Vermont soars as airlines self-insure - Captives

On the eve of its 17th annual captive insurance conference, the leading onshore domicile enjoys a record pace of captive licensing, while high-profile new self-insurance schemes--such as the airline industry's Equitime--take center stage. Oh, and Vermont's Governor Howard Dean wants to be your President.

It might seem a foregone conclusion that when the time came for the U.S. airline industry to start a $2 billion risk retention group called Equitime to self-insure its war and terrorism liability, it would consider the ambitious entity in Vermont. Indeed, as the premier onshore domicile for captive insurance companies, the Green Mountain state is the likely choice for programs that need a well-established framework for the complexities--and challenges--of the self-insured approach.

There's no question that the current rock-hard market for property insurance, reinsurance, workers' compensation, and other high-priority risk management transfers make it a heyday for captive domiciles. But very often, captives require the fronting services of licensed insurers, and today's hard-market discipline has now thinned the ranks of carriers willing to front, creating a near crisis for some captives. Vermont not only pioneered the captive legislation that has become virtual boilerplate for up-and-coming domiciles such as South Carolina and, this year, Arizona, but it also symbolizes canny captive management and government support at a time when captive companies need it most.

The recent statistics back that up: the first half of 2002 saw 26 new captives licensed in Vermont, a record pace for a state that has averaged 25 new captive licenses annually since 1981 (400 captives are now active, out of 553 licensed). Leonard Crouse, Vermont's captive insurance director and a regulator who has always affirmed that well-run, solvency-focused captive companies are the backbone of a successful domicile, is confident of "strong activity well beyond the first quarter... with some very quality companies expressing interest." Crouse also notes with pride that while Vermont may often be pigeonholed as a domicile focused on pure, or single-parent, captives, it also services 42 risk retention groups (out of a global tally of 70), and more association captives and industrial insurers than any other domicile.

More interest in all this will be sparked this month, when the Vermont Captive Insurance Association (VCIA) holds its 17th annual confab in Burlington (August 13-15; for information, visit http://www.vcia.com or http://www.captive.com). Already in 2002, PepsiCo, Tribune Company, MGM Mirage, Abbott Laboratories, and U.S. Bancorp have licensed Vermont captives.

The rush of activity is one thing, but having the infrastructure in place is another. Vermont Director of Financial Services Dan Towle acknowledges that there are now more captive domiciles to choose from than before, but he points to "our stable regulatory environment, accessible government officials and world-class professional support" as key selling points for Vermont.

The Dean Factor

Considering that the state's premium volume now exceeds $5 billion annually, this is a governmental success story with some interesting potential ramifications. Democratic Gov. Howard Dean, M.D., for example, stands tall in that regard, having presided over and doggedly supported much of the growth of Vermont's captive industry since taking office in 1991. At this point, Dean--the longest-serving Democratic governor in the country--has credibly joined the crowded field of Democratic presidential hopefuls. He certainly has the look of a genuine new force in the party. For one thing, he can point to a strong record of supporting, via good-guy captives, the conservative businesses of insurance and reinsurance--which have never been higher-profile in the national media--while keeping budgets balanced and championing social justice.

"Dean is the sort of under-the-radar-screen moderate who could emerge in a big way," says one Pennsylvania Democratic insider. "He was tough on state income taxes, which the conservatives appreciate, and he doesn't budge on his fiscal convictions. Plus, he's a doctor--a family doctor--and when he focuses on health care reform--which is going to be a huge issue--he could really start to command attention."

Dean's destiny is one thing. His Vermont legacy is another, and that legacy is well-supported by the sweeping success of the state's captive insurance movement. The Equitime story, so far, is certainly a prime example of a captive domicile licensing a huge risk retention concept that will focus the eyes of the industries involved.

The stability of Vermont's regulation, for one thing, may play a role in helping Equitime overcome the hurdle of securing reinsurance, since Equitime plans to retain the first $300 million of its limit and, reinsure the balance with the federal government, which began covering airline's terror and war risk after Sept. 11. The Department of Transportation--which would like to leave the terrorism risk business to the commercial market--hasn't decided to reinsure Equitime yet, though it supports the risk retention group's concept.

That concept would provide up to $2 billion in war limits, including tenor cover, at a fraction of what that same cover will cost in the commercial market-mainly, a consortium led by American International Group Inc. (MG), and one led by Allianz and Berkshire Hathaway--according to outspoken airline leaders such as Chris Duncan, chief risk officer for Delta. With nine major airlines becoming Class A shareholders in Equitime by contributing $5 million each in start-up capital--and smaller subgroups contributing proportionally--Equitime projects gross written premium of about $450 million, which would immediately cover its full $300 million retention.

Minneapolis-based Marsh managing director Scott Russell, who heads the broker's U.S. airline practice, told the press recently that Equitime's premium rates could be about 65 cents per boarding passenger, depending on various factors. This compares with a total of $3.10 per passenger for the war risk cover that includes, for example, the AIG consortium's $1.85 per passenger and the $1.25 per passenger routinely collected for war risk under the $50 million third-party sublimit of aviation markets.

While some experts are quick to point out that a 65-cent rate may be far too low to be shouldered by the risk retention group's own capital, others take a more optimistic view. They predict that the four-plane hijacking of September 11 has caused such change and scrutiny of potential aviation terror that it's unlikely anything similar will be attempted any time soon. Indeed, if the focus of terror does shift away from airliners, then Equitime could prove to be a best-case scenario, meaning great business for Vermont and a way for the government to back away from aviation reinsurance in only a few years.

