Courting Captives.

Several states are setting up captive insurance domiciles to lure new and old business away from longtime leaders, like Vermont and Hawaii.

Clayton Ingram is always answering the same questions: "Does South Carolina's captives law have backing from the state government, and is it here to stay?"

As the director of business development in South Carolina's new Alternative Risk Transfer Services division, Ingram is charged with attracting captive insurance business to the state. So when prospective captive companies want assurance that South Carolina is a captive-friendly domicile, Ingram is ready with his response: The state has a division of the Department of Insurance dedicated solely to captives with its own personnel and a solid commitment from the insurance commissioner, the governor and the Legislature. His pitch seems to work, because captives are listening.

In June, one year after its captive legislation was passed, South Carolina will have a dozen captives signed up, Ingram said. He also projects a solid revenue stream by 2002, "so no one will tinker with us." As of February, South Carolina had six captives, two of which are redomestications, one each from Hawaii and Vermont.

Vermont--the grande dame of captives--has taken notice of South Carolina's captive business. Lisa Ventriss, president of Vermont's captive association, sees South Carolina as an aggressive domicile "that is keen on growing and marketing."

Illustrating South Carolina's aggressive, business-centered tone, Gov. Jim Hodges predicted that the state's natural advantages eventually will allow it to surpass Vermont as the leading U.S. domicile. And Ingram's ability to promote South Carolina's captive status as a long-term business commitment is the main reason the state is viewed as a leading contender in the new wash of entrants to the captive market.

While South Carolina is expecting a dozen captives after only one year, many states that have had the enabling legislation on the books for years have attracted few captives. Fourteen states have captives numbering in the single digits. For example, Nevada, which passed its captive law in 1999, has two licensed captives. Clearly, Vermont is the leader with 489 licensed captives.

States are busily passing captive-friendly legislation to get their piece of the estimated $28 billion industry. Vermont reportedly pulls in about $1 billion annually from its captives. The state reports that in 1998, in terms of cost-benefit ratio, it collected $11.5 million from premium taxes and licensing fees. The same year, the state spent $500,000 to administer and regulate the captive program.

Seventeen states, the District of Columbia and the U.S. Virgin Islands have captive legislation on the books. The Captive Insurance Companies Association reports that in the last two years, eight states and the District of Columbia have passed enabling legislation.

The District of Columbia, which became a captive domicile in October, is the most recent in the United States, and Montana is scrambling to get laws on the books this year. The director of the insurance bureau in Washington, D.C.--Margaret Schundler--said the district is searching for a captive director and is focusing on attracting association captives, because so many associations are based in the nation's capital. "We're trying to get the show on the road," Schundler said.

Facts and Figures

Large corporations and associations set up captives in lieu of buying traditional insurance coverage. Captives are formed either because insurance coverage isn't available or because the prices are too high. States want to lure captives, because they are a nonpolluting, revenue-generating, noninvasive industry. James Kinder, president of the South Carolina Captive Insurance Association, said, "South Carolina's leaders view the development of captives as an overall economic-development program that's completely supported by the governor's office."

Captives have grown over the past several years at a rate of 4.5% to 5.5% annually, and new captives are expected to increase at a rate of more than 5% a year through 2005, according to A.M. Best Co. The drivers of captive growth are the hardening of the commercial insurance market, the lure of a captive to control one's own risk, and the move of captives into new business lines. Captives aren't just for workers' compensation anymore; they now are covering employee-benefit programs, executive stock-purchase plans and long-term disability coverage.

Segregated-cell captives are the latest addition to the captive lineup. In a segregated-cell captive, assets and liabilities held within each cell are segregated from the assets and liabilities of the company itself. In this structure, creditors of one cell have no legal recourse against the assets of any other cell and, in some domiciles, against the general assets of the company.

Guernsey, the birthplace of segregated-cell companies, reported a 41.7% growth rate in the number of cells within segregated-cell companies during 2000; new captives grew only 0.9%. All four leading domiciles--Bermuda, Cayman, Guernsey and Vermont--now allow this type of captive insurance company. Some of the newer domiciles, such as Nevada and South Carolina, benefited from their competitors' experience and included segregated-cell provisions in their original enabling legislation. A.M. Best believes that as the top four captive domiciles continue to adopt innovations, they will increase their dominance in the alternative market in terms of number of captives, net premiums written, capital and surplus and invested assets. This will leave less market share for the remaining, newly emerging domiciles.

Copycats

South Carolina and other states admit to modeling themselves after Vermont when setting up captive legislation. "We're using the Vermont model and making it comparable to Montana's other insurance laws," said Betsy Griffing, chief counsel in Montana's auditor's office. Griffing drafted the captive legislation as part of the state's economic-development plan and hopes to compete with Hawaii and Colorado for West Coast captive business. The Montana Legislature is expected to pass a captive law by the time its season closes in April, Griffing said.

