile new ground. The shape of the global market is changing as new jurisdictions join the club. A sudden fascination for a special captive called segregated cell companies has further affected the way the pie is sliced.

CHASING BERMUDA

Bermuda continues as the market leader, 40 years after it jumped out to a bead start. About 30 percent of the world's 4,800 captives are domiciled in Bermuda. Growth in the Bermuda captive sector waxes and wanes, as it does everywhere. In 2002, captive formations grew less rapidly, offering the professional service providers some breathing space. Last year, Bermuda was at full tilt again. But this year, for the five months to May 2004, new registrations were 28 percent lower than they had been a year earlier. (These are small numbers, where the timing of a couple of deals can exaggerate underlying trends.) Still, there's no doubt that Bermuda continues to incorporate captives relentlessly.

Beyond simple market supply and demand, the biggest factor in determining Bermuda's fate is the competition. The island's business corps is already doing all it can, all the time. The competition was once from the Cayman Islands and perhaps the Channel island of Jersey, and, although no one ever mentioned it much, Vermont. Now, Bermuda is up against the world.

The most interesting development in the captive sector in the past few years, broadly speaking, has been the spread of activity into almost half the U.S. states, solid growth in the major European centers, the start of a serious captive sector ill the Asia/Pacific region, and new interest in the Gulf.

More immediately for Bermuda is the effort being made in its back yard (more accurately, by its nearest neighbors to the southwest), the Caribbean.

CAYMANS COME ON STRONG

The Cayman Islands are home to about half the captives in the Caribbean, 660 as of June 30, 2004. Last year, they reported annual premiums of $4.9 billion. Where Bermuda is home to some 400 physically present insurance companies, Cayman is a brokered market, more solidly concentrated on captives. In the two and a half years to June 2004, Cayman's captive numbers grew by 22 percent.

Cayman's captive mix is skewed more heavily toward medical malpractice, professional liability coverage for hospitals and nursing homes, and other health care service providers. This sector has been growing at a steady clip for some time, forming captives as solutions for the insurance problems of medical facilities and professionals. That market continues to grow at a steady pace, yielding only to the dictates of the parent's economy.

Segregated account companies have proven enormously popular in Cayman, as they have in Bermuda, and 13 percent of Cayman captives are now operated as segregated account companies. The concept of segregation, an umbrella holding company, appeals to smaller and midsize companies. Companies not yet ready to make the jump to full captive formation can efficiently use a cell within a larger entity as a halfway house.

Elsewhere, the British Virgin Islands are home to about 300 captives, excluding credit life companies. BVI captives are used for a variety of lines, and can be a sensible alternative for smaller companies unwilling to pay the higher prices charged by Bermuda or the Caymans.

The Barbados captive market also represents a fast-growing alternative to the mainstream captive jurisdictions. The insurance sector in Barbados has traditionally been splintered geographically, and lacks the focus that a single center brings. The roads are still pleasant, and the pace of life in Georgetown remains relaxed, but that may change if the insurance and capital markets continue to discover the alternative advantages that Barbados has to offer. More than 400 insurance companies call Barbados home, of which about 60 percent fall into the definition of captives. Growth in the captive sector has been moderate, but consistent, with great interest from Canada.

About 80 captives are registered in the Turks & Caicos Islands. Aruba, the Bahamas, Curacao, Panama, St. Lucia, St. Vincent and the U.S. Virgins are all active captive jurisdictions, although none has many more than 20 incorporations. Belize and Granada have joined the captive business, as has the island of Anguilla.

Although Bermuda is home to half of Latin America's captives, and most Caribbean jurisdictions have European and Japanese captives on their rosters, the major customers for all these jurisdictions are North American companies.

The Caribbean does not see itself, as a whole, in competition with Bermuda, but (odd though it sounds) with the U.S. and Europe.

U.S. A HOTBED

Twenty-one U.S. states, plus the District of Columbia, currently permit the use of captive insurance companies. Vermont has about 500 captives, Hawaii more than 100, and South Carolina has incorporated about 60. Texas and Iowa both have around 60 risk retention groups, a sort of "captive light" that is attracting growing interest in the United States. North of the U.S. border, British Columbia has attracted almost 20 captives.

In Europe, Guernsey (about 350) and Luxembourg (about 280) are the powerhouses of the European captive sector. Also growing fast are Ireland (at about 200) and the Isle of Man (about 180). Switzerland has about 40 captives; Denmark, Gibraltar, Jersey, Liechtenstein and Malta each have 20 or fewer.

