Captivating Growth.

The number of captive insurance companies is increasing worldwide, fueled, in part, by firming prices.

The market for captives will continue to grow this year, thanks to a continued firming trend in prices in commercial lines, and in spite of pressures from a deteriorating stock market and regulatory authorities.

In Vermont, the largest captive market in the United States, regulators are seeing steady growth and a back-to-the-basics approach among new captives--a trend Derick White, assistant director of the state's captive insurance department, said his department began to notice during the last six months of 2000.

"We're seeing a definite trend of captive insurers going back to the basics--workers' compensation, general liability, auto liability," White said. "We think it's the result of the market turning. They know that next year their rates are going up, some by quite a bit. Even though the market's just starting to turn, people are setting their captives up now."

In A.M. Best Co.'s 2001 edition of Best's Captive Directory, A.M. Best analysts say that price-firming trends--especially in the middle market--have not yet triggered a widespread migration of insureds to self-insure through alternative markets, though "sustained price increases will only increase the likelihood that sophisticated insurance buyers will more seriously consider an alternative market solution over the mid-term."

Best's captive Directory lists all the captive insurance companies in the world, with information taken from a variety of sources. There are 4,458 captives in the 2001 directory, a net increase of 103, or 2.4%, over last year.

A.M. Best data show steady growth of captive insurance companies--between 4.5% and 5.5% over the past several years--with an acceleration in growth in 2000. By year-end 1999, the alternative insurance market comprises nearly 40% of the total commercial market in the United States, and A.M. Best believes that market share will approach 50% in 2003.

Tracking Cells

Carol M. Pierce, editor of Best's Captive Directory, said that while the increase in the number of individual captive companies during 2000 is less robust than the historical year-over-year increases, it does not properly account for the recent rapid growth in segregated cells.

"By counting cells, rather than the segregated-cell companies themselves, the net increase is 6.2%, which is more reflective of the true growth in the captive industry," Pierce said. "Tracking changes both ways is new in the Captive Directory this year but is similar to how A.M. Best tracks ratings on individual companies and groups."

A segregated-cell company is a single legal entity, but the assets and liabilities held within each of its segregated cells are separate from those of all the other cells, as well as from the general assets and liabilities of the company itself. Under this structure, creditors of one cell have no recourse against the assets of any other cell or, in some domiciles, against those of the company itself.

Terence Rollins, managing director of AMS Insurance Management Services Ltd., which manages 80 of the 240 captives in the British Virgin Islands, is seeing a lot of inquiries for nursing care and medical malpractice liability coverages because of skyrocketing costs in the U.S. market.

"Practitioners are seeking alternative methods of risk financing," Rollins said. "They're challenging, as it's often tough to find enough like-minded physicians prepared to buy in to the concept of reciprocal risk sharing. Additionally, their reluctance to commit substantial capital long term still leaves them with a big reliance on the reinsurance market, which is itself hardening, raising attachment points, premium levels and becoming more selective."

Rollins also is seeing a lot of new inquiries in the annuities field--particularly for those targeting high-net-worth U.S. citizens. The lower operating cost base of the offshore annuity providers enables them to offer contracts to eligible annuitants at lower entry rates than many U.S. onshore insurers, he said. "Since the offshore companies generally operate without local taxes on their own profits, they're able to offer contracts with entry 'loads' on the initial invested funds that are lower than those in the U.S., giving annuitants better value."

Rollins said there is increasing interest in workers' compensation captives for employee-leasing companies, who can enjoy some profitability on the better-run accounts themselves, provided they have an admitted U.S. carrier partnering with them to satisfy domestic regulations.

Captive Trends

A.M. Best analysts say hot issues and emerging trends in the worldwide captive market also include the following:

* Captive growth in Europe and Asia will accelerate.

* Tax issues will make offshore captives more transparent, as the managers of offshore captives work to fend off pressure from governments to level the tax playing field. A report from the Organization of Economic Cooperation and Development on "harmful tax competition" is driving much of this effort.

* Health-care captives are moving toward insuring medical malpractice for on-staff physicians as the insurance market tightens for coverage on individual doctors.

* More companies in the United States will divert their life and health benefits into alternative-market vehicles such as captives, in the wake of a U.S. Department of Labor ruling allowing Columbia Energy Corp. to insure employee benefits in its captive. (Columbia Insurance Corp. is domiciled in both Vermont and Bermuda.)

Vermont's White sees the same trend coming in employee benefits. "A couple of sponsored benefits programs are seeking Department of Labor clearance," he said. "After Columbia Energy, which took the government four years to decide, it will pick up."

White said no one knows how long it will take for the next employee-benefits captive to be approved, Six months is his best guess. "After the next one, the rest should be on a fast track," he said. "They will take maybe six weeks to get through after that."

White said he doesn't know who will be next for a Department of Labor approval. "They're all keeping it extremely confidential," he said.

Rollins said employee-benefits captives cannot operate in the British Virgin Islands, because they don't have the necessary clearance from the Labor Department.

                       2000 Captives by Domiolle
                                               % of Total
2000  Prior                             Total   Captives   New Captive
Rank  Rank   Domicile                Captives  Worldwide    Formations
 1      1    Bermuda                    1,405    31.5%              51
 2      2    Cayman                       535    12.0%              48
 3      3    Vermont                      381     8.5%              13
 4      4    Guernsey                     370     8.3%              24
 5      5    Luxembourg                   273     6.1%              10
 6      6    Barbados                     237     5.3%               9
 7      9    British Virgin Islands       184     4.1%              42
 8      8    Ireland                      178     4.0%               9
 9      7    Isle of Man                  173     3.9%               2
10     10    Hawaii                        73     1.6%              16
             All Other                    649    14.6%              21
             Worldwide Totals           4,458   100.0%             245
        % of New
2000  Formations
Rank   Worldwide
 1         20.8%
 2         19.6%
 3          5.3%
 4          9.8%
 5          4.1%
 6          3.7%
 7         17.1%
 8          3.7%
 9          0.8%
10          6.5%
            8.6%
          100.0%
Source: Bests' Captive
Directory, 2001 Edition