By Lisa Lopez Snyder
John Weitzel of W.A. Taft & Co., a captive management consulting firm, represents 140 captives in the state. (Photo by Paula Illingworth)
Contributing Writer
A quiet but rapidly growing industry is thriving in South Carolina, making it the third largest market of its kind in the United States and the 10th largest in the world.
The industry? Captive insurance, which in the simplest terms is an insurance company owned by the parent company to underwrite its subsidiaries’ property and casualty insurance needs.
Today some 158 licensed captive insurance companies call South Carolina home and their impact is significant. The firms net the state some $3.5 million in premium taxes in 2006, and bring more than $20 million in economic benefits to the state. Worldwide, the number of captives grew from 3,361 in 1997 to 5,119 in 2007, according to the industry news source Business Insurance.
Unlike with a traditional insurer, where premiums are forever “gone” once paid, parent companies that form their own captive insurance company retain the risk—and the possibility of a return on investment—for the service they buy. A company can choose to own or “rent” a captive insurance company, say industry officials. For many parent companies, whether South Carolina-based or headquartered outside the state, captives are their best option to manage risk, and the Palmetto State has become an attractive place to establish this insurance product for a number of reasons.
Why captive growth, why South Carolina?
Captive insurance started 30 years ago, when companies started to establish their captives offshore. Over time, more companies sought to insure their own risk as a response to the high cost or lack of availability of certain types of insurance coverage in the commercial market, say industry managers.
On Aug. 11, 2000, Gov. Jim Hodges signed into law an act that permitted the formation of captive insurers in South Carolina. The Department of Insurance then not only set up procedures for establishing captives, it created an office specifically for captives, separate from other divisions focused on traditional insurance.
Many companies turn to captives for their insurance needs to beat the “hard market,” said John Weitzel, managing director of the Columbia-based W.A. Taft & Co., a captive management consulting firm, and president of the South Carolina Captive Insurance Association, which represents 140 captives in the state.
“After Sept. 11, insurance pricing and a number of insurance products became more challenging and difficult for people,” Weitzel said. “People found they either couldn’t find the coverage they wanted in the traditional market or the pricing got outrageous, and that encouraged them to look at alternatives. This spurred captive growth.”
Captives may be located offshore or onshore, can also reinsure the risks of their owners or other parties they select, are regulated under special captive legislation by domicile regulators and are not permitted to write workers’ compensation and auto liability on a direct basis, but may reinsure.
“The health care industry, for example, has been traditionally underserved by the traditional insurers,” Weitzel said. In 2001, the St. Paul Cos., the single largest underwriter of medical malpractice insurance, decided to drop out of that market. “That created a terrific opportunity for captive insurance,” he said.
Captives offer companies several advantages. For one, they can reduce costs that traditional insurers have, such as overhead and other expenses, and most important, they are able to avoid the unpredictable pricing of the traditional market, Weitzel said “The traditional market is very volatile and the pricing goes up and down,” he said. “By forming a captive, a company can smooth out that volatility quite a bit.”
Companies also perceive they have better loss control in their industries, Weitzel said. “They feel they are being treated by the insurance market as an average risk.”
Paul Newton, a CPA and senior vice president of the captive management firm USA Risk Group of S.C., agrees. “Companies feel like their losses are better than average and they want to take advantage of the underwriting process.”
Who owns captives?
In South Carolina, many captive owners represent the health care industry, mostly hospital systems, large physician groups, assisted living facilities and nursing home associations, to name a few. Transportation, home builders and contractors are other common captive owners, say industry officials.
Many companies whose captives are managed in South Carolina are not headquartered in the state, Weitzel said.
Of the 35 companies that USA Risk Group of South Carolina manages, four are South Carolina companies, said Newton. The other companies for whom they manage captives are based in Florida, Mississippi, New Jersey, Ohio, Pennsylvania and Texas.
