Protected Cell Structures Fuel Captive Insurance Growth
A hardening insurance market is among the factors resulting in more captives, nearly 20% of which are protected cells.
- Anthony Bellano
- August 2022
CAPTIVE DOMICILE: Burlington, Vermont, will host the 37th annual Vermont Captive Insurance Association Conference from Aug. 8-11.
- Growth Spurt: Some 18% of new captives formed over the past two years were protected cells, compared with just 8% three years ago, according to Marsh.
- Protected Cell Leaders: Excluding Bermuda and the Cayman Islands, cell activity was concentrated in four domiciles, all in the U.S.: North Carolina, Vermont, Tennessee, and Delaware.
- State Legislation: Delaware recently approved the use of captives by corporations to cover directors, officers, employees and other indemnifiable people, while Vermont clarified rules surrounding parametric contracts.
The number of new protected cell captives has been on the upswing across the United States in the past few years as the overall captive sector also has seen an increase in captive formations.
The growth in the captive formations has been fueled by a hardening insurance market while cell captives have become increasingly popular because they are a simpler, cheaper option for companies to enter the market, and can lead to bigger things.
Some 18% of new captives formed over the past two years industrywide were protected cells, compared with just 8% three years ago, Marsh Captive Solutions Managing Director Michael Serricchio said. “Cells are really great, especially for middle-market, medium-size corporates,” Serricchio said.
“It was kind of an interesting perfect storm for captive growth because the industry was not traveling all over the world and regulators were able to deal with huge volumes of new captive applications.”
Marsh Captive Solutions
Excluding Bermuda and the Cayman Islands, cell activity was concentrated in four domiciles, all in the U.S.: North Carolina, Vermont, Tennessee, and Delaware, according to a report from Strategic Risk Solutions, which provides captive management and advisory services.
North Carolina saw the biggest growth, with the addition of 157 new cells and the loss of 29 existing ones, bringing the state's total to 667, according to the report. Vermont added 100 new cells and lost 10 existing ones, which brought its total to 485 protected cells. In Delaware, 45 new cells were added, but 104 existing cells were lost, resulting in a total of 466. Tennessee welcomed 65 new cells while at the same time losing 35, for a total of 341 protected cells, the report said.
A protected cell company, also known as a sponsored cell or segregated account company, is an insurance company that offers the benefits of a single-parent captive without the need, and associated time and expense, to create a separate legal insurance entity, according to Marsh.
Hardening markets present opportunities for new structures, according to Best's Market Segment Report: Captives' Flexibility and Control Enable Them to Outperform Commercial Peers. The cell structure is being more broadly developed under various names such as Segregated Account Company, Segregated Portfolio Company, Protected Cells or Incorporated Cells, according to the report.
“For owners of small to medium-sized enterprises across a wide variety of industries and businesses, cell companies may provide general business protection. Some captive managers and professional insurance management teams offer a platform or access to a risk pool under a tightly written policy with a broad menu of coverages, ranging from active shooter to small airplane coverage, all of which are covered under the same risk pool despite the variety of claims. No financial support is commingled. They are 'only' required to share losses under the terms of the pool and, in most cases, provide ongoing proof of financial wherewithal and viability, as well as collateral,” the report said.
Cell captives can be used as a steppingstone for employers who may want to move into a single-parent captive in the future, said Chelsea Carter, Artex Risk Solutions business development-account executive.
“For example, employers may face timing restrictions or coverage placement challenges that require an expedited entry into alternative risk solutions,” Carter said. “Cell captives provide employers with a quick and easy solution to finance their risk, but can also be easily transitioned into a single-parent captive when the time is more appropriate.”
Captive formations of all types have been growing since late 2020 as the economy began to recover and a hard insurance market persisted.
In 2020 and 2021, Serricchio said Marsh formed about 200 new captives, which grew what he called an “astonishing” $3.4 billion in premium.
Nick Hentges, co-CEO of Captive Resources, a consultant to member-owned group captive insurance companies, said the company added more than 1,000 new members during the pandemic, including more than 500 new captives in 2021.
Vermont insurance regulators licensed 45 new captive insurance companies in 2021, the fourth-highest year of growth in the state's captive sector's 40-year history, state officials said earlier this year. The growth in captives brought the total to 620 licensed captives—589 active and 31 dormant captives—31 more than it had at the end of 2020. The department added its largest one-year total in 2003, when it licensed more than 70 new captives.
Vermont's 52 sponsored cell captives host nearly 500 cells and separate accounts, in addition to the licensed captive companies. Nine of the 45 new licensees were sponsored cells.
“They are growing as fast as the overall captive market,” David Provost, deputy commissioner of captive insurance for the State of Vermont Department of Financial Regulation—Captive Insurance Division, said of protected cells. “They're a great solution for all kinds of businesses. They're often touted as ideal for smaller businesses due to the lower cost and ease of entry and exit, but I've seen some very large companies form cells for simplicity and ease of management as well.”
“They’re a great solution for all kinds of businesses. They’re often touted as ideal for smaller businesses due to the lower cost and ease of entry and exit, but I’ve seen some very large companies form cells for simplicity and ease of management as well.”
State of Vermont
Department of Financial Regulation—Captive Insurance Division
The intent of the law in Vermont is to allow a cell to do pretty much anything a stand-alone captive can do, and regulation of the cells is balanced to the risk retained, Provost said.
The number of captives worldwide totals 6,027 captives, up from 4,951 in 2006, although the market suffered a 2.5% decline from 2015 to 2020, according to a report from Strategic Risk Solutions.
