Lloyd’s of London is working with an applicant which could establish the first Captive Syndicate in over 20 years, while the London Market Group (LMG) remains confident that the UK government remains keen to pursue a wider captive regime outside of Lloyd’s.
There are two separate captive initiatives in development in the United Kingdom.
One is the Lloyd’s ‘Captive Syndicate’ offering that would facilitate the formation of a captive within the iconic insurance market, while the other is based on an effort to create a new class of captive insurer, within the UK’s current regulatory framework, that would experience a lighter regulatory touch than commercial (re)insurers.
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These projects are not in competition with each other, and present quite different offerings to the captive market.
The LMG, which has been lobbying government to welcome captive insurers for over three years, is in favour of a bifurcated insurance regime which would ensure captives writing only first party risk would be treated proportionally in a framework that would look more similar to Bermuda and Guernsey than those regulated within major European Union domiciles, such as Luxembourg and Ireland, that have to follow Solvency II.
Captive Intelligence understands that the UK Treasury has intimated captives will be back on its agenda in January 2024, as it is currently prioritising the Financial Services and Markets Bill and Solvency UK.
The latter project is to reform and update Solvency II, post Brexit, into a more tailored regime named Solvency UK.
Speaking as president of the Insurance Institute of London in a speech in November 2022, CEO Marsh of UK & Ireland Chris Lay threw his support behind the idea of a UK captive regime.
Lay, who ran Marsh’s global captive business from 2014 to 2016, said at the time: “An ambitious regulatory model for captives, combining a proportionate risk-based solvency regime with London’s global reinsurance market, could make the UK a unique and attractive location for captive investment.”
Lloyd’s Captive Syndicate
At Lloyd’s, the reintroduction of Captive Syndicates has been discussed and consulted on since 2019.
The first and only captive formed within Lloyd’s was by SmithKline Beecham Plc in 1998, but was put into runoff in 2001 after a merger with Glaxo Wellcome and a review of the group’s captive strategy.
The new offering, which was approved by the Council of Lloyd’s in August 2021, is now being more widely marketed by the corporation itself and several managing agents touting the offering.
A Lloyd’s captive could bring several unique advantages, such as a Lloyd’s rating, access to
insurance licences around the world which would remove the need for a front, and a ready-made insurance infrastructure to support the operation and management of the structure.
The disadvantages, however, are likely to be higher frictional costs, a reliance on managing agents rather than experienced captive managers and restrictions on business plans and the type of insurance that can be written.
Lloyd’s has been very open that the Captive Syndicate will be a niche offering, only really relevant for the largest accounts.
It is also thought that clients who explore this option will likely already have a captive in place and use the Captive Syndicate as an additional tool.
The syndicate application fee is £100,000 and the expected minimum annual premium threshold to make it feasible is predicted to be $20m.
Despite the narrow criteria, there has been interest from large coporates in America, continental Europe, the Middle East and Asia and Captive Intelligence understands there is confidence the first Captive Syndicate could be established by the end of 2023 in time for a 1/1 renewal.
Fluid Truck’s captive insurance programme began writing on 1 April and in an exclusive interview for the Global Captive Podcast, head of insurance Courtney Claflin explained the rationale and motivations for the new formation.
Captive Intelligence revealed in February that the American commercial vehicle truck rental company had established Nereus Insurance Co Inc, domiciled in Washington DC, and would begin by writing auto liability, commercial auto physical damage (APD) and excess.
Fluid Truck makes it easy to rent commercial vehicles 24/7 and currently operates in 400 cities in the U.S. It offers trucks, vans and electric vehicles to more than 100,000 users on its platform.
Claflin said the drivers for Fluid Truck to go down the captive route were for two-fold, and not dissimilar to the motivations for many new captives right now – “control” and to “offset the commercial pricing of product”.
“We’ve reached the point where our premiums far outstrip the claims, and so consequently, much like everybody else, you’ve got two main components behind the formation of a captive, which is capture the underwriting profits and corresponding investment income from your risk financing arrangement,” he said.
“And two, to control your own destiny and be able to chart it out yourself. As opposed to being the tail on the dog.”
When it came to choosing the domicile, for Claflin it was a straightforward decision to return to Washington DC where he has extensive experience from his time at University of California.
“I enjoy the law, the law is fantastic,” he added.
“The regulators themselves, Sean O’Donnell and Dana Sheppard, I have a very good relationship with them. I’ve built a lot of captives and a lot of programmes with them. it’s stable for me in the captive world.”