Most captives are managed by captive management companies due to the legal, regulatory, accounting, financial and other expertise required to operate and manage the underwriting, claims and investments operations. Only about four out of the 158 captives in the state are managed by the parent company, according to the S.C. Department of Insurance.
“It is a regulated entity, and most companies don’t operate in that environment,” said Robert Johnson, managing director of the captive operation at Marsh Management Services, a global insurance broker and risk adviser. Captive management firms, he said, are there to protect companies, but “in a lot of ways we are also an extension of the insurance department.
“We play the role of somewhat of the middle person. We act on behalf of and support the business goals of the clientele and ultimately we bring the two together in a business plan that is mutually beneficial.”
Right for your company?
Despite the advantages, captives may not be for everyone, industry experts say.
The process begins with a feasibility study.
“We meet a company and talk about what their goals and needs are, and whether or not a captive will meet those goals,” Newton said. The captive management firm will look at an estimate of what losses, costs and benefits will be. Then the firm helps the company design a business plan and the pro forma statements, and then sets up a meeting with the department of insurance — along with all the principals — to discuss the lines of coverage, how they will fund their losses and all the aspects of captive management.
If the department allows the application to go forward, the captive management firm will submit all the required documents: business plan, officer, feasibility study, business plan and copies of policies. Once the captive is licensed, the management firm will serve as a liaison to the attorneys, the insurance department, actuaries and other professionals involved in the captive’s operation.
South Carolina regulators eye this process carefully. “One of the most important things we look at is the parent to the captive,” said Jeff Kehler, manager of the alternative risk transfer division at the state Department of Insurance. “Is it well-funded?
“Companies that are suffering from serious cash flow issues or don’t have an engaged management that has a firm belief in and effective risk management loss prevention program in place, probably won’t be a good prospect to form a captive,” he said.
Kehler’s office also looks at the company’s plan of operation, whether it’s “solid” and whether it “makes sense.” Does the parent company have sufficient expertise and experience in business? Is there adequacy of loss prevention and risk management programs?
It is also important, Kehler said, for a company to select a captive manager and work with them to establish the service providers that are necessary to operate the plan.
Because of the specialized nature of the industry, the department has staff in two offices, one in Columbia and one in Charleston, dedicated solely to the captive insurance market.
Captives aren’t licensed to compete with the traditional insurance companies because “the difference in regulation would give captives an advantage, which would be inappropriate. We want to have a fair and equitable level playing field,” Kehler said.
“You also need a well-developed infrastructure. Forward-leaning legislation (in South Carolina) enables captive owners to get the most benefit out of their captives. I think we have a reasonable but prudent regulatory environment as well.”
Positive economic impact
The captive boom has brought a $20 million economic benefit to South Carolina, Kehler said, and an entire captive service industry that has mushroomed within the banking, legal, investment, actuarial and accounting industries.
Eight of the 10 largest captive managers have offices in the state. Among those is Marsh Management, which manages more than $21 billion in premiums each year. The company opened its office in Charleston in 2003. The captives USA Risk managed wrote about $500 million in premiums last year, and five or six are writing between $15 million and $25 million in premiums.
It’s clear, Kehler said, “if someone comes to South Carolina and wants to start a captive, everything they want is right here.”
Types of Captives:
Single-parent captives, which underwrite only the risks of related group companies.
Diversified captives, which underwrite unrelated risks in addition to group business.
Association captives, which underwrite the risks of industry or trade association members (medical malpractice is a liability risk that is often insured this way).
Agency captives, formed by insurance brokers or agents to allow them to participate in the high-quality risks, which they control.
Rent-a-captives, in which companies have the benefits of a captive insurance company without certain costs, capitalization requirements or legal ramifications.
Employers need to answer these questions:
• Does our company culture support this effort from top to bottom?
• What is our critical mass?
• How strong is our risk management?
• Do we have strong loss control procedures?
• Who will we choose to manage our captive?
• Can we commit to this for the long term?