How are things shaping up for your domicile so far in 2015 from a captive standpoint, and how representative do you think that is of the wider US industry?
John Thomson: In 2015, Connecticut has seen several new types of captive approaches for consideration and licensure. In 2014, we did a lot of work on single parent or pure captives. This year we have licensed a sponsored captive, for SOBC Corp in the UK. We are also in the process of licensing a sponsored captive that will be owned by a global broker.
These are exciting evolutionary changes as they show that people are taking advantage of the statutes in Connecticut that allow alternatives to pure captives.
An area where we have seen changes, which is pretty reflective of the turmoil in the US market, is with risk retention groups (RRGs). There are many states that have been aggressive in forming RRGs, but one of the things we will see in the US right through to 2016 is how they are regulated. States are changing their philosophies and that is causing managers to consider new places to domicile their captives.
We have embraced the National Association of Insurance Commissioners (NAIC) model for RRGs and have always found ourselves in line with leading states such as Vermont. They have shown excellent leadership in this area, and I think domiciles should always look towards leadership when it comes to regulation.
Jason Flaxbeard: The captive market seems to be developing well in 2015. We are seeing many more opportunities with captives, most of which relate to business expansion, mergers and acquisitions and the development of enterprise risk management (ERM) plans. Of these, the most exciting part of the business is the creation of ideas around the captive of third-party business within a captive. The fronting marketplace is responding to clients’ requirements to support these opportunities.
The US industry from a large account captive basis is very strong. Captives have developed into an integral part of the ERM process and are being used more widely. We are also seeing a number of opportunities in the middle market space, particularly through aggregation of risks. There has been a slight uptick in the number of captives which have been around for a while that are interested in offloading some of their historical risk, deal economics depending.
Mark Koogler: Ohio adopted captive legislation in 2014 and at this time, the state has not licensed a captive. There is strong interest in Ohio for captives, due in part to the number of insurance professionals positioned to assist in the formation and management of captives, and the number of Ohio-domiciled businesses that have captives domiciled in other jurisdictions.
One of the obstacles facing interested Ohio parties is that the state’s captive legislation limits pure captives from insuring controlled unaffiliated risks. Therefore, unless a parent’s organisational scheme can provide for risk transfer and risk distribution, the availability of the Ohio captive legislation is limited.
Skip Myers: 2015 has been a good year for the District of Columbia. Although captive formation has generally slowed down across the industry, the District of Columbia has gotten its share of captives, particularly RRGs. The domicile has great experience and is especially attractive for them.
Ellen Charnley: Nervada has had a good few years of solid growth, which I believe is indicative of overall US captive growth.
Are there any particular regulations coming up or a general trend that concerns you?
Koogler: The only general concern I have is the continued scrutiny the Internal Revenue Service (IRS) places on 831(b) captives.
The headlines would indicate the problem is with captives but the details indicate that most of the issues are the cause of unscrupulous promoters.
We see a lot of that in the miscommunication among advisers and potential captive owners and our goal at the Ohio Captive Insurance Association and my law firm, Porter Wright Morris & Arthur, is to educate interested parties regarding captives and make sure formation and governance are done properly.
Thomson: I don’t think there are any real concerns, but there will be continued discussion on a number of fronts. While there will be continued focus on RRGs as captives, there will also be increased regulation of captives formed for financing XXX and AXXX reserves. There are new and emerging regulatory frameworks, as well as new accreditation standards for specific types of captives. Also, there are potential new regulatory standards emerging from entities such as the International Association of Insurance Supervisors (IAIS).
From a global perspective, regulatory and solvency standards emanating from disparate entities such as the NAIC, the EU (Solvency II) and IAIS will need to be reconciled into a consistent or unified approach and there is going to have to be a lot of discernment and compromise.
Myers: There aren’t any major concerns in the District of Columbia, but the NAIC continues to look for opportunities to further regulate the captive industry.
