Expert Commentary

Insurance Captives on Shifting Sands

The "hardening" of the market, along with increased premium rates, has been prayed for and predicted for so long that many have forgotten what a hard market looks like. We may be about to find out.

July 2011

Throughout my history in the insurance business, there have been cycles, formerly 3 years in duration, where rates hardened, profits were made, and then competition reduced rates and underwriting standards to live off the interest of increased cash flow. This was known as cash flow underwriting—get the money in the door. I recall one A-rated insurer that filed a 100 percent rate deviation in Illinois. Giving it away to get cash? Uh, what cash?

And, of course, the losses would drive the rates back up, and we would start all over again.

Macro Indicators of a Hardening Market

No one, including me, is predicting another hard market or return to cyclical underwriting. The world is far too complicated, global, and fast for that to happen. However, allow me to point to some items that, on the surface, may mean little but, in a macro view, may indicate that we're heading toward higher prices.

Some liability lines are seeing both hardening rates and even withdrawal from the market by underwriters who do not wish to play in a low-return game. This is particularly true for truckers—perhaps not everywhere, but I have seen several examples of this movement.

Workers compensation is clearly showing signs of upward revisions. This also is not nationwide but is increasing in size, number of Securities and Exchange Commission codes, and locales every month. Seeing a shortage of underwriters may not be far off. Increasing medical costs, as usual, and increased claim filings attributed by many to the economy are driving the pressure on rates. (I can't get work, but I hurt my back at my last job, so I will file a claim.)

There is an anecdotal increase in cases of the Internal Revenue Service (IRS) going after audit preparers for giving bad advice on captive formations and related wealth-management products. How is this related? Well, aside from being an enforcement of the law, it is also clearly a new source of untapped revenue for the Feds. This also applies to captive managers. Can increased professional liability premiums be far behind? Increased costs for the captive?

On another front, there is a noticeable increase in states forcing the reclassification of independent contractors as employees. How does this relate? It is another new source of untapped revenue, as the employer will owe back taxes and of course union dues, insurance premiums, and claims under workers compensation.

As I speak to clients, prospects, and colleagues, we have not previously learned of so many instances of the IRS field auditors asking about captives as the first topic. The word has gone out: "Find those captives and check them very closely for compliance!"

There are now more tax rules than ever, and tax advisers must keep up. No longer does the IRS consider a captive's CPA to be the uncompromising source for expertise.

How many reinsurers of captives hold Greek, Portuguese, Italian, or Irish debt? At a minimum, they hold investments of funds that hold these under water bonds.

None of this is necessarily related, and the law must be enforced without question. My view is that now that money is global and information of all types can be traded instantly, the old ways of thinking are going away. Anybody can track down your activity. We truly live in a time when a camel sneezing in Saudi Arabia can influence your renewal.

In the past, captives were generally anonymous and private. Often, regulators forgot or ignored them. No more. They are solidly in place as revenue producers for state and domicile regulators and now for the tax man.

This will not cause a slowdown in formations, but I caution that it must force the captive owner to be certain that he or she is getting good advice and holding the practitioners to high standards. I always advocate care and caution, and the aforementioned matters reinforce the need to deal with professionals and to learn about what the captive responsibilities and opportunities mean to you. Know your captive!


For those enjoying the "soft" market, now is the exact time to plan ahead for a captive formation. A few more months, and the scene could change—and not favorably for the new owner.

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