Listen to the full interview with Courtney Claflin, head of insurance at Fluid Truck, on the Captive Intelligence website here, or on any podcast app. Just search for ‘Global Captive Podcast’.
Peter Johnson, FCAS, MAAA is a Senior Actuarial Consultant with Spring Consulting Group, LLC and Spring’s Property & Casualty Practice Lead. He has 17 years of actuarial experience in reserving, pricing, alternative risk funding, risk optimization, captive feasibility and reinsurance risk transfer work. This experience includes workers’ compensation, medical professional liability, professional liability, automobile, general liability, cyber liability, mortgage insurance and other enterprise risks.
You’re not new to the captive world. You’ve had your captive for several years and generally feel good about its performance. However, you’re now in one of the most difficult markets we’ve seen in a while.
Peaking in June of 2022 at 9.1%, the annual 2022 inflation rate leveled out at 6.5% at the close of the year. This is significantly higher than the average inflation rate for the last ten years (1.88%), as reported by Forbes.
COVID-19 (especially the stimulus packages), supply chain problems, widespread worker shortages, Russia’s invasion of Ukraine and resulting oil price surges, the housing market, and more predictable market cycles are some of the driving forces behind such high inflation.
Is the worst over? Possibly, but a recession is still a very real threat.
So, you feel good about your captive, but you look around and the market is hard, premiums are rising, capacity is inadequate, underwriting standards are rigid, an unstable economy is keeping many up at night, natural disasters seem par for the course, and the world is still picking up the pieces after a global pandemic.
Through all of these changes and more, it is critical that your captive adapts.
Instead of crossing your fingers that the status quo will pull you through, we recommend taking this opportunity to understand how to better align your captive with the market and/or rebuild an underperforming aspect of your current risk funding solution.
With organisations hyper focused on every dollar, this is a time to leave no stone unturned regarding maximizing the advantages offered by a captive. Enter, risk optimization.
Risk optimization is the process, related to a risk, of minimizing the negative and maximizing the positive consequences and their respective probabilities.
The idea is much easier to conceptualize with Spring’s graphical representation. The following chart illustrates an insured’s measure of variation in risk along the x-axis (coefficient of variation) and the measure of the insured’s expected retained profit along the y-axis.
There is an optimal combination of retained risk that maximizes the ratio of profit to risk volatility (“PR Ratio” = “Profit to Risk Ratio”) for each insured within a captive programme.
This is represented by the red dot and is similar to the concept of modern portfolio theory, except we are looking at retained profits relative to retained insurable risks and are not focused on investment strategy.
The key takeaway is when it comes to an insured’s captive risk funding programme, there are various other reasons why optimizing your risks is important. These reasons include:
Your aggregate risk profile hasn’t been examined from the ground up for several years (or longer) and things may have changed significantly
A fresh set of eyes can objectively determine how to get the most out of your captive using captive risk optimization
The opportunities for creating efficiencies in your risk funding solution only increase while going through hard market cycles like the one we are currently experiencing, where various casualty and property lines are seeing double digit rate increases on top of forced retention increases and reduced coverage limits/sub-limits from the commercial market
Change implementation can be planned based on your priorities and strategic objectives
Additional savings for risks or risk layers currently insured by the commercial market could be brought into your captive, leading to a decrease in volatility and an increase in savings
We generally find that moving most risks/risk layers from the commercial market to a captive result in between 10% and 40% in long-term savings. These savings generally come from a combination of investment income on the captive’s invested assets, captive underwriting income and the lower operating costs of a captive (compared to commercial coverage)
To demonstrate such savings, a large healthcare system client of ours with a captive insures a combination of P&C and benefits risks. In the last 10 years they have saved approximately 40% of guaranteed cost premium levels, or $100M. By recently adding medical stop-loss and coverages to their captive, they continue to create more savings while stabilizing results (i.e., reducing the CV illustrated in the chart above).
Claims experience is better or worse than originally expected, therefore capital adequacy and pricing sufficiency should be reviewed
Regulations may have changed, such as recent practices that have come out of captive court cases
Taking into account these various issues that drive the need for occasional but regular risk optimization studies, Spring has developed the following five-step process:
Goals
Impact
Strategies
Structure
Measurement
Goals stage
In this initial stage, it is important to focus on confirming the goals and objectives of your captive, both new and old.
Have the older goals been achieved? How have they changed over the years? Will your current corporate strategy elicit the creation of new goals?
Also critical at this early point is the collection of data, and not only the stats and facts of the captive, but also the more subjective (qualitative) data that can be gleaned through management interviews and informal stakeholder surveys.
