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An Attorney’s View of Delaware’s Captive Success

An Attorney’s View of Delaware’s Captive SuccessThere are two reasons why Delaware is enjoying explosive growth in its number of captive insurance entities – one regulatory, one more subtle.

The first is a recent change in statute allowing the licensing of Delaware series captive insurance companies, accounting for 370 units in just the past 3 years. The second is Delaware’s on-going industry and government partnership to create an attractive business environment.

In a recent interview, Jeffrey Simpson, Director of GF&M Law, commented that “Anyone considering forming a captive should consider Delaware because of its cutting-edge stature, accommodation and consultative regulators, and deeply entrenched transactional infrastructure.”

Simpson and his firm provide legal services to every type of captive that can be licensed in Delaware, from pure captives through to risk retention groups.

“Delaware's captive regulators will consider any reasonable proposal and ... are open to new and creative designs. At the same time, they are not pushovers and are careful to protect policyholders and ensure that captives operate within certain limits.”

“Delaware regulators are also careful to consider the needs and conveniences of their captive citizens when refining or implementing policies and practices. They take pains to employ methods and set requirements that are reasonable, practical, and helpful to their audience.”

Simpson and his firm have experienced Delaware’s captive-friendly industry and government partnership firsthand. He commented that “GF&M Law works with dozens of these structures and hundreds of series formed within them.” Their work has helped sponsors form series captives for first party enterprise risks, medical stop-loss, and workers compensation, to name a few.

Growing Pains

 

This Captive Insurance Brief is excerpted from Growing Pains, a recent feature article in Captive Insurance Times. To download the full article, click here.


 

Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.

 

A Regulator’s View of Delaware’s Captive Success

A Regulator’s View of Delaware’s Captive SuccessSince 2005, Delaware has become the world’s fastest growing captive domicile and is now the 10th largest domicile in the world.

In a recent interview, Steve Kinion, Director of the Bureau of Captive and Financial Insurance Products, explained how innovative regulations have been the key to Delaware’s quantum captive growth.

A critical initiative was the recommendation to Delaware’s insurance commissioner to allow the licensing of the world’s first series captive insurance company. From the beginning, Mr. Kinion was instrumental with this unique initiative which in just three years has seen Delaware license 370 series units.

“This pioneering activity allows individual series, either formed under a Delaware limited liability company or statutory trust, to become captive insurers.”

“Until the captive bureau allowed this form of captive insurer, no other captive domicile had even considered doing so.

Today, series captives are the most popular form of Delaware captive. However, Kinion also pointed out that Delaware will also cater to nearly all types of captive insurance entities.

“Captives formed to ensure the XXX and AXXX excess reserve for term and universal life insurance policies have become an area of expertise for Delaware. As Delaware's chief captive regulator, I believe that my captive bureau does a very good job in regulating these types of captives.”

“We are firm, but fair in our approach. I have been … very vocal in my defense of captive insurers … and specifically these life reinsurance captives before the National Association of Insurance Commissioners.”

Looking ahead, Kinion believes that its well-structured captive insurance industry has set the state up for the future. He explains that Insurance Commissioner Stewart promised the citizens of Delaware a vibrant captive industry -- and it seems that she has managed to deliver on that promise.

“Today the captive industry provides Delaware with revenues and economic opportunity … the state of Delaware is a great choice of domicile for firms, as long as being an insurance company is of the utmost importance to them.”

He added: “Captive insurers that satisfy the rules for risk transfer and have assuming risk as their core mission will find Delaware to be an advantageous domicile.”

He also issued a warning – “Promoters who wish to form captives whose primary mission is anything but being an insurance company, will find Delaware unwelcoming.”

Growing Pains

 

This Captive Insurance Brief is excerpted from Growing Pains, a recent feature article in Captive Insurance Times. To download the full article, click here.

 

Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.

Delaware Domicile Reports Massive Growth

Delaware Domicile Reports Massive GrowthThe staggering growth of Delaware captives – from 5 to 608 since 2005 – is due to both a pioneering regulatory statute update and its captive-friendly regulatory structures.

In a recent interview, Richard Klumpp, President and CEO of Wilmington Trust SP Services, described how these changes have helped to make Delaware America’s third largest domicile.

In 2005, Delaware led the industry by becoming the first domicile to license serial captive insurance companies. Its captive growth was also aided by the state’s captive-friendly regulatory structure.

Klumpp commented “The base upon which the 2005 revised statute was built … still exists today … both flexible but substantial regulation and a strong public-private partnership.” Delaware captives also enjoy the ongoing support of the Delaware Captive Insurance Association, as well as Delaware governing entities.

