Hard market of soft, captives keep streaming into Vermont: deregulation, flight to quality, demand for complex risk financing make Vermont more attractive

Risk & Insurance, April 14, 2003 by Thomas J. Slattery

The continued and steady growth in the number of captive insurance companies and captive domiciles led the short list of top trends in today's alternative market in a random poll conducted recently by Risk & Insurance magazine.

In a hard market that development, in and of itself, comes as no surprise. What is surprising is the relentless growth of captives, and the deep and restated conviction of industry professionals that the trend will continue into the future irrespective of overall market conditions.

Industry insiders interviewed by R&I, people from across the captive insurance spectrum, all do business in Vermont, the top captive venue in the United States and the third-largest captive insurance market in the world. They were asked to assess overall market developments and trends as well as those related to Vermont.

Typically, captives flourish when the traditional insurance market constricts in terms of availability and pricing. As a consequence, many risk managers are left to find solutions elsewhere, which has fueled the growth of the alternative market. When the traditional market subsequently softens, as all agree it will, conventional wisdom will return to the traditional marketplace to one degree or another.

Our sources pointed to the impressive growth of captives throughout the soft market of the '80s and '90s.

They expect this growth to continue even after the hard market softens in two or three years.

New Trends Emerge

Other trends in the captive insurance business have emerged. They are:

* The hard market, which by all accounts will extend into 2004 at least, and will continue to drive business into alternative markets like captives. [See accompanying article.]

* Expansion of captives into new markets such as health insurance, employee benefits and financial services, driven by passage of the Gramm-Leach-Bliley reform measure. The act has allowed financial services captives to expand into areas such as fixed annuity reinsurance.

The increasing sophistication of risk managers and the role of captives in enabling them to better manage internal risk. With more scrutiny of corporate affairs by regulators, a captive structure that's well managed gives senior management a better tool to track financial data and off-balance sheet liabilities.

* A continued "flight to quality" by risk managers who favor captive domiciles which have deep experience and infrastructures, and a favorable and consistent regulatory and legislative environment. Vermont was invariably brought up as a domicile which possessed these qualities in abundance.

* Growth of "segregated cell" captives--called sponsored captives in states like Vermont and rent-a-captives offshore--which open up the benefits of captive facilities to smaller entities. The cells operate like single-parent captives, but participants have no capital requirement.

However, the consensus among those interviewed emerged on the issue of captive growth over the long term. They stressed the fact that astute managers of risk, if a captive operation makes sense for their situation--and it doesn't for all--will be in captives even in a soft market in order to position themselves for changes in conditions.

To Captive or Not To Captive

"You know, captives aren't for everybody," explains Len Crouse, who for years has headed the captive insurance division of Vermont's Insurance Department. Grouse, along with his assistant director, Derick White, is the go-to source on captive insurance regulation on the state.

"You have to see what works for your own company," says Grouse. "They're not for a company that just wants to get a quick fix, a company that just wants to alleviate the hard market conditions for six months to a year. You've got to be committed to this thing in the long term. If you don't build on it and put a lot of premium into a captive insurance company initially, and make it grow and work, then in two or three years, when the market gets soft again, you're going to get better offers and better rates outside."

"What do you do then?" he asks. Take all the premium out of your captive, fold it and go back to the traditional market? And wait there for the next hard market?

"That's not the way to do it," says Crouse. "We had a lot of captives formed during the last soft market cycle. We did very well. A lot of these companies formed because they wanted to position themselves for the hard market, and they did. They put the smaller, traditional lines of insurance in their captives. They didn't write a lot of premium, but when the hard market hit these people were in a position to add a lot more capital to their captive program, and off they went."

When the market turns, says Len Grouse, Vermont's captive business will continue to grow. "We licensed 25-30 companies each year in the soft market of the '90s. We did a great job. I attribute that to the sophistication of risk managers today. I think they understand risk better and plan long term more. A lot of them, in the '8 Os, said, 'Life is good, things are good, but let's position ourselves for the next change.' And they did."