Vermont isn't worried, although it's keenly aware of new contenders. "We don't believe Vermont has any reason to be threatened. We have a 20-year track record and a great reputation," said Vermont Captive Insurance Association's Ventriss. In April, Vermont's Department of Insurance expects to license its 500th captive, she said.

Ventriss is philosophical about other states borrowing Vermont's captive legislation wording. "A mentor once told me 'the higher up the flag pole you climb, the more they can see up your skirt."' Ventriss calls it "domicile envy" and suspects that the new entrants to the captive industry are trying to re-create Vermont's success and rock-solid reputation for their own.

Rhode Island used Vermont's laws as a template, because "they are the standard," said Giovanni Ciccone of the Rhode Island Economic Development Association. The growing number of corporations--such as Textron and Hasbro--based in the state motivated Rhode Island to create captive legislation three years ago, in hopes that the corporations would form captives. The state currently has two licensed captives.

Doing Homework

South Carolina used Vermont and Hawaii as models when it was drafting its captive legislation.

"We did extensive homework and investigated why we would want the legislation, how to write it and how to make it ongoing. We didn't subscribe to the 'if we build it they will come' way of thinking," Ingram said. Taking a business approach aimed at finding what the customer wants and needs, Ingram and South Carolina's Insurance Commissioner Ernest Csiszar went on the road to various industry events, such as the Vermont Captive Conference, and met with brokers and captive management groups. They also contacted states that have captive legislation on the books for advice on what worked and what to avoid.

Csiszar, who has an investment-banking background, is known for his hands-off, business-friendly philosophy. The approach in South Carolina toward captives, Csiszar said, is "if it's not prohibited, it's permitted."

The New and the Old

The veteran and rookie captive domiciles have diverse plans for the remainder of the year. Vermont intends to keep its focus on attracting captives with quality business plans to maintain the state's captives industry. "We don't want to get caught up in a numbers game and try to beat the new kid on the block to maintain status," Ventriss said. South Carolina's Ingram plans to attend many captive industry conferences, such as those sponsored by the Captive Insurance Companies Association and the World Captive Forum set for Palm Beach Gardens, Fla., in November. "We'll set up an exhibit and a booth. It's more effective showing up and meeting and talking to people one-on-one," Ingram said.

U.S. Captive Facts

First U.S. Captive Domicile: Vermont, 1981

Latest U.S. Captive Domicile: Washington, D.C., October 2000

Number of U.S. Captive Domiciles Four Years Ago: 7

Number of Current U.S. Captive Domiciles: 19

Captive-Forming Considerations

Just a few years ago, when corporations were deciding where to set up a captive, they were asked, "Do you like to golf or ski?"--a reference to Bermuda and Vermont, the top captive domiciles. But according to captive manager Gary Osborne, a senior vice president with USA Risk, there are many more points to consider now that the number of U.S. captive domiciles has grown to 19.

* Time zones and accessibility: Today's business world is getting squeezed with tighter schedules, and executives don't have the luxury of time to fly to far-off sites for domicile meetings. That means that distance is a factor when a corporation is deciding where to set up a captive. If a corporation is based on the East Coast, Hawaii is eight hours away by airplane. But Vermont isn't easy to reach by plane, with limited direct-flight access, Osborne said. Newcomer Nevada, however, is readily accessible via airline terminals in Reno and Las Vegas. Nevada's Insurance Commissioner Alice A. Molasky-Arman says being accessible is very important to business. She plans to meet with members of Nevada's captive industry and prospective businesses on a regular basis. "Even if we don't always agree, I have always found that businesses are very appreciative of the opportunity to have a voice," she said.

Molasky-Arman also has plans to contact many Nevada industries, specifically the hotels and casinos, that already have captives located in other domiciles. "A lot of the hotels and casinos weren't aware that we have captive legislation, and I think they should be told. They can have the opportunity to come home to Nevada," she said. Nevada also has a leg up in this category, offering a frill array of luxurious accommodations, entertainment and recreational resources, the commissioner said. Although the state doesn't presently have an active marketing plan, Molasky-Arman is working with the governor's Commission of Economic Development and the Las Vegas Economic Development Authority to form a plan to sell Nevada as a captive domicile. Both organizations plan to travel with the commissioner to various captive seminars and symposiums to promote its captive industry.

* Regulatory environment: Osborne said companies considering setting up a captive must be comfortable that the laws on the books today will be there in the future. "You don't want what happened in Colorado, where captive legislation ran hot and cold with changes in governors," he said. Avoiding "waxing and waning" captive legislation is key to Vermont's 20-year success in the industry, said Lisa Ventriss, president of the Vermont Captive Insurance Association. Vermont's trade association helps to stem adverse changes to captive legislation by educating policymakers about the industry, specifically its great economic benefit with little impact on the environment.

* Environment: The adages "location, location, location" and "perception is everything" ring true for the captive industry. The domicile of the captive must fit with a company's image, and many are not comfortable with the choice of Bermuda or Hawaii, because they have "the connotation of a holiday spot," Osborne said. U.S.-based companies also are more likely to want a captive domicile in this country, believing in the image of "buying American," and trusting U.S. state-regulated industries over foreign ones.