The goals stage highlights your current insurable risks and your means to fund that risk. Some of the most common P&C risks to insure in captives include, but are not limited to:
Strategies stage
In this phase, a professional captive optimizer would first analyse any additional lines of coverage that could be insured by your captive. The key is to determine the possible return by line and then prioritize them.
The risk hierarchy exhibit below shows the typical order of prioritization, starting with the bottom layer and working up.
Secondly, a surplus management strategy would be developed. There are many considerations in appropriately managing the capital and surplus levels over the life of a captive, including average cost of capital, retention levels, reinsurance use, taxes and others that a team of actuaries and consultants would review and develop strategies to address.
Structure stage
Now that you know what you want to do and how, it’s time to take a closer look at how it will all work together in a logical structure.
Economic trends and market changes should give you some food for thought. For example, pure captives are increasingly changing to sponsored entities.
It is important to identify investment management best practices as well as the optimal collateral structure.
Impact stage
The Impact Stage of a Risk Optimization Study involves looking at all the different pieces of the captive puzzle to determine how they would be affected by the changes you’re considering.
A few activities here would include:
Conduct the analysis of your risk financing optimization
Includes quantification of benefit/cost over lifetime including cost of capital
Allows for a better understanding of the optimal PR Ratio considering the insured’s P&C and benefits risk tolerance
Cost of capital and risk premium loads can be minimized
Appropriate modeling of correlation between risks is instrumental to this process
Review your current reinsurance levels and optimize your use of reinsurance
Stress test the captive with reasonable adverse case outcomes
Measurement stage
Finally, all sound captive projects end with measurement. This is the time to determine to what extent goals were met and impacts made.
A great deal of this stage relies on the creation of solid industry benchmarks against which to measure current and future captive performance. It is also important to develop implementation plans based on what you uncover.
At the conclusion of the measurement phase, Spring would produce a risk optimization study report detailing all the findings of the risk optimization study that are outlined and reviewed along with the recommendations developed in this last phase.
These findings can serve as a baseline for measurement going forward.
Regardless of how old or new your captive is, there are bound to be numerous internal and external factors that have changed since it was created.
In 2023, the market is a bumpy ride, making it a great time to have a professional not only take a snapshot of how your captive is currently performing, but also help you project and strategize as to where your captive should be in the future.
Hearings in North Carolina’s Senate have concluded with unanimous floor passage of SB 319, which, if passed, would extend the premium tax holiday for captives re-domesticating to the State until 2025.
The Bill was then referred to the Senate Rules Committee which approved it on Wednesday 26, and then sent to the Senate Floor on Thursday where it passed both second and third readings.
Senator Todd Johnson was the Bill’s primary Senate sponsor.
“We are fortunate to have Senator Johnson as our primary sponsor,” said Tom Adams, NCCIA president.
“His knowledge of insurance and our products has been a key factor in the success of our legislation over the past two legislative sessions.
“Bills such as SB 319 are notoriously difficult to pass due to the loss of tax revenue to the State that is embodied in our bill. We look forward to it’s passage in this session of the General Assembly.”
In 2022, North Carolina introduced legislation that waived premium taxes for the year in which a captive re-domiciles. It also waives the next year’s premium taxes.
The waiver is designed to encourage captives to re-domicile to North Carolina, but the original legislation did not run for the full two years originally intended.
After Senate passage, the Bill has been messengered to the House where it will follow a similar path. Representative Chris Humphrey will be the primary sponsor in the House.
SB 319, if passed, will extend its application until 1 January, 2025.
NCCIA fundraising
Leon Rives, Jeremy Colombik and Alex Webb have been named as the initial board of directors of NC Captive PAC, the new political action committee of the Association, by Diana Hardy outgoing chair of NCCIA.
“The Board and I have charged the new board with the organisation and raising the initial corpus of the PAC,” Hardy said.
“As past Chairs of the association they are familiar with the membership, and I know from personal experience they’re not afraid to ask for a buck.”
The initial goal for the committee will be to raise around $15,000-$20,000 thousand over the next two years.
In episode 84 of the Global Captive Podcast, supported by the EY Global Captive Network, Richard is joined by Fluid Truck’s Courtney Claflin to discuss their new captive formation, London & Capital’s Shadrack Kwasa and Rabbani Wahhab to review the Q1 economic landscape, and three members of CICA’s NextGen initiative – Claire Richardson, Dylan Feringa and Bailey Roese.
Time stamps
0.00 – 3.00: Introduction
3.00 – 10.30: Courtney Claflin, head of insurance, discusses Fluid Truck’s captive formation in Washington DC.
