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Smaller firms break into captive market, drive growth

Among the major drivers of new captive formations is increasing interest from smaller companies in tapping the alternative risk transfer market.

“I think the small captive market is very frothy,” said Brady Young, president and CEO of Strategic Risk Solutions Inc. in Concord, Mass. Several captive managers are focusing on companies that wouldn't have been considered to be captive prospects in the past, he said, as strong cash flows, strong earnings and risks that aren't covered by traditional insurance replace total annual premiums as the new metrics for identifying companies that could benefit from forming captives, he said.

“It's surprising how much interest there is out there from those types of companies,” Mr. Young said, adding that the “small captive” category might be driving 70% to 80% of new formations.

“Utah was kind of the first to figure that out and target that segment of the captive market,” he said.

Many of those small captives are able to benefit from 831(b) tax elections, under which the U.S. federal government taxes them only on investment income if their annual premiums are less than $1.2 million. Concerns remain among some managers, regulators and others in the industry about cases in which those captives are formed for purposes of tax hedging rather than true risk transfer, however.

“We're seeing the midsize captives, 831(b)s,” said Andrew Sargeant, chief operating officer at USA Risk Group Inc. in Montpelier, Vt. “I know there's been a lot of activity out in Utah with some of these.”

But, Mr. Sargeant said, “We're very careful when we work with these, because we want to make sure that there's proper risk transfer and risk activity when you form these and it's not merely a tax play.”

Smaller companies also are showing considerable interest in using captives in their employee benefit programs.

“There's a lot of interest in benefits in captives: medium-sized employers looking for a magic bullet and hoping or thinking their captive might be it,” said Mr. Young. There is a “lot of interest, certainly a lot of smoke on using a group captive for medical benefits.”

“The real interest is in medical stop-loss,” said Les Boughner, managing director of Willis Group Holdings P.L.C.'s North American captive practice in Burlington, Vt., with employers forming group captives to provide that stop-loss coverage.

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