* Infrastructure: Most states don't have dedicated resources or a clear channel of communication to deal with incoming captive business, Osborne said. "You have to spend money to make money. Most states just think it's enough to put the law on the books," he said. Osborne gives kudos to South Carolina for having dedicated a person to deal with captives right from the start. Doing business with some states, is "almost more trouble than it's worth," he said.

Nevada's commissioner admits that her state is struggling in this area. "Right now, it's something that we're working on; we don't have a captive manager The way the laws are set up, the regulations are self-supporting and obviously we don't have any funding until we reach a certain level of population. But I see a captive director in the future," she said, Vermont was the first onshore domicile to recognize the importance of creating a separate captive department within the department of insurance and credits that distinction as helping the state to reach its top status as a domicile today.

Safe Harbors

Islands that have become favored captive domiciles because of their tax regulations are being asked to agree to new principles.

Inflammatory rhetoric has swirled around the subject of tax havens--those low-tax, business-friendly islands and territories that have become favorite hosts for captive insurance companies and other alternative-risk vehicles. Talk of blacklists, "harmful tax practices" and bullying tactics in the past several months has pitted tiny governments against the developed countries whose corporate citizens often go offshore to manage their insurable risks.

The rhetoric is dying down, though. A landmark January meeting in Barbados brought the feuding sides together to cooperate in rooting out government policies that foster tax evasion or unfair competition among offshore domiciles. Spearheading the effort is the Organization for Economic Cooperation and Development, a Paris-based group of mostly developed countries that had begun labeling various countries as "tax havens," or worse, as engaging in harmful tax practices. The OECD then sought commitments from those countries to adhere to a set of principles supported by its members.

Many of the targeted countries reacted with alarm. They feared that the OECD was trying to push them into uniform taxation and accused the developed countries of mounting an unfair campaign against less-developed nations. The escalating tension led to the Barbados meeting Jan. 8-9, sponsored by the OECD, the Barbados government and the Commonwealth, an association of countries with its roots in the former British empire. At the meeting, countries from both sides agreed to form a task force to begin addressing the issue together. The OECD's proposed memorandum of understanding, committing signers to a predetermined set of principles, will be set aside if the task force succeeds in developing a mutually acceptable, political process to implement three broad principles: transparency, nondiscrimination and effective exchange of information.

Special Treatment

The treatment of insurance companies--captives and other special-purpose vehicles--was a part the OECD's concerns. One territory that had to make adjustments was the Isle of Man, a British dependency in the Irish Sea. It had given insurers that write only foreign business the option of paying no corporate income tax. The OECD zeroed in on that "ring-fenced" tax regime, which treated certain insurers differently from any other corporate taxpayers on the island.

The solution was fairly painless, said David Vick, deputy chief executive of the Insurance and Pensions Authority on the island. He said the isle is moving toward a scheme where all insurers, whether they write domestic business or not, will qualify for the tax-free treatment, paying instead a modest annual fee. There should be no net effect on insurers' tax burden, he said.

Vick said he wasn't aware of any negative effect on the insurance business. "If anything, it ought to bring a little more certainty to the situation," he said.

Indeed, the OECD and other international organizations have been far more concerned with issues such as money laundering, facilitated by the secrecy that some jurisdictions allow for financial dealings. The campaign against tax havens is of much greater concern in areas such as trust business, said Thomas Jones, an international tax attorney with McDermott, Will & Emery in Chicago. "This has little if any impact...on the captive world," Jones said.

Steve Butterworth, director of insurance on the English Channel island of Guernsey, was more wary of the international scrutiny, but he said insurers on the island understand that "we're not going to sign up to anything that wasn't beneficial to us."

Heavy-Handed Tactics

Butterworth said insurers on Guernsey have a menu of options for their taxation, plus the ability to defer taxation on reserves until claims are paid. The Isle of Man's approach is one possible solution, but Butterworth said the government has made no commitments yet. He suggested that Guernsey was still smarting from OECD tactics that initially were viewed as heavy-handed.

"On this point, I think the offshore territories are completely right," he said, adding that the OECD ought to look at the tax practices of some of its own members. The OECD maintains that it is doing so and denies that it is treating nonmembers more harshly.

Philip Stamp, chairman and chief executive officer of Aon International Risk Management Group, said taxes shouldn't be the primary reason for owning a captive in the first place. The captive should have a good business reason to exist for purposes of the owner's risk management, he said. "If the captive can't demonstrate that, then it probably shouldn't be there, so we're quite happy if we're judged on that basis and we have to come up with justification for that," Stamp said.

The tax question points to a larger issue that the captive industry has struggled with for more than 20 years, Stamp said: "Is a captive real or is it an artificial mechanism? We have to be able to demonstrate that it's not an artificial mechanism; it's a real value-added dimension to the risk-financing plans of major corporations." On that basis, he suggested, examining captives for their tax-related motivations can be a healthy test.

Brendan Noonan