Charnley: I’m not aware of any specific regulation but I understand that the Nevada Division of Insurance has several draft regulations in progress that would affect the area of captive insurance. The main area of focus is on continuing to keep up with revisions to NAIC Accreditation Standards as they apply to RRGs.
For non-RRG captives, the general regulatory trend is towards measures that would facilitate efficiency of review for applications and business-plan changes while maintaining consistent quality and rigor of the review process.
Flaxbeard: Regulations don’t concern me as a captive practitioner. Appropriately created captives will continue to operate within regulations as they add value to a client’s risk management department.
The regulations are merely the boundaries within which captives operate to deliver an all-important benefit to client operations. I do not see any regulations on the horizon that would affect those boundaries greatly.
There may be some discussion around the IAIS proposals on captive regulation, but I don’t see that this will adversely affect client value. Compliance may prove onerous but the benefit of captives will continue.
How encouraging for the industry are recent events such as the reintroduction to the Senate of the Captive Clarification Act? Are they symbolic of an improvement in the government’s attitude towards captives?
Myers: I do not think that there has been an improvement in the federal government’s attitude toward captives. In fact, I think it knows little about captives and would benefit from a greater understanding.
The Captive Clarification Act is needed to clarify a misunderstanding about the scope of Title V of the US Dodd-Frank Act.
Charnley: If passed, the Captive Clarification Act is a positive first step, however, captive owners should still seek tax advice when determining if they are subject to self procurement tax. Simply removing captives from the Non-admitted and Reinsurance Reform Act (NRRA) does not automatically mean every state will amend its provisions for payment.
The NRRA is simply the method by which the tax is allocated and collected. I believe there is a lot of misunderstanding around this point.
Koogler: Government recognition of the value of captives and their participation as a mainstream risk management tool is extremely important. The support for captives shown by the federal government and the Tax Court is very promising.
Flaxbeard: While the Captive Clarification Act is an encouraging issue in itself, what is truly encouraging is the effort of the domicile regulators and captive associations in understanding the hurdles that face the industry and addressing them to ensure that captive boundaries remain appropriate to allow the industry to continue to add value to client programmes.
The government’s attitude toward captives has always been favourable. What might be of more importance is regulatory understanding across the board that captives are appropriate risk financing tools. The government’s attitude towards tax matters is a different issue to the government’s attitude towards captives.
Thomson: I believe that there is going to be a very interesting and spirited debate surrounding the issues associated with this proposed legislation. I see that the underlying principle involves the need for states in the US to be able to collect the premium taxes that are appropriate in their state. I think there is a belief that states can collect and keep 100 percent of the tax even though they do not have 100 percent of the risk. This is very similar to the issues surrounding the unitary tax issue that is evolving in the US with respect to state-based income tax for corporations.
I foresee the position that states will be begin taking is that corporations, including their captive subsidiaries will be expected to pay their proportional share of applicable taxes in each state. This is an emerging issue that needs to be understood and vetted.
A fair and comprehensive solution has yet to be identified, but we can achieve it through discussion and collaboration.
Is diversification of the types of cover/insurance vehicles available something that is gaining popularity in the US and your state?
Flaxbeard: Absolutely. Captives exist to provide value to their owners. That value comes through efficient risk financing, appropriate risk management planning and a tracking of results leading to action. What gets measured gets done.
Captives have always had a place in corporations and mature captives are continually looking for avenues to add more value, whether that be through collateral management, access to underwriting profits (warranties, third-party business) or support of parental business through a return on investment profile. I would argue that captive expansion has always been something that is popular.
Thomson: Looking for new horizons in captives is a very exciting thing. I think a number of things are going to emerge. Firstly, we are seeing very clear movement by captives to assume new risks such as cyber and terrorism. We have seen an increase in requests from Connecticut captives to include terrorism in their captives and taking advantage of the Terrorism Risk Insurance Program Reauthorization Act. What’s interesting is where we are also seeing a convergence of cyber risk with terrorism. A cyber breach is, in many cases, viewed as an act of terrorism. There is potential strength in captive owners managing those risks together.