10.40 – 23.30: Shadrack Kwasa, executive director, and Rabbani Wahhab, senior fixed income fund manager, discuss a messy quarter involving inflation edging lower, a confusing jobs market and banking disruption – and, of course, what all that means for captives and their investment managers.
24.30 – 39.50: CICA NextGen members Claire Richardson, of Hyant, Dylan Feringa at PNC Institutional Asset Management, and Bailey Roese, partner at Dentons, discuss why they have got involved and what appeals to them about the captive insurance industry.
AM Best has affirmed the financial strength rating of A- (Excellent) and the long-term issuer credit Rating of “a-” (Excellent) of Apogee’s Vermont-domiciled captive, Prism Assurance.
Prism is a single parent captive insurance company of Apogee, one of the largest architectural design and construction companies in the United States. The outlook for the ratings is stable.
The business profile is limited as the captive provides very specific lines of coverage to Apogee, although the captive’s risks do have a level of geographical diversification due to the scope of its parent’s operations.
The ratings reflect Prism’s balance sheet strength, which AM Best assesses as very strong, as well as its adequate operating performance, limited business profile and appropriate enterprise risk management (ERM).
Prism’s balance sheet is supported by risk-adjusted capitalisation at the strongest level, as measured by AM Best’s capital adequacy ratio (BCAR), strong liquidity and its afforded financial flexibility and support from its parent company.
AM Best said the company’s operating performance reflects consistent annual net profits and a low-cost expense structure that has led to an underwriting expense ratio that is a fraction of its peers’ average in comparison.
The company’s operating income is largely the result of a steady flow of royalty and investment income, which adequately offsets any volatility in underwriting and generally allows for healthy profits each year.
The captive is interwoven into Apogee’s ERM program, and as a result, Prism displays excellent risk identification and mitigation processes.
AM Best said Prism is an integral component of Apogee’s overall organisation’s risk management capability and awareness.
“Prism works cohesively with business units across the overall organisation to reduce claims severity and frequency,” the ratings agency said.
A small Florida trucking business may have to shut-up-shop if a Florida bill targeting risk retention groups and surplus lines carriers is passed into law.
“If this bill goes through, I might have to either close my doors or I might have to relocate to another state,” Linda Allen, CEO at Hardcore Trucking, told Captive Intelligence.
“I have a small trucking company, and I have two trucks. Florida is one of the most expensive states to have truck insurance, and I pay $36,000 a year. I carry a $1m coverage on each truck.”
Under the current proposals, any RRGs operating in the state would require an AM Best “A” rating and a minimum financial size of $100m in capital surplus in order for an RRG to write commercial auto liability in Florida.
“I mean, the big thing they need to do is all the AM Best rating language needs to be removed and a hundred million of reserve money needs to be removed,” said Lewie Pugh, executive-vice president at Owner Operator Independent Drivers Association (OOIDA), which owns a RRG with members operating in the state.
“If they take that out, the bill would be fine.”
Pugh said the proposals could be very damaging due to small business truckers operating on very tight margins. Bill 516 could see insurance premiums hike substantially.
“If you take the RRGs out of the insurance market, you’re just going to make prices go up because there is less competition,” Pugh said. “That’s normal capitalism and basic economics.
“Everything’s very expensive for truckers with very little profit. Insurance is one of your biggest expenses and Florida is one of the top three most expensive states to procure insurance for commercial auto. So, it makes it very challenging for small business truckers to find affordable insurance.”
As a result of costly insurance prices, small business truckers often join an RRG as a means of bringing their costs of insurance down.
Joe Deems, executive director of the National Risk Retention Group Association (NRRA) previously said that imposing the requirements would eliminate coverage for 96% of the companies that use RRGs for commercial auto coverage.
“If this bill passes,” Deems said, “it will destroy everything they have that’s working.
“If Florida can get away with violating the federal law by making any financial rating a requirement to do business in their state, it may set a precedent to make other states bolder to do the same thing.”
Hope?
However, there is hope that law makers in the state might reverse their decision after hearing industry concerns about the impact the proposals could have on RRGs in Florida.
“Lawmakers were very open to what I said and very sympathetic and very understanding,” Pugh added.
“I don’t think they realised the unintended consequences of the way this bill was written, and the effect it was going to have on small business truckers and other RRGs.”
Pugh said he was 75% confident that the bill would not go through in its current format.
Allen highlighted that when she testified against the bill, her senator said “I don’t even know why you’re concerned about this?”
