The state of the US market: Uncertain federal policy but SMEs going strong
Alabama Captive Insurance Association
President and CEO
North Carolina Captive Insurance Association
Vermont Captive Insurance Association
How would you describe the current state of US captive insurance?
Norman Chandler: The market is stable and growing, although growth has slowed the last couple of years in the enterprise risk space. However, we have seen a pickup in more traditional captive formation. Is it looking good? We are thinking that long term, the market is going to continue to see growth, however, types and coverages will continue to change as market conditions warrant.
Thomas Adams: Captives in the US are still growing both in popularity and in numbers. When businesses take time to sit down and assess their insurance needs and then look at options to lower their cost for this part of their business, they are increasingly looking at the captive option. This indicates there is an acknowledgement on an increasing number of accountants, attorneys and insurance advisers that this is a plausible option for many companies. We also see this reflected, in our domicile, in the rapidly increasing formation of Internal Revenue Service (IRS) Section 831(b) captives.
Richard Smith: The amazing thing about the state of the US captive market is that despite underlying weaknesses in the overall insurance market, we still see growth in the captive industry. We are seeing growth in small- and medium-sized entities (SMEs) seeking some of the same advantages that used to be the preserve of larger organisations, but we are also seeing sustained interest in larger organisations across the industry spectrum. The one truism about captives is they continue to be a flexible financial planning and risk mitigation tool that can meet the ever changing need of the business world—if you have seen one captive, you have seen one captive.
SMEs are increasing their share of the captive market. What challenges are your SME members having to overcome to set up their own captives?
Chandler: I think US domiciles have done an excellent job of encouraging growth in captives for SMEs. The biggest challenge at this point is the uncertainty regarding tax policy and enforcement. Hopefully, that will become more settled over the next year. Another challenge is capitalisation. We think that the domiciles that base initial capitalisation on the type and volume of business are most apt to meet the needs of SMEs.
Smith: I feel like the risk management sophistication we used to see in only larger institutions is no longer a barrier to entry to captive insurance. A combination of increased knowledge in SME risk management programmes and the expertise of the captive industry’s service providers has provided this capability.
For SMEs, the biggest challenge is the capital requirements that companies need to get started. However, with the growing use of group captives and sponsored cells, there are myriad ways an SME can take advantage of captive insurance programmes that also optimise scarce financial resources.
Adams: The biggest challenge to increasing micro- and mid-sized captives may be getting their owners to simply take the time from their schedules to look at what a captive may do for their business. There must also be a willingness to commit the financial resources necessary to do the study and then fund the setting up of their captive. Traditionally, some certified public accountants and attorneys have not taken the time they need to familiarise themselves with the intricacies of captive formation and simply do not know it is an option that perhaps could benefit their clients. In North Carolina, led by the North Carolina Department of Insurance, we have been working hard to get that word out in meetings around the state.
Captives with premiums of less than $2.2 million per year are attracting greater attention from regulators, perhaps as a result of this increase interest. What are your SME members telling you in light of this scrutiny?
Adams: IRS Notice 2016-66 was and continues to be bad news for small captives. We heard from our members loud and clear on this and undertook a strong initiative with the North Carolina congressional delegation to explain what this grotesque overreach by regulation will do to slow the growth of captives. It makes little sense for an anti-regulation administration to have let this rule go forward. It adds both cost and time to an industry that is more than adequately regulated at the state level. We will continue to work to roll back this regulation on the regulatory and congressional levels as well as with the courts.
Smith: When Congress increased the maximum premium volume from $1.2 million to $2.2 million for small insurers to take advantage of the 831(b) tax election, it was a bit of a double-edged sword. On the one hand, increasing the premium limit will allow thousands more SMEs to take advantage of the programme and should expand the use of captive insurance by a large factor. The 831(b) election has become an important captive structure, helping business owners appreciate that they can do more to manage risk than just buying traditional insurance coverage.
However, on the other hand, there are less-than-scrupulous financial advisers that are seeking to undermine the programme by marketing the 831(b) programme as a tax scheme. This has caused the hackles to be raised at the IRS, which has listed 831(b) transactions as a “transaction of interest”, thereby giving captives a black eye and casts such a broad net that it will create unnecessary financial and regulatory burdens for captive owners and service providers. My hope is, that once and for all, we can eliminate the few bad actors in this area and open up captives more broadly to all SMEs.
Chandler: There is nervousness among potential new captive owners regarding federal tax matters. Existing owners are generally more worried about the increasing costs of compliance due to the federal requirements. On a state level, the greater attention has created more competition among domiciles. We think this has been effective and an overall positive for captive owners. The competition has helped keep costs under control at the state level and has encouraged creative resolutions to problem solving. Once downside to more small captives at the state level is the demand on state examiners. We’ve started to see some states get a little taxed in trying to keep up with the examinations required under state law.
The Fortune 500 segment has evened out. How are they becoming more sophisticated as insurers? Where are you seeing innovation?
Adams: As a relatively new domicile, we have seen a slow growth in our large captive population led by a number of companies choosing to redomicile here. The main difference between large captives and the micro captives is that the larger ones are able to look at risk management, claims management and operations in more detail. As smaller captives learn from one another, we would expect them to come together to develop best practices that will allow greater sophistication by all captives.
Chandler: We are seeing most of the innovation in management of employee benefits. Most of these captives are more affected by market conditions. We’ve seen some of these greatly reduce workers’ compensation risk in the captive recently due to such a soft market. We think workers’ comp will start to turn in the next two years. However, these captives should stay nimble to take advantage of market conditions.
Smith: One area of innovation is that new technology is currently being used to mitigate risk in different industries. With advances in technology, companies are discovering new and innovative ways to control costs, improve effectiveness of resources and compete more successfully. As the availability, speed and accuracy of data increases, companies have a greater ability to measure performance, highlight previously unforeseen risks and prevent losses.
Growth in cyber liability insurance policies to deal with increasing cyber threats and potential costs of a breach is another hot topic. Captives can help institutions create best practices for avoiding breaches, mitigating breaches, and responding to the inevitable breach.
More seasoned captive owners are seeking to add employee benefits and medical stop-loss coverage in their captives. And, in general, these organisations are seeking new ways to optimise their captive’s risk profile by developing a framework to properly measure and benchmark captive operating performance specifically related to the owner of the captive. Captives change and adopt new capital, finance and underwriting strategies in alignment with the changing needs of the captive owner insureds.