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Smaller companies try captives

Midsize firms opt to retain some difficult, expensive risks

Smaller companies try captives

A growing number of midsize companies are forming captives, providing vigorous growth for the captive market.

While the vast majority of Fortune 500 companies already have captives, that percentage plummets among smaller companies, experts say.

However, a growing number of smaller firms are forming captive insurers, including 831(b) captives.

The 831(b) captives, also known as microcaptives, earn no more than $1.2 million in annual written premiums and thus are eligible for the Internal Revenue Code's 831(b) election not to be taxed on those premiums. Though, efforts are underway in Congress to raise the premiums limit.

The total number of captives worldwide increased 7.1% in 2014 to 6,876, according to Business Insurance's annual survey.

? While Bermuda continues to be the leading domicile, its captive total decreased 3.7% to 800 in 2014.

? Among U.S. domiciles, Vermont remains No. 1 with 587, down one from 2013.

? Among European captive domiciles, Guernsey held onto its lead with 321 captives, an increase of three entities over 2013.

“The biggest trend is the industry is becoming more defined by how captives are applicable to the smaller and middle-market customers, rather than the historic focus on Fortune 500” multinational companies, said David J. McManus, Bermuda-based president of Artex Risk Solutions Inc., a unit of Arthur J. Gallagher & Co.

“I think that's where all the excitement is, and certainly the innovation and growth,” he said.

Middle-market companies with revenues of $30 million to less than $1 billion account for only 5% of all captives, Mr. McManus said.

There is “tremendous opportunity for growth,” he said.

Smaller and midsize captives face exposures for which it's “not as easy to get appropriate coverage in the market,” whether it is an emerging risk such as cyber, or political risk or surety, where pricing is either not competitive or the right type of coverage is not available, said Chris Lay, London-based president of global captive solutions at Marsh L.L.C.

In the United States, Utah, Delaware, North Carolina and Tennessee were the domiciles with the strongest growth in number of new captives in 2014 among the larger captive domiciles.

“It's kind of a banner year for a lot of the newer domiciles,” said Brady Young, president and CEO of captive manager Strategic Risk Solutions Inc. in Concord, Massachusetts. “That's really a reflection of growth in middle-market companies forming captives to address enterprise risks and the various uninsurable risks that they have.”

Other risks being funded through captives include pension longevity and catastrophes.

David Snowball, director of the captive insurance division of the Utah Department of Insurance, said most captives domiciled in the state are the smaller 831(b) plans, although it has larger captives as well. Utah is attractive, he said, in part because of its friendly business environment and the department's responsiveness to businesses' needs.

C.B. Batts, chief financial officer of Kalamazoo, Michigan-based waste management firm AZO Management Services Inc., moved two captives that are not 831(b) plans to Utah from the Cayman Islands late last year. One captive focuses on risks including general liability, fleet, aviation and umbrella risks, while the second specializes in environmental risks.

“We were looking for something that was very competitive in regulation and in fees” similar to the Cayman Islands, which he said the company left in part because of the “encumbrances of the U.S. government” concerning offshore domiciles, Mr. Batts said.

While Vermont remains the largest U.S. captive domicile and is the third-largest in the world, “We've been at a plateau for a few years, in part because we're not an attractive domicile for the microcaptives,” said David F. Provost, deputy commissioner of the captive insurance division in the Vermont Department of Financial Regulation.

While Mr. Provost said 17 new companies were licensed last year, Vermont's total captive count was virtually flat.

“Once you've been around for 30 years,” mergers and acquisitions and companies that shut their captives down are limiting captive growth in Vermont, which Mr. Provost said is “part of the business cycle.”

Meanwhile, the IRS has become “much more strict about the use of captives,” particularly small captives, in “any tax planning way,” said Phillip England, chair of Anderson Kill P.C.'s captive insurance group in New York.

Beyond microcaptives, Marsh's Mr. Lay said companies generally continue to use captives as part of their risk management and risk financing strategy “where they are seeing an opportunity to create value.”

Thomas P. Stokes, New York-based practice leader with JLT Insurance Management US, a unit of Jardine Lloyd Thompson Group P.L.C., said that with the rulings in the IRS' Securitas and Rent-A-Captive cases, which overturned IRS rules on the tax treatment of captive insurance, “there's a little more confidence” about establishing captives. “We're seeing a lot more activity in that area where (companies are) are saying, "Let's take a look at that.'”

But even without taking the tax rulings into account, “I think you'll see a lot more uses of captives,” Mr. Stokes said.

“More and more premiums are being diverted from the commercial markets” into captives, he said of companies' efforts to reduce their costs and centralize their risk management functions.

Companies today want to set up captives close to their corporate headquarters, said Mark Morris, Kansas City, Missouri-based senior vice president in Lockton Cos. L.L.C.'s risk finance group, who has conducted captive feasibility studies for company clients interested in Kansas, Ohio, Oklahoma, Missouri and Texas.

Directors and officers can more readily do business with their captives when they are nearby and potentially pay lower taxes, he said.

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