The use of medical stop-loss insurance in captives is also growing in the US, particularly when used in conjunction with self-funded healthcare programmes. In addition, corporations are considering the funding of post-employment medical benefits in their captive subsidiaries.
I see that new alternative uses of captives will emerge as captive owners look at their balance sheets and see emerging and unfunded risk obligations. Corporate leadership is recognising that they may want to try and provide a financial solution and begin to fund these emerging and growing financial exposures.
Myers: One of the great benefits of the captive industry is experimentation with new types of coverages. These things run in cycles. I would suggest that there is always some diversification experimentation—we just may be seeing a little more now.
Koogler: The growing diversification of coverages offered by captives in general is important to the growth of the US captive markets. Cyber insurance, health insurance and employer liability insurance coverage seem to be gaining ground among captives.
In Ohio, the captive legislation is somewhat vanilla and any expansion of coverages not designated by statute would require the approval of the insurance superintendent.
Until a captive owner prospect presents a proposal for coverage outside the statutory requirements, it is not clear how receptive Ohio would be to more diversified lines of coverage.
What do you predict for the future of the US captive industry and your domicile in particular?
Thomson: We are looking at positioning Connecticut as a place where owners can come and use their captives to strategically manage financial capital, and access new capital, protecting their company’s balance sheet with captive programmes. We are very open to these discussions, and now captive owners are recognising these possibilities.
Koogler: Based on the continuing revisions to captive legislation among a large number of US captive domiciles, I predict the competition among domiciles will only increase.
Those domiciles that coordinate changes to corporate law, such as permitting series limited liability companies, and insurance law, such as permitting protected cell captives and coverage to extend to controlled unaffiliated risk, will continue to lead in captive formations.
Those domiciles recognise captives as economic drivers and when regulators and government leaders are on the same page, initiatives can take hold more quickly.
In Ohio, there does not yet appear to be interest on the regulatory side to revise the captive legislation to make it comparable to what other US domiciles are doing.
The concern for captive domiciles that are not consistently re-evaluating their legislation is that they will be left behind in the competition for captives.
Flaxbeard: I see it as business as usual for the foreseeable future. I also expect to see a continued review of programmes to drive value such as third-party business, ERM integration, mergers and acquisitions work, and expanded use of segregated cells.
Myers: I think the future of the captive industry is excellent, particularly in the District of Columbia because of its solid, experienced regulatory approach.
Charnley: I suspect that Nevada will continue to grow and be a strong domicile of choice for captive owners.
How are regulatory developments outside of the US, such as Solvency II, likely to affect business at home?
Myers: The NAIC is trying to keep Solvency II at arm’s length. Our current system of state regulation does a good job for captives. I suspect there will be efforts to bring the states into more uniformity.
Hopefully, this will not interfere with the ability of captives to experiment, grow and improve.
Thomson: We don’t see any captives forming in Connecticut in order to avoid Solvency II, but there is a convergence. The Own Risk and Solvency Assessment, which is one of the pillars of Solvency II, is being adopted by the NAIC. Convergence is where I see regulations going. We have to realise that we live in a global ‘village’. I think the US, just as other regulatory jurisdictions, needs to be open-minded and come to the table to discuss this.
Flaxbeard: Regulatory diversity will contract as regulators trend towards monitoring captives much in the same way.
The business of regulation will be affected by the IAIS proposal, which will lead to regulators approaching captives in much the same way.
Solvency II has already changed the approach to captives, ensuring that capital is monitored and utilised appropriately.
As regulators advance towards collaborative regulation, the industry will emerge stronger and will continue to deliver value to its owners.
Koogler: We are not seeing regulatory developments outside the US affecting business in Ohio at this time.
However, the Ohio Captive Insurance Association has members heavily involved in captives throughout the US and in foreign jurisdictions so it is well positioned to monitor the impact of such regulatory developments on captives domiciled in other US jurisdictions and owned by Ohio businesses.