Expert Commentary

Captive Domiciles—Everybody on the Bandwagon!

Captives are no longer the exotic, fun-filled risk financing adventures they once were. They've become rather commonplace, set up in almost any state with more than three zip codes. About 32 states are now captive domiciles. In time, the rest of them, with the probable exception of California, will most likely hang out their shingles.

September 2012

Back in the day, the term "captives" used to mean international intrigue—Iranian hostages and visions of lazing on the pink sands of dodgy tax havens, with Internal Revenue Service agents posing as tourists from Des Moines. In those long ago halcyon days, if the captive sold insurance to third parties, you had to actually travel offshore to conduct business with the captive.

That's right—book a trip to a tropical island to place your excess directors and officers liability program! That was necessary because the captive was not a U.S. company and was not required to pay U.S. taxes and, therefore, could not conduct business in the United States. These types of captives exist today; they're mainly cell captives owned in the majority by non-U.S. taxpayers.

Even better, prospective single-parent captive owners would engage in a series of meetings with professionals with enticing accents, between rounds of golf, to arrange for the formation of their new captive. At the end of the process, the newly minted board would convene at the Swaying Palms Hotel bar for several rounds of Dark 'n' Stormies or Rum Swizzles.

If you're new to this game, please know that these offshore island captive domiciles are alive and well. The denizens' accents are just as enticing, the drinks are just as tasty, and the quality of professional captive services is generally very high. This is true because the first captive domiciles were all offshore locales. The changes, to date, have to do with the proliferation of onshore captive domiciles.

Turning Onshore

Captives owned by U.S. taxpayers require special domiciles because, as insurance companies, they are subject to state insurance laws. The most important difference between a captive domicile and a U.S. state without captive regulations is the levels of required capital. Captive legislation recognizes that captives, as limited risk assumption vehicles, should not be required to hold the extraordinary amounts of capital required of an insurer that sells insurance to the general public.

Onshore domiciles run the gamut from experienced and trusted to exuberant and hopeful. The oldest domiciles fall into the former category, as their institutional experience covers the majority of risks placed into captives. These domiciles, and there are only a small handful of them (the onshore old guard), are in many ways very similar to offshore locales insomuch as they are flexible regarding lines of business and have highly experienced professional service providers.

Due to their experience, these regulators have developed trusting relationships with the resident captive managers, which bodes very well for the managers' clients. Another hallmark of these domiciles is that their regulators enforce their acceptability standards with equanimity—little is specifically excluded, but if it is, no appeal will change that position.

In other, newer U.S. domiciles, the regulators naturally have not yet formed meaningful relationships with the managers, so they tend to be more questioning, closely examining the smallest details. Of course, their marketing folks tell us that they're willing to review just about any captive idea, but their lack of experience in anything other than the standard captive lines of insurance (workers compensation, for example) means that they are understandably less willing to approve such a captive application.

Onshore captive domiciles are proliferating. Other states look at the success (revenue generation) of the old guard and assume that similar success awaits them. As the old saying goes, however, all that glitters is not gold. It takes many years for a state to establish a solid reputation as a go-to captive domicile. States considering joining the club often assume that all of their resident captive-owning companies will leave their current domicile and bring their captive business "home." This is a mistaken notion. Captive owners do not usually think like this. Yes, there are a number of high-profile cases where this has occurred, albeit for political reasons more than anything else.

Experience Counts

A good domicile is more than just enabling legislation. Good domiciles have superior professional service providers. Remember, this sliver of the insurance business is as arcane as it gets. Attorneys, auditors, and managers steeped in captive experience do not grow on trees. You might say that even the old guard had to start somewhere, and they too were greenies back in the day. That's quite true, and more and more risk managers are deciding to place their captive (and their trust) in newly minted domiciles.

One school of thought says that every state and U.S. territory should be a captive domicile. Why should a state's captive owners be forced to conduct this business in another state? You might say no one is forced to use these newer domiciles—a U.S. company can still use one of the fine island domiciles located just offshore or use one of the old guard onshore domiciles. Yes, in theory this is correct, but sometimes a company's chief executive officer discovers that his or her state has captive legislation and often resists any argument to snub his or her state in favor of a competing state. So, off you go to Hooterville (the state's capital) to begin the formation process. "You're here to see whom? Our 'captive' regulator? Well son, the Bureau of Prisons ain't in this building…." Just a joke, friends. I couldn't resist.

So, dear reader, you can readily see how this state of affairs has wrung much of the fun and adventure out of the captive experience. The old options for our annual meetings used to be (and still are): do we like to ski or sit on the beach? (These activities allude to two of the old guard domiciles, one offshore and one onshore.) Now, as often as not, it's this: Do we drive or fly to Hooterville?

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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