Captive Island. Puerto Rico's long-time plan to become a haven for captive insurance companies is becoming a reality.

They've done all the paperwork, passed the necessary laws and mapped out a plan for success. Now all that's left for Puerto Rico is the waiting. This tiny island commonwealth has been chasing captive domicile certification--and status as a major international insurance center--for decades.

"Back in the 1980s, there was an effort and a law was passed trying to integrate international banking and insurance, and the international banking center of Puerto Rico was created,' said Ruben Gely, director of the island's International and Offshore Insurance Center. The center oversees international insurance companies, reinsurance companies and captives.

"But that law really emphasized the banking side; it does not provide for international insurance business. It really was quite limited," Gely said.

Puerto Rico's insurance office has been petitioning for its share of the wealth ever since. Currently spearheading that effort is Insurance Commissioner Dorelisse Juarbe-Jimenez, who has overseen the overhaul of insurance regulations for domicile certification; efforts toward accreditation by the National Association of Insurance Commissioners; the island's positioning as a liaison between the NAIC and Latin American insurance regulators; and the creation of tax incentives to attract companies to domicile in the island.

The commonwealth's Legislature approved the island as an international and offshore domicile in September 2004, via public laws that took effect in March 2005, establishing the island's International and Offshore Insurance Center. "Our center is really ready to do business and to receive applications," Gely said.

Choosing a Domicile

A big draw for captive insurers is the structure of a state or territory's captives system, from its legislation down to its support systems, said Molly Lambert, president of the Vermont Captive Insurance Association. Vermont has the most captives in the United States, at 791 licensed companies; mergers and dissolutions of companies have left 563 active captives today.

"Now there are 26 other states that have captive insurance laws on the books. The stat used to be that Vermont outnumbered all of the other states combined. Lambert said. Its nearest competitor is Hawaii, which recently registered its 200th domiciled captive insurer.

"What makes a domicile like Vermont attractive is the large captive infrastructure that's there--the experience in the department of insurance there that they've gathered over the past 25 years in the industry," said Chris Ridge, managing director of captive management for Liberty Mutual. "It's the expertise of the regulators and the service providers"

"When you're choosing a domicile, you're looking for regulators in the domicile who understand captives: some sophistication of the service providers in that domicile," Ridge said. Liberty Mutual has about 120 captive operations in several states, as well as Bermuda and the Cayman Islands. "You're looking for flexibility of regulators in the domicile to allow you to use the captive like you really need to use it to get business done."

"It's like any other business experience: you're looking for a quality product, you're looking for people who understand your business, and you're looking for people and political environments that are stable and in it for the long haul," Lambert said.

Why Captives?

Captive insurers mean tax revenues for Puerto Rico, and captives are a dean, nonmanufacturing industry that does not add to environmental pollution, Gely said. The island has been offering tax incentives to business since the 1950s: those incentives have already been extended to the island's international banking center, and are now being offered to the insurance industry.

Vermont politicians look at the captive industry fondly for two masons. The premium tax generated by captive insurance companies domiciling ha the state goes into the state's general fund. Plus, the industry accounts directly and indirectly for 1,400 jobs statewide, Lambert said.

Puerto Rico likely wants to be a captive domicile for the same reasons as Vermont: "They're good jobs. Not only are the jobs numerous in Vermont, but they're very good. There are high wages," Lambert said. "The premium taxes generally are a bonus. Your growth is with the side industries like we have with bankers, lawyers and accountants." The premium taxes collected in

Vermont for 2005 were just over $22 million, Lambert said. "That's close to 2% of our general sum budget."

So far, Puerto Rico has just one authorized captive: international reinsurer Oceanus Re. It's classified as a Class 3 insurer, which means it provided a $1.5 million investment.

Puerto Rico plans to name several others this year: There are five-to-10 prospects in some step of development, Gely said. "My expectation is within the next month we will have another international insurer, a Class 4, which requires a minimum investment of $100 million." He would identify the company only as a "world-class insurance company, a major company:

"My personal target will be to have 15 to 20. We can do it," Gely said. "We're just starting. We don't have the benefit of publicity and promotion. We haven't had that benefit yet. As long as other companies jump in and we make some promotional effort, they will eventually come in because we have a unique alternative."

Then there's the tourism impact. "The companies need to host a board meeting here annually; we also have a huge annual conference that draws 1,300 people every year," Lambert said. "There are a whole lot of Financial benefits."

A Matter of Law

Since Puerto Rico is a U.S. territory, becoming certified as a captive domicile was the same process as for the 50 states. It is awaiting formal accreditation from the NAIC, for which it must prove that its laws are fully compatible with the NAIC's model laws and procedures.

Puerto Rico's captive domicile law is comparable to Vermont's, said Nancy Gray, executive director-North America for all of Aon's North America captive domiciles. Aon has captive offices in Vermont, Arizona, South Carolina, Hawaii and Vancouver, Canada, plus captive operations in Washington, D.C., New York, and Delaware.

"What a lot of the states have done is taken Vermont's captive law word-for-word and adopted it. Puerto Rico has not done that; they have their own law on their books, but it's very similar in terms of their requirements" Gray said.

"From our perspective, we need to evaluate whether Puerto Rico has any advantage over these established domiciles," Gray said. "Some of the challenges they will face is the competition of already-established U.S. domiciles and the fact that they have this offshore feel."

