2009 Seen as Transition Year for Captives

The growth in captive insurance companies was held hostage for the past year, but regulators and industry participants are optimistic the sector will pick up the pace by the end of 2009.

A soft insurance market and the overall economic slowdown kept many companies, groups and agencies from forming new captives in 2008. This year could be a time of transition, with a hardening of professional lines nudging the formation of new captives in 2010, they said.

With businesses getting better terms in traditional markets, the premium cost-savings incentives in forming a captive are currently not present, said Rick Stasi, chief operating officer of Avizent Alternative Risk.

"We're still in a fairly soft market," said Mark Bernfeld, a vice president in Towers Perrin Reinsurance's consultative placement division. "People are going to wait at this point and see what the market does."

Another factor was uncertainty over a proposed U.S. Internal Revenue Service rule that would have curtailed the ability of many onshore captive insurers to set aside reserves on a tax-free basis. Captive trade groups warned it would have threatened jobs and revenue in the 28 states that function as captive domiciles (BestWire, Feb. 21, 2008).

Even after the IRS withdrew the proposed rule in February 2008, there remained a lot of unknowns about what the agency was going to do, Stasi said. "They never want to make a stand because they want to have the flexibility," he said.

Still, he added, "If you form a captive for the right reasons, and not just for the tax flexibility, you're going to stay out of trouble."

Some U.S. captive domiciles are planning their own tax incentives to lure new enterprises to their states after a bumpy 2008. The largest domestic domicile, Vermont, saw 32 captives registered in 2007, but just 16 in 2008.

The Green Mountain State has proposed one-time non-refundable tax credits of $7,500 to offset premium rates for newly registered captives in 2009 and 2010. The proposal would also raise from 10% to 12% the percentage of premium tax revenue the state can use for the regulation and promotion of the captive sector. The state offered similar incentives from 2001 to 2003, years of sharp growth in captives.

Molly Lambert, president and chief operating officer of the Vermont Captive Insurance Association, said the new round of incentives show the state is recommitting to captives.

Montana, which according to the State Auditor's office hosts just 30 captives, is also considering incentives. Under H.B. 160, captive insurance companies would be permitted to pro-rate the $5,000 minimum premium tax.

Despite the 2008 slowdown, new states are getting into the captives act. Michigan and Connecticut each adopted legislation last year to become captive domiciles. Connecticut opened for captive business on Jan. 1, 2009, but has not yet seen any applications, said Dawn McDaniel, spokeswoman for Insurance Commissioner Thomas Sullivan.

"There's a lot more competition for Vermont and the Cayman Islands than there used to be," Bernfeld said.

New domiciles show faith in the sector, but do not have the built-in infrastructure and expertise to attract new captives, Stasi said.

But once captives are established, Stasi said, they are rarely dissolved. "They don't get out," he said.

(By Sean P. Carr, senior associate editor, BestWeek: [email protected])