“And I said I’m concerned because I do business in the state, and I want to continue to do business in the state.”
If the Bill passes with the current language, NRRA said its final phase of the campaign would be to commence litigation to and challenge it at the federal level, with an estimated cost of $150,000.
65% loss ratio limit highlighted as particularly problematic for wider captive and commercial market
IRS has previous in attacking larger captives and could return post-831(b)
Expanded IRS insurance teams focused on micro-captives will need to be redirected in future
Captive industry encouraged to submit comments in response to proposed regulations
While Internal Revenue Service proposed regulations are focused on those taking the 831(b) tax election, some have warned the wider industry to be on red alert should the IRS broaden its scrutiny to larger captives.
The proposals, published on 10 April, have polarised opinion across America’s captive landscape, with some arguing the IRS is out to “destroy” the micro-captive industry, while others have branded it a “refreshing change”.
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Alliant Insurance Services has launched Alliant Re, a reinsurance brokerage division, which will include offering captive reinsurance solutions.
Alliant Re will leverage proprietary data and analytics, industry relationships and insurance expertise to navigate market conditions and provide customised risk transfer solutions to protect insurers from large losses.
Reinsurance solutions offered by Alliant Re include facultative insurance, automatic and semiautomatic reinsurance structures, deductible buy-downs, captives, managing general underwriters (MGU) and individual risk placements and programs.
“It is critically important for insurance carriers to have effective risk transfer solutions in place to protect against unforeseen and catastrophic losses, which are happening all too frequently,” said Tom Corbett, Chairman and CEO of Alliant.
“Our established reinsurance brokers have the relationships and experience to help ensure clients have the financial resources to pay out large claims when appropriate and remain viable in the insurance market.”
Alliant Specialty boosted its captive capabilities in September 2022 when it hired Pete Kranz, formerly captive practice leader at Brown & Brown, as a senior vice president to lead its risk finance and strategic consulting solutions.
Alliant Insurance Services is one of America’s leading distributors of diversified insurance products and services, operating through a network of specialised national platforms and local offices.
EY has confirmed it will limit tax services and not report any benefits from ‘listed transactions’ on tax returns should the Internal Revenue Service’s criteria for micro-captives in its proposed regulations be confirmed later this year.
Speaking on a GCP Short, Paul Phillips, EY partner and Global Captive Network co-leader, and Mikhail Raybshteyn, partner and Americas Captive Insurance Services co-leader, gave their views on the proposed regulations published 10 April, what they mean for captive owners and services providers.
The proposed rules set the criteria for whether captive insurance companies making the 831(b) tax election should be designated listed transactions, transactions of interest or neither.
Raybshteyn said the 831(b) tax election remains valid because it is still congressionally approved law and tax code, but that does not mean they are “free of scrutiny”.
“As we all know, due to some abuse in this space, the IRS’s focus in this space increased and the proposed regulations is the latest step in the IRS’s approach to review and assess legality of certain transactions that the IRS deems abusive and have been used as such by some of the participants,” he said.
“As we’ve mentioned on numerous prior occasions, a captive insurance arrangement needs to be structured for valid business and insurance reasons, not tax reasons. Validly structured arrangements should be well documented and supported.”
Many service providers that work with captives taking the 831(b) tax election likely now have a choice to make, especially those that have clients that fall into either of the ‘listed transaction’ or ‘transaction of interest’ buckets.
Jeremy Colombik, managing partner at Management Services International, told Captive Intelligence last week that he would be more hesitant to manage 831(b) captives that qualify as a transaction of interest, and he would not work with any that qualify as listed transactions.
The majority of EY’s captive work is with larger captives, often owned by multinational corporations and writing tens or even hundreds of million in premium, but Phillips said it was EY’s policy not to work with structures that are designated a listed transaction by the IRS, aside from helping clients to exit them.
“I suspect that many service providers would have internal policies or internal controls that would prohibit them from participation or assistance with any transaction that the government has deemed abusive,” Phillips said on the Global Captive Podcast.
“For EY and our team, the difference between a transaction of interest and a listed transaction is important because, by policy as well as our own operational controls, EY will not participate in a listed transaction.
“And with this restriction, it includes the fact that EY will not be the preparer of a tax return that reports the benefits of a listed transaction.
“So as a listed transaction, the only real tax assistance that we will provide is how to properly exit the transaction.”
Listen to the full 19-minute podcast episode with EY’s Paul Phillips and Mikhail Raybshteyn on Captive Intelligence here, or on any podcast app. Just search for ‘Global Captive Podcast’.
