Reduced demand for construction curbs captive formations

The economic downturn and its impact on construction business seems to have interrupted the formation of new construction captive insurance companies and groups, though existing construction alternative risk transfer programs appear to be holding their ground and, in some cases, enhancing offerings to members.

In Vermont, “Nothing new has been formed this year, nor has anything closed down,” said David F. Provost, deputy commissioner in the Captive Insurance Division of the Vermont Department of Banking, Insurance, Securities and Health Care Administration. “I can't recall any in our pipeline that are construction-related either.”

But, added Mr. Provost, while no new construction captives are forming, “I haven't heard anything bad, either. I haven't heard of companies really struggling.”

“Obviously the market is tight, and real estate is down and things aren't being built that much. But some of our companies actually had specialties, and those specialties are going along just fine,” the Vermont regulator said.

“One of them...primarily built buildings on military bases, so they had a fairly long backlog,” Mr. Provost said. “Another bunch was roofers and, well, the roof's got to be fixed even if you're not doing new construction.”

As recently as last year, Vermont licensed “several” construction industry captives, Mr. Provost said, and approximately 5% of Vermont's captives are construction industry-related, ranking the industry sixth—just ahead of the retail and energy industries—as a source of captive business for the state. “It's a significant piece of the business,” he said.

South Carolina has 15 active construction industry captives, said Jeff Kehler, program manager of Alternative Risk Transfer Services in the South Carolina Department of Insurance.

Since the economic downturn began in 2008, the parent companies of two South Carolina construction captives went into bankruptcy, Mr. Kehler said, but, “The captives were fine. They were well-funded, had no financial solvency issues or anything.”

One of those two parent companies ultimately went out of business and the captive was shut down, but the other remains in operation and the captive is functioning normally, Mr. Kehler said. “The other ones seem to be doing fine,” he said.

Regarding new construction industry risk retention groups, “We haven't seen one of those in a while,” Mr. Kehler said. “I think the economy has had an impact on new formations.”

Les Boughner, executive vp and managing director of Willis Group Holdings P.L.C.'s North American captive practice in Burlington, Vt., is seeing a similar landscape for construction captives.

“We have one dedicated construction group that is maintaining its status quo and growing a little bit. But it is definitely one of the depressed segments out there,” he said. “I don't think we have done a wholly owned captive for a construction company for a couple of years now.”

“I wouldn't say it's gloom and doom,” Mr. Boughner said, adding that the Bermuda-domiciled construction group his office manages “hasn't had problems and they have, in fact, grown incrementally.”

Michael O'Neill, president of Dallas-based American Contractors Insurance Group Inc., which operates through a Bermuda-domiciled captive and various U.S. affiliates, noted that the construction industry tends to lag the broader economy. “Construction is not a real good indicator of the economy because it's the last one into a recession and the last one out,” Mr. O'Neill said.

In response to the economy, ACIG has been looking to help members improve their margins by reducing losses. “Their profit margins are under a lot of stress right now, so we're obviously emphasizing risk management and safety and quality,” Mr. O'Neill said.

In 2009, ACIG modified its approach to writing insurance for contractors, trying to bring programs more in line with the life cycles of the projects members were working on.

Rather than annual renewals—which left members looking at the possibility of rates and limits changing over the course of a multiyear project—ACIG began offering a “project attaching approach,” Mr. O'Neill said, that sees the coverage running through preconstruction, construction, the warranty period and the state statute of repose.

“You're basically buying a coverage that goes from start to finish,” Mr. O'Neill said. “Many of these jobs are taking 24 to 36 months,” potentially exposing contractors renewing coverage annually to changing prices and coverage terms over the life of a project.

With the project attaching approach providing certainty about insurance costs and limits for the life of a project, “it allows them to price the project from start to finish,” he said.

A sort of “pilot group” of six of ACIG's 38 member insureds are taking advantage of project attaching coverage, Mr. O'Neill said.