He also had significant praise for Delaware’s insurance commission, and its commissioner. “Karen Weldin Stewart is also a great help to the state, supporting the continued growth of the industry, including additions to staff. It continues to put on successful networking events and has recently increased its advertising budget to broaden our reach. In addition, the Secretary of State's office, long a proponent of the Delaware Advantage, continues to aid our marketing efforts.”

And while many other states have experienced captive growth during this same time period, Klumpp explained that Delaware has not suffered as a result.

“Various states translations of the US Dodd-Frank Act have caused us to add new domiciles to our feasibility studies, but on balance, the market continues to grow. So, even in light of other domiciles arriving on the scene, we have not observed a decrease in the percentage of deals that come to Delaware.

Aside from its 2005 statute update, Delaware’s on-going flexibility in attracting new captives cannot be understated. This is also true for the captive management arm of Wilmington Trust.

Klumpp commented that “Wilmington Trust SP Services does not tend to target a particular client because of its industry or type … we prefer to look at each prospective client as an individual, and put together a program specific to that client.”

Growing Pains

 

This Captive Insurance Brief is excerpted from Growing Pains, a recent feature article in Captive Insurance Times. To download the full article, click here.

 

Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.

How to Exit a Captive

WHow to Exit a Captivehen the time comes to divest or terminate a captive, the two most common options are a sale or liquidation.

While selling the captive is not unheard of, it can be complicated.  Finding a buyer may prove to be difficult and the cost of selling the captive can be considerable.  For this reason, the most common option for exiting a captive is liquidation. 

In liquidation, the disposition of reserves can be complex. Yet an even more involved problem is the handling of existing claims.

Depending upon the types of coverage insured by the captive, the process for paying out claims could extend for many years. This process is typically resolved in one of two ways:

  • Commutation -- A commutation is an agreement between the parent and captive -- or in a fronting arrangement, the fronting insurer and the captive -- where the existing obligation of the captive is terminated for a fee. It is considered to be the most practical option for two reasons. First, it does not require the parent company to find an insurance company willing to accept the risk. Second, because commutation has limited legal requirements, it can be finalized relatively quickly.
  • Loss portfolio transfer -- This is an agreement in which another insurance company takes the place of the captive on the insurance contract.  This is a less popular option primarily because of its legal ramifications, regulatory requirements, and the difficulty of finding another willing insurance company.

Although no captive can be expected to exist indefinitely, long term success is more likely when a captive’s owners have a policy of ongoing evaluation and maintain a solid working relationship with its captive business partners.

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Lifecycle of a Captive -- For an informative review of the three lifecycle phases or stages of a captive insurance entity, download “Lifecycle of a Captive.”

 

Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.

 

Why Captive’s Sometimes Fail

Why Captives Sometimes FailFor most captives, there eventually comes a time to draw down the final curtain.

Some startup captives die young and never get off the ground. For others, a more competitive commercial insurance marketplace nullifies cost savings. Even well run captives must be wound down when they exceed their economical service life.

Generally speaking, once a captive has reached the end of the road it should be given a quick and merciful demise. The faster it can be wound-down, the less costly the process will be.

Often, the most significant problems encountered in the winding down of a captive occur because its owners are not well prepared for the event. The end of a captive should never come as a surprise to its owners, but often does.  

This tends to cause the captive to incur unnecessary taxes, legal fees, and other costs to run-off existing claims -- all before returning accumulated earnings to the shareholders. 

For this reason, it is important to properly structure the captive’s organizational documents in its start-up phase, with periodic reviews throughout the captive’s life.

However, not every captive needs to be terminated.

In some cases, a captive can be sold, assuming a solution can be found for the difficult and sometimes costly process of deciding how reserves should be handled and claims allowed to run-off.

Winding down a captive is rarely easy. But when owners codify the process as part of a captive’s start up documents -- and update them over time -- the associated costs and time required can be greatly minimized.

describe the image

 

Lifecycle of a Captive -- For an informative review of the three lifecycle phases or stages of a captive insurance entity, download “Lifecycle of a Captive.”

 

Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.

What Risks Should a Captive Insure?

What risks should a captive insure?A captive insurance entity may not be the best vehicle to insure every risk faced by its parent company.

Often, it may make sense for a captive to cover risks which were either previously excluded or formerly covered by the commercial insurance market. Alternatively, some risks insured through the captive from its inception may be better covered commercially. 

To insure that the proper vehicle is used to cover a particular risk, three areas should receive periodic captive management review:

State of the Commercial Insurance Market -- An important factor in deciding where coverage should be obtained is the current condition of the insurance market in the US and worldwide.

