The year 2014 saw new developments in the captive insurance industry, combined with a healthy dose of the same-old-same-old...
The year 2014 saw new developments in the captive insurance industry, combined with a healthy dose of the same-old-same-old. Some of the events were predictable, while others caught many by surprise. In 2015, with the proliferation of new domiciles, seemingly pro-captive court rulings and some aggressive planning opportunities, the stage is set for significant advances in captive insurance and, perhaps, a few battle scars, too.
TRIA reauthorisation spurs organisations to think about alternative ways to cover some of their terrorism exposures
The Terrorism Risk Insurance Act (TRIA) soap opera had a number of twists and turns during the year, ending with the act's swift passage by the new Congress in January 2015. As we predicted, President Barack Obama did not hesitate to sign the legislation. The extension, which doubles the federal backstop trigger to $200 million for qualified traditional terrorism events and increases the copayment from 15 to 20 percent, wasn’t ideal, but a reasonable compromise. More importantly, the new law is not due to sunset again until the end of 2020, giving insureds more certainty than they had in 2014.
Now entities exposed to these risks can better evaluate captives as a way to insure for both traditional, and nuclear, biological, chemical and radiological (NBCR) events, which commercial markets are not yet equipped to cover.
Two recent tax rulings against the IRS change the landscape for captives
Last year, captives for Rent-a-Center and Securitas were on the winning side of tax court rulings, in which the Internal Revenue Service (IRS) contended neither captive was truly an insurance company. They were so judged, according to the separate rulings.
There are a number of reasons why this bodes well for organisations looking toward new captive solutions, but the courts basically said that if a captive is operated on an arm’s length basis with the proper intent to insure risk, the IRS should not challenge based on technicalities.
There is one caveat: the Rent-a-Center case saw significant dissent, meaning that the IRS may not be done challenging captives on these grounds. However, the landscape has changed enough for organisations seeking alternative insurance solutions can look toward captives with more confidence.
Overall, soft market conditions will continue through 2015
This condition will not matter to those organisations seeking captive-centric benefits. We have always counselled our clients to look beyond the lowest premiums.
At some point, today’s soft market will become tomorrow’s capacity problem, leaving those organisations looking, perhaps hurriedly, at other solutions. Compare this to rushing out and buying a gas-guzzler now that gasoline hovers around $2 per gallon. Who knows what the price will be 18 months from now. Short sighted thinking is becoming a thing of the past.
We recommend that organisations examine the many other benefits of a captive-centric approach. Such an approach can improve loss control, resulting in fewer incidents and lower severity of claims. By enjoying the same tax status afforded commercial insurers, captives further build on their ability to accumulate capital to protect against loss.
The best thing to do is to take a fresh look. Understand the advantages and disadvantages. Whether the decision is to start a captive or transfer more risk to one, a greater comprehension of the many benefits of captive insurance will come.
More domestic companies will move their offshore captives onshore
There are a number of reasons why captive owners will consider either moving onshore or choosing to establish a new captive domicile in the US.
Firstly, the differences between offshore and onshore have all but disappeared. While there remain very attractive offshore domiciles, the advantages have narrowed and costs are usually less expensive onshore. Secondly, as more states introduce captive legislation, there is greater access to localised regulation and oversight.
Choosing a new captive domicile depends on each entity’s unique risk transfer needs, but should come after a comprehensive feasibility study. Understand that with so many domiciles from which to choose, a comprehensive analysis by decision makers is paramount to choosing the right location.
The attack on the Dodd-Frank Act will continue
Last year saw Congress poke significant holes in this contentious law, which has become a poster child for complex legislation. The Republican-dominated Congress has promised to remove some provisions and water down or delay others, but the act doesn’t appear to be going anywhere.
Captive owners are focusing their interest on one area of the now five-year-old act, the Non-Admitted and Reinsurance Reform Act (NRRA). While this part of the legislation may have simplified some of the complexities of individual-state regulation, the confusion over taxing surplus and excess lines continues.
Clarification of whether NRRA empowers states to impose premium taxes on insurance transactions outside of their jurisdiction was requested three years ago. If so, will states be able to coordinate their collection and redistribution? The answers to these questions are as elusive as ever.
There is hope that Congress will finally tackle this part of the Dodd-Frank conundrum to provide clarity, but the best guess is that this particular aspect of the bill will not be addressed this year. Captive owners that may be in the process of evaluating whether to redomicile their captives should stay tuned.
Group captives will find a broader audience
For years, captive insurance managers have predicted a trend where the middle market would comprise a growing percentage of the overall captive insurance market. We believe this year we will see a strengthening of that trend, especially in the group captive area.
More small- and medium-sized companies are expressing an interest in this type of captive. They are looking at like-minded companies of similar size with similar exposures and exploring how captives can help them manage both costs and risk. There is no reason why only the biggest companies should enjoy the benefits of captive participation.
One reason for the increased interest is the continued confusion around the requirements of Obamacare and how it affects smaller employers. Group captives were tailor-made for smaller companies that wish to enjoy the same advantages.
The IRS will continue to focus on 831(b) captives
Small captives, organised under IRC Section 831(b), are the fastest growing segment of the captive industry. As a refresher, these small captives can write no more than $1.2 million in annual net premiums and can elect to pay tax on investment income only, exempting them from tax on underwriting profits. The one caveat causing trouble for many, however, is that the entity must qualify as an insurance company, thus having the necessary attributes such as risk transfer and risk distribution.
In 2015 the IRS has expressed some concern about these vehicles being used as tax and estate planning vehicles. A dozen or so captive managers have been contacted by the IRS to participate in an investigation into possible abuses (JLT Towner is not among them). We believe this scrutiny will intensify.
For existing small captives, there is little worry as long as it was formed and operates for solid insurance purposes. Captive managers can help to stay current with developments as they occur.
In fact, this is good advice for any captive. Institute an annual programme review to ensure that a captive is operating at peak efficiency. Explore whether the reason the captive was formed is still valid and whether te captive might entertain new risk transfer opportunities. Research the new opportunities to manage risk through captive-centric risk management practices. The more prepared a captive is, the better it can weather any environment.
