Captive insurers enjoy popularity but still face hard-market realities. (Briefing).

The rapidly hardening insurance market of the past two years has encouraged an explosion of alternative-market insurance solutions, especially captive formation.

But there's a down side--reinsurers, under intense pressure from losses attributed to events of Sept. 11,2001, and the stock market, are much more reluctant to back captives fully. Adding to the complexity is the shrinking number of insurers willing to act as fronts--to lend their good name and high financial-strength ratings to captives as support, for a fee.

In a panel discussion on these hard-market realities at the International Captives Congress in Bermuda, Paul Baffle, a partner with JLT Risk Solutions Management (Bermuda) Ltd., a captive manager, said there are "harsh realities we have to deal with out there today."

With restricted availability of reinsurance and rising costs for fronting services, increased retentions and stricter collateral requirements, captives are squeezed by a classic supply-and-demand problem.

Robert Davis, senior vice president of business development with Ace Risk Management, said the hard market in fronting, from the insurer's perspective, has more peril than it once did.

"In order to satisfy some of the more stringent corporate-governance rules, particularly since the Sarbanes-Oxley Act, using a quality front carrier is needed," he said.

Why would an insurer get involved in fronting? "There's a high return on equity," said Davis. "It also lowers the expense ratio when you cede reinsurance business to a captive in exchange for a fee."

But the downsides include a reduced net-to-gross ratio. "If the ratio is out of proportion--a lot more gross than net--it is looked on unfavorably by rating agencies," he said.

2002 New Captive Formations by Domicile


Cayman Islands          97
Bermuda                 79
Vermont                 70
Guernsey                49
British Virgin Islands  45
Barbados                19
Ireland                 18
South Carolina          21
Hawaii                  16
All Other Non-U.S.      24
Other U.S. States       24