Captives were slower to catch on in Europe for a variety of reasons. The American economy is larger, and its greater homogeneity allows good ideas to spread faster, for one thing. Cultural imperatives also apply. But captive use in Europe is probably increasing at a faster rate than that of the United States, having taken hold of the European risk managers' view of the world in the way that it attracted their U.S. counterparts.

In the Asia/Pacific region, Singapore, with about 60 captives, is the market leader. Vanuatu has about 20; Hong Kong, Labuan and Guam have about a dozen between them. In Africa, Mauritius has about 15 captives and the Seychelles had one, at last count. And in the Gulf, the idea of captives has suddenly caught on in Bahrain, the Gulfs vibrant business center, which has registered its first captive. Now Dubai has passed captive legislation.

Competition is rife in the captive industry. Rates of captive formation are not exactly anticyclical, but the need to start captive operations goes in waves, depending on the urgency of other matters. Captive insurance often sits below the radar when greater "affairs are at hand and comes to the fore when calm has been restored and hard markets ask for premiums that make operating a captive attractive.

Getting Your Benefits Captive Approved

Until recently, employers seeking to fund employee benefits plans through a captive insurance vehicle needed deep pockets and lots of time. The U.S. Department of Labor did not grant exemptions to funding ERISA benefit plans without a lengthy review of the plan design, the ability to pay claims and the true benefit to covered employees. Typically, a review of this nature and magnitude took one to two years.

However, following DOL's granting of two private rulings to Columbia Energy in 2000 end Archer Daniels Midland 2002, International Paper this year set a precedent for an expedited, 45-day "fast track" ruling on its employee benefits captive. Now that the element of timing has changed, many organizations see captives as viable long-term solutions for benefit plan funding.

Once you have made the decision that a captive is right for funding your qualified benefits plans subject to ERISA (i.e., medical, dental, life insurance, disability), you will need to seek an exemption from the DOL. To do so, you will need to demonstrate a solid reason for implementation, most importantly an enhanced benefit to the plan's participants and beneficiaries.

Before you begin the captive or DOL application process, you should undertake a feasibility study to review whether a captive makes sense. These studies can be conducted at a high level for all employee-benefit programs or can focus on particular programs you already have analyzed. Regardless of the approach, however, the results of such a study will outline your funding options, your potential cost savings and tax effects, the domiciles to consider and the recommended program structure you should adopt.

Once you have determined to move forward with funding your employee benefit program(s) in a captive, the next step is for your consultant(s) and attorney(s) to meet with the insurance commissioner or captive regulator and the DOL to discuss your funding concept on a blind basis.

Using the key issues raised at the meeting and a behind-the-scenes list of legal, regulatory or compliance concerns that the captive design team has assembled, you must finalize the program structure. A written description of the proposed captive (transaction) process is developed and reviewed by legal counsel and your tax specialists. This written description will form the basis of the captive business plan, a required piece of the captive application you will submit to both the captive regulators and the DOE

Each captive domicile has specific forms and information you need to submit, including the captive business plan. Information such as overall captive structure, recent company performance and financials, service providers used, domicile resources employed and fronting and/or reinsurance arrangements are also needed.

During the discussion phase with the DOL, you will need to clearly state the intent of your captive, identify how the financing and administration will work, and provide any other supporting information the DOL requests.

It is usually your consultant's job to translate your mission and key objective into the major design elements of the captive, underscore the financial feasibility and funding strength of the captive, and help negotiate any conditions that the DOL may want to impose.

Once you are granted an exemption, your work is almost over! If you have not already done so, you will need to finalize your captive organization, including confirming officers, creating banking resolutions and investment policies, and, finally, writing your own unique captive by-laws. You may require assistance reviewing banking and insurance documentation, bidding insurance and investment management contracts, and preparing the captive for incorporation, which involves negotiation, capitalization and communication.

The secret to success is to create a solid work plan that is realistic and takes into account the typical "bumps in the road," and to design a captive that meets your mission's objective and financial criteria.

And, don't forget to include on your project team experienced and knowledgeable advisors who have worked with the IRS and the DOL and can negotiate on your behalf.

--Karin Landry, Karen Trumbull English and Evren Sungur. Landry is managing partner, English is partner and Sungur is a consultant with Spring Consulting Group, LLC, in Boston.

COPYRIGHT 2004 Axon Group

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