Broadly speaking, the South Carolina Department of Insurance anticipates three trends for the onshore US captive world in 2018, the first is related to captive structures and the root motivations of their owners, the second is related to larger or more established captives, and the third is related to the presently indistinct regulatory status of captive managers.
Regarding the first trend, we anticipate that many 831(b) captive owners in the US will continue to reassess the viability and raisons d’être for their captives in light of the 2015 PATH Act and subsequent developments. Some will restructure their ownership arrangements to preserve eligibility to take the tax election in accordance with the 2015 Act, others will probably shut down their captives. Frankly, I don’t see either scenario as a net negative for the captive industry.
We may see the risks placed with these small captives move in from the fringe enterprise risk captives (ERC) exposures seen in recent years and start to correspond more closely to traditional lines of insurance. They may well generate higher premiums and produce more real losses, and generally start to resemble more small-scale versions of the mainstream captives that have been around for decades. I see nothing undesirable or threatening about such developments.
Of course, some domiciles have tied themselves very closely to these so-called ERCs, a term I’ve always considered to be nothing more than a euphemism intended to avoid using the 831(b) label. South Carolina is not one of those domiciles.
Although we do have some captives in our portfolio that make the 831(b) election, we look at those captives the same way we look at other captives in terms of our licensing decisions and overall regulatory scrutiny. I should add that we certainly don’t want to discriminate against small-sized companies wishing to avail themselves of the advantages of captive ownership for real risk management and risk financing reasons, but we are also not interested in serving as a haven for tax-driven or estate-planning-driven vehicles, with all the uncertainties and questions about the sustainability and even the legitimacy of such structures.
Regarding the second trend, we are seeing a wider recognition of the threats posed by emergent risks such as cyber, supply chain, and terrorism. Along with the dense webs of interconnectivity among today’s corporate operating exposures—together, all these dynamics will continue to fuel interest in captives, and in addition, prompt owners of more established and financially robust captives to consider expanding their captive utilisation plans to encompass new risk exposures and possibly higher limits of coverage.
In other words, owners of solidly capitalised captives with a track record of good earnings from well-priced and prudently reserved business will become more alert to ways to put their captives’ accumulated surplus to work to protect the operations, earnings, and reputations of their parent organisations.
Regarding the third trend, we expect to see a heightened focus on the qualifications of captive managers and the whole question of whether they currently escape regulation of any kind and should be licensed, and if so, under what sort of standards regime and by what regulatory authorities. This is a fairly fraught subject about which some regulators—myself included—have quite strong views. In a nutshell, I think the licensing of managers is an ill-conceived, largely defensive or reactive idea that could open the whole captive sector in the US to unwanted intrusion by forces skeptical of—if not outright hostile to—the captive sector.
But there are some regulators who seem to be attracted to the idea of licensing managers, and I predict that in 2018 the, until now, behind-the-scenes informal conversations about this subject will erupt into a full-blown public discussion, with consequences that are not only hard to foresee but also potentially beyond what any captive industry stakeholders might desire, intend, or have any ability to control.
I would caution my fellow regulators to tread very carefully on this turf, lest we all be consumed by unintended consequences of a distinctly undesirable kind.
As regulators, we already have plenary authority to regulate the captives themselves, and if we’re not doing that, then shame on us. From a solvency supervision standpoint, we should be putting the emphasis on the three things that have the greatest bearing on a captive’s solvency: capital adequacy, premium-to-risk adequacy, and reserve adequacy.
Going into 2018 we expect to be an active participant of these discussions about the advisability or inadvisability of establishing a licensing regime for captive managers. I think there are sound alternatives that would be better for the industry as a whole, and will be advancing my ideas about this in the coming weeks.
Secondly, the South Carolina Captive Insurance Association, in collaboration with some of my South Carolina Department of Insurance colleagues, has developed new draft captive legislation intended to be a comprehensive clean-up and modernisation bill, which we expect to be introduced shortly into the South Carolina General Assembly with support from South Carolina Department of Insurance director Ray Farmer and some leading members of the legislature. It would be premature for me to provide details about the draft bill at this stage, but as the legislative path forward becomes clearer, more information will be forthcoming.
My colleagues and I, as well as our industry partners, are very excited about this, and believe that if passed in the current form as approved by the association, the bill will be enthusiastically received by all South Carolina captive stakeholders, and will enhance South Carolina’s appeal not only as a captive domicile but also as a base for conducting captive management operations.
Thirdly, we will continue to focus on the four core values that have defined our regulatory approach ever since I took over the Captive Division of our Department four years ago: across-the-board professionalism, consistency of execution, the quality of our captive portfolio, and owner value.
We believe that most captive owners, especially of large or mid-sized publicly traded companies, will gravitate toward a jurisdiction that emphasises quality over sheer numbers. By safeguarding our own reputation as a domicile that takes our solvency oversight responsibilities seriously, we help protect the reputation of our captives and their owners and managers as well.
We see ourselves as having an important part to play in facilitating the creation of something that will be of meaningful value to our captive owners for many years to come.
Finally, we in South Carolina will not allow ourselves to lose sight of what the whole captive movement is, and always has been, about. In the final analysis, it’s all about owner choice and owner value.
The reasons for forming captives in 2018 are as valid and varied as they’ve ever been. Captives exist to provide business owners and executives with more choices and better tools for managing and financing their companies’ risk, so that their companies can go about operating and building their core businesses with less uncertainty and more security. It’s both as simple, and as complicated, as that. They are not about elder generation owners of privately held companies trying to find tax-advantaged ways to transfer wealth to downstream generations while getting tax deductions at the parent company level and at the same time escaping tax on underwriting income at the captive level.