Fronting, Other Issues

Meanwhile, the season's brace of captive insurance conferences--which will conclude with this month's VCIA forum--has helped to focus captive managers, insurers, and service providers on key issues. In June, for example, the International Captives Congress (ICAP)--an IBC event held this year in West Palm Beach, Fla.--sought straightaway to provide solutions to the fronting dilemma, with an opening panel on the subject.

For captives that may be having difficulty closing a fronting deal with a carrier, Brian First, vice president of Hartford Alternative Markets, offered some specific advice on what a fronting carrier is looking for in a captive program. For starters, he said, the main things are a captive's quality, its alignment of interest, and its profitability. Beyond that, there are more subtle factors.

"Is (the captive's risk appetite) consistent with the carrier's appetite? Does it bundle or unbundle services'? What's the risk type?" he asked. "The strongest prospects also have a story they are proud to tell, an identity that sets them apart. Also important is to consider historical premium, loss, and exposure data. Is there a knowledge or service advantage that makes (your captive) a non-commodity?"

In addition, First pointed out, the ingredients must be there for a long-term relationship between a captive program and its fronting carrier. "Are there channel conflicts; will existing relationships be affected?" he asked. "It requires an analysis of your key partners--their financial strength, commitment, and capability. There must be potential for profitable growth (in the captive/fronting partnership), with return on capital, resource investment, and implementation costs."

Jeffrey Kehler, special projects manager for Liberty Mutual Captive Services, explained that the current hard market for traditional insurance was "infusing a little hard market pain" when it came to finding fronting carriers for captives. Those market realities now include less competition among fronting carriers; higher costs in terms of front and other service fees; tighter underwriting in terms of risk selection, financial review, terms and conditions; a lower tolerance particularly for credit risk; higher attachment points for stop loss; and a greater emphasis on claims management and loss prevention programs.

At the same time, a two-way street still exists, and captives need to scrutinize their potential fronting carriers as well. "Obviously, is your carrier a financially strong company, looking at A.M. Best and credit ratings?" asked Kehler. "Is there significant expertise in the carrier's captive unit--in underwriting, fronting and specific industry expertise? Is there the ability to provide excellent claim handling and loss-prevention services? And is there flexibility in the fronting carrier's approach that will provide you with real value for the cost?"

Captive Menu

Beyond the structural problem of fronting, though, the current captive boom continues to affirm that the captive concept, typically lumped with the varieties of "alternative" risk transfer, is more than ever a mainstream solution. For example, ICAP sessions explored the increasing ways that captives can be exploited to solve specific business problems.

Tom Wronski, of Fidelity Investments, and Chip Manozzi, of RM Access, detailed a menu of captive uses, many of them rather complexly structured but nonetheless viable, for managing increased primary retentions, and underwriting key life insurance, construction occupancy and other programs. The uses for a captive become almost limitless, in their view, extending to credit insurance, terrorism/property cover, a finite/catastrophe program, along with surety, weather, employee benefits and more.

Of course, the issue of writing employee benefits in captives remains a live one, and one that remains something of a grail for companies, ever since the Department of Labor (DOL) approved it for one firm, Columbia Energy Group. With another major corporation, Archer Daniels Midland (ADM), awaiting DOL approval to write employee benefits through its Vermont captive, the ADM approval could set the stage for subsequent applicants to access the DOL's "expedited review" procedure, which requires a judgment within 45 days if a company can cite two substantially similar filings with the last five years. In other words, the ADM outcome could open the long-predicted floodgates for employee benefits in captives.

At the VCIA conference, this ongoing issue will be fully explored and updated by a panel that will include not only ADM corporate vice president Mike Lusk, but also attorney P. Bruce Wright, of LeBoeuf, Lamb, Greene & MacRea. Wright is viewed as something of a guru on the subject, having played a key role in shepherding the long-suffering Columbia Energy decision to its final approval.

From the standpoint of timing, the hard market is always a ripe environment for dusting off captive programs and putting them back to work. Another VCIA session will thus focus on "Emerging From Hibernation (Reactivating a Dormant Captive)," with a focus on regulations and new tax law issues that may come to bear. Jean VanTol, president of Resort Hotel Insurance Co. and VCIA's chairman, will lead that panel.

Other timely topics will be addressed--from a look at the optimal retained risk in a world made more volatile than ever to the nuts-and-bolts of claims management, accounting requirements, investment challenges, and disaster recovery. The conference will also mark something of a debut for VCIA's new president, Molly Lambert, who replaces the departing Lisa Ventriss, who has taken on a leadership role with the Vermont Business Roundtable after several successful years of representing Vermont captives.

Lambert is the former secretary of commerce and community development for the state of Vermont, serving the Dean administration since 1998. Lambert also served for seven years as executive director of the Church Street Marketplace in Burlington. Obviously, she knows her state and how to market its charms and efficiencies. At this particular point, it may be something of a slam-dunk to represent the premier U.S. captive domicile to potential customers, many of whom may be scrambling to take advantage of the captive concept. But Lambert, like the rest of Vermont's hard-driving captive establishment, isn't likely to take anything for granted--not at a time of such change and uncertainty.

Matt Damsker can be reached at mdamsker@lrp.com.

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