The AM Best report said the number of U.S. domestic captives declined marginally from 3,182 in 2019 to 3,107 in 2020, a 2.4% decrease. AM Best attributed the decline to increased scrutiny by the Internal Revenue Service regarding 831(b) captives and the rise in economic uncertainty from the pandemic during the first half of 2020 which likely resulted in a small number of captive closures as well as a reduced number of new formations.
“As economic activity and confidence resumed, and the hardening insurance market persisted, the flexible, adaptable, and innovative solutions that captives afford their owners continued to prevail,” AM Best said.
“As a result, there was an increase in captive applications in late 2020 and early 2021, with a growing interest in captive cells as a more expeditious and efficient solution in a challenging market,” the report said.
“Cells effectively borrow a third party insurance management and licensing platform to address certain risk transfers more quickly, with smaller amounts of capital investment, and gain professional oversight so they don't have to take their eyes off the primary business that they are insuring. Further, these are easier to close (or go dormant) when a hard market softens or when a business sponsoring a cell closes or sells. They are also able to restart should a market turn again or should another business need arise if they have left their capital in the cell, which many do for a period of time since distribution is a taxable event,” the report said.
AM Best rates more than 200 global captive insurers in a variety of jurisdictions, according to the report.
“The COVID-19 pandemic disrupted supply chains and put enormous financial pressure on nearly all industries and companies worldwide,” according to a Marsh report, which said captives experienced record growth in virtually every area. The number of automotive captives, for instance, grew 28% from 2019 to 2020, the most of any industry, according to the Marsh report Global growth affirms captives' value in solving business challenges.
“We're seeing the growth within new and existing captives be tied more to the expansion of how employers will use their captive insurance vehicles and fund for different types of insurance,” Artex's Carter said.
“That could be using the captive to fund for increased retentions on their primary lines of coverage, the ability for the captive to participate in a quota share arrangement higher up the insurance tower, or even looking to have their captive access reinsurance markets directly.”
The pandemic gave insurers the chance to reevaluate how they do things, Jonathan Habart, director of captive insurance, Tennessee Department of Commerce &Insurance, previously told AM Best TV. As a result, a number of new types of captives are emerging, such as cannabis captives and pandemic coverage through their business interruption policies.
For many companies, time is of the essence right now because of the financial strains related to the global health pandemic, geopolitical issues and other factors. The pandemic equaled the hard market, which equaled captive growth, and “that's why I think we saw so much of it,” Serricchio said.
“I think the reason folks, regulators, actuaries, brokers, and state insurance departments were able to take on that growth is because they were hunkered down. It was kind of an interesting perfect storm for captive growth because the industry was not traveling all over the world and regulators were able to deal with huge volumes of new captive applications,” he said.
Serricchio said the captive growth is tied to challenging market conditions, and is spread across different lines of coverage, including property, liability, directors and officers, cyber and workers' compensation, among others.
“We saw all of those lines growing and challenged, so the captive industry responded and you saw a lot of captives form,” Serricchio said.
States also have been passing legislation that can contribute to the growth of the captive insurance market.
Delaware recently approved the use of captives by corporations to cover directors, officers, employees and other indemnifiable people, as long as they acted in good faith and there is no reasonable cause to believe their conduct was unlawful.
The action was taken in response to a hardening market, Delaware Department of Insurance Senior Policy Adviser Christina Haas said in an email.
“In many cases, there has been a sharp increase in premium, more exclusions, resulting in less coverage,” Haas said. When premiums began to dramatically rise in 2020, she said the Delaware General Assembly worked to enact the legislation quickly.
No new captive insurers had been approved in the state resulting from this legislation as of June 10, Haas said. In all, Delaware has 748 captives.
Recent legislation enacted in Vermont also clarified laws surrounding captives. The bill clarifies the ability of Vermont's captive insurance companies to enter into the parametric risk transfer contracts, which pay a sum in the case of a quantifiable event, such as a hurricane of a specific category hitting a specific area, whether the contract holder suffers a loss or not.
In signing the bill into law, Vermont Gov. Phil Scott said parametric contracts are becoming more common as a form of protection against catastrophic events.
“We always thought it was legal anyhow, but we wanted to put it into the statute to make sure it was very clear that it was approved by the department,” Provost said.”It's one of those things that kept popping up. We were getting questions about whether or not it was acceptable, so we just decided to put it right in there to make clear that it was.”
“Vermont's always on the cutting edge of new and innovative thinking,” Serricchio said. He said he expects other states to follow suit because, for the most part, these types of contracts are not excluded by law.
“It gets people thinking about it,” Serricchio said. “It gets captive owners thinking about it. It gets them talking to reinsurers. I have predicted for a couple of years that parametrics would grow in captives, and I think you're starting to see that.”
“The fact that Vermont has incorporated it into their overall insurance strategy is a good thing because it gives employers the ability to have another avenue to consider when structuring the insurance needs in light of some of the changes within the market,” Carter said. “Ultimately, each domicile will have to make the decision as to what works best for the domicile, how the domicile will grow and what they want to be able to offer their captive owners.”
Serricchio said he expects to see growth to continue among these captives and the new captives as they expand their existing lines of coverage.
“I do think you're going to see some growth in the next 18 months,” Serricchio said. “I don't know if it's going to be as stellar as the last two years, but the activity, the phone calls, the education that we do continues and it hasn't slowed down. We actually hired some more folks to take on new feasibility studies and new educational sessions with our clients. When you have a lot of new captives and they get formed with one, two or three lines of coverage, year after year, they want to do more, and they want to increase.”
”It is hot,” Provost said of the current captive market. “Anybody in captives is busy right now. Every domicile I talk to is having record years or near record years. Every captive manager is loaded up with existing business and new business. It's a hard market still and whenever that happens, captives start getting active again. The insurance market permanently loses a fair chunk of business every time they go through hard markets like that.”