Aon has noted movement from offshore domiciles in the 1980s and prior--when a lot of captives were formed in Bermuda--hack to onshore domiciles. "Post-Sarbanes-Oxley and post-Enron, it's become more politically incorrect to be offshore," Gray said. "That's been fueling a lot of the growth in the United States. Companies are looking for domiciles that won't raise any red flags."

Whether a company setting up a captive seeks an onshore or offshore domicile is largely up to its personal needs, Lambert said. "The quality of the regulation is very good in the offshore domiciles, as it is here. I think it just becomes a question for the boards of various companies, if that is a threshold question for them."

There are advantages to both onshore and offshore captive domiciles. "In general, offshore is typically lower capitalization costs, which can be a major advantage. Onshore--in most instances, it's a little more cost effective to set up onshore," Ridge said. "In the United States you can do some things that you can't do offshore, specifically set up risk retention groups or captives that write employee benefits. You can't do either of those offshore."

"Whereas the U.S. continues to grow in terms of capturing most of the market share, domiciles such as Bermuda are not seeing significant growth as far as captive operations;' Gray said.

Why Form a Captive?

There's a broad spectrum of companies interested in forming captives, Ridge said. "A lot of professional liability companies are being formed right now, medical malpractice primarily, but you're also seeing captives for legal professional liability, construction-related captives for property and builders risk, and workers' compensation. For Liberty Mutual, that's our major line of business: workers' comp and general liability."

Many companies will form a captive during hard-market conditions when they're not getting the overall capacity they need, Gray said. Yet Aon is seeing captives form regardless of market conditions.

"In 2006, over 150 captives formed in the United States, and we were faced with soft-market conditions," she said. That was in spite of a year that followed extreme weather risks. "We still saw another good year of captive formation."

Captives also can offer a company a lot of leverage, especially during insurance renewals. "Going into the marketplace, if carriers know you have a captive as an option, sometimes that provides good leverage for pricing of capacity," Gray said. They can also come in handy when it may be difficult to place risk or a unique exposure, and a company can use its captive to fund for those exposures.

"The other thing we frequently hear about is captives axe used to fund deductibles," Gray said. Captives also can be used to access the reinsurance market: "You can write property coverage through the captive to access the market."

Key Points

* Puerto Rico has attracted its first captive insurer since becoming an international insurance center, and hopes to domicile up to 20 captives in the near future.

* The U.S. territory has much to offer prospective captive insurers, including an established domestic insurance regulatory system.

* The island's advantages over other offshore domiciles include its geographic access to Latin America.

Puerto Rico as a Captive Domicile

The Caribbean island of Puerto Rico is the smallest and most eastern island of the Greater Antilles, according to Web site www.welcometopuertorico. org. It lies about 1,000 miles southeast of Miami, and, with an area of some 3,508 square miles, is about three times the size of Rhode Island.

"We think we have some cultural benefits because a significant part of our population is able to communicate in English and Spanish," said Ruben Gely, director of the island's International and Offshore Insurance Center. "Then there is the weather side: It's just about the same weather all the time. It's a place to do business all through the year."

The benefits to domiciling in Puerto Rico are more than geographic. The island falls under the jurisdiction of the United States, which controls interstate trade, foreign relations and commerce. It shares U.S. laws and currency; yet the island maintains a local taxation system and is exempt from compliance with the Internal Revenue Service.

"There are some benefits to U.S. capital, and other benefits to European or Asian capital coming in," Gely said. "First, we have a very stable government. We have a fully integrated economy that is U.S.-dollar based. We have protection of the federal courts. And we have, of course, a domestic court system."

Puerto Rico now has 34 breaking entities and 54 domestic insurers. The domestic insurance department has been in service more than 80 years, Gely said. Puerto Rico has been either the third- or fourth-largest insurance domain in Latin America for several years. "We have a very, very strong insurance industry--$7.5 billion," he said.

"We are a member of the NAIC and have at the same time an official relationship with the corresponding Latin America authorities and associations," Gely said. "So it's a very strong and sound regulatory environment. We want to offer that expertise to the rest of the world, and we are."

Access to Latin American companies is a big advantage for Puerto Rico, said Nancy Gray, executive director-North America for all of Aon's North America captive domiciles. "A lot of times companies are looking at the access: 'What would it mean for me in terms of where I need to travel for nay board meetings?' Sometimes geography does enter into the equation."

Who's Who in Captives?

Captive--An insurance company that primarily insures the risks of its owner and is actively managed by the owner and/or insureds. Assets of the captive are generally owned by the insured.

Association captive--A captive that underwrites the risks of members of an industry or trade association.

Rent-a-captive--A captive insurance company that provides access to captive facilities without the user needing to capitalize its own captive. The user pays a fee and must provide collateral.

Special-purpose vehicles for risk securitization--Reinsurance companies that issue reinsurance contracts to their parent and cede the risk to the capital markets by way of a bond issue.

Risk-retention group--An owner-controlled insurance company authorized by the Federal Liability Risk Retention Act of 1986. An RRG will allow members who engage in similar or related business or activities to write liability insurance for all or any portion of the exposures of group members, excluding first-party coverages such as property, workers' compensation and personal lines. The statute allows a group to be chartered in one state, but able to engage in the business of insurance in all states in which it registers.

Pure captive--insures only the risk of the owner or the owner's subsidiaries.

Sources: South Carolina Department of Insurance, Vermont Department of Insurance, Illinois Captive & Alternative Risk Funding Insurance Association

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