In a hard market, it is likely that a captive could provide more attractive options than purchasing insurance in the commercial market. 

However, in a soft market, competition drives down commercially available rates. This may make it possible for cheaper insurance to be obtained outside of the captive. This is especially true when the risk associated with providing the coverage is greater than the potential underwriting gain.

Impact of a Captive’s Domicile -- A changing environment within a captive’s domicile can make the captive more or less attractive as an insurance vehicle. In some cases, it may make sense to move a captive to a new domicile.

Today, more and more US states are entering the captive insurance marketplace. Most will attempt to craft their captive laws and regulations to create a niche that sets them apart from other captives.

In many cases, it is not uncommon for the benefits to outweigh the costs required to move to a new domicile.   

Cost of Procurement Taxes -- Currently there are a handful of States that are assessing procurement taxes.  However, as states look for solutions to increase revenue, it is possible that more states will assess such taxes.

The Dodd-Frank Act has armed States with the ability to assess procurement taxes in situations where the parent company’s home office operations are in one state but their captive is domiciled in another.  The procurement tax is based on the level of premium written by the captive and is assessed against the parent company. 

Captive owners should communicate with their tax professionals to understand the impact procurement taxes might have on their captive.  If the impact is significant (and captive laws exist in the parent company’s home state), it may make sense to redomicile the captive. 

In short, captive owners who periodically monitor the three factors mentioned above can increase the chances of having a captive that serves them well today, and tomorrow.

describe the image

 

Lifecycle of a Captive -- For an informative review of the three lifecycle phases or stages of a captive insurance entity, download “Lifecycle of a Captive.”

 

Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.

What Makes a Captive Successful?

What makes a captive successfulSuccessful captives typically have a management team that shares a common and well-defined purpose and keeps the lines of communications open.

By selecting the right service providers, owners are able to identify and reach critical success milestones early in the startup process. In addition to a solid business partner team, successful captives typically share these characteristics:

Well Defined Risk Management -- The job of a captive’s risk managers is to thoroughly evaluate the coverages needed by the captive owner, as risks change over time.

This includes identifying risks better secured in the commercial market vs. lines more appropriate to purchase through the captive.  The risk management process also includes proper underwriting to ensure that the premium charged is adequate for the risk being insured. 

Strong Loss Control Program -- Such a program must have two goals.

The first is to minimize the likelihood of a loss occurring. The second is to minimize the impact of monetary and intangible losses after a loss event.

Satisfactory Loss Experience -- The cornerstone of a successful captive is its ability to provide satisfactory loss experience from year to year.

For this reason, it is rare for a captive designed merely for tax reasons to survive over time. This is not to say that tax benefits should not be an important part of a captive’s value, but its main purpose should be to function as an efficient and profitable insurance entity.

Similarly, captive success is rare when sufficient loss control and risk management programs are not established and followed.

Increasing Capital and Surplus -- If the annual premium is sufficient to cover losses (and losses are sufficiently controlled) the captive will likely recognize income resulting in increased surplus. A successful captive produces such results from year to year, building value for its owners.

Successful captives generally achieve the success factors mentioned above early in their business life, and most experience at least a moderate level of success.  An indication that a captive has successfully moved from its startup to its maturation phase is that the transition goes largely unnoticed.

describe the image

 

Lifecycle of a Captive -- For an informative review of the three lifecycle phases or stages of a captive insurance entity, download “Lifecycle of a Captive.”

 

Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.

Choosing a Captive Startup Team

Choosing a captive startup teamThe success of a captive startup depends heavily on the skills and knowledge of its business partners such as captive managers, risk managers, actuaries, attorneys and auditors.

Assembling the right team is critical to ensure that controls are in place to remain in full regulatory compliance while charting a path towards achieving its initial goals.

Ideally, key service providers should combine a sound understanding of the evolving captive industry with knowledge of the captive’s parent company. In addition, maintaining open lines of communication between team members is crucial to keeping the captive on the right track.

For this reason, expectations and responsibilities should be clearly defined to ensure timely and full compliance with all regulatory reporting requirements.  Ideally, these processes and procedures should be clearly defined before operations begin. 

These tasks can include preparation of captive annual reports, audited financial statements, annual loss reserve certifications -- as well as planning for captive board meetings.

In addition, deadlines for the regulatory requirements as well as financial reporting (i.e., monthly or quarterly financial deadlines) should be agreed upon and monitored. 

Of course, no two captives are the same. For this reason, owners and their service providers must be in complete agreement on what needs to be done, by whom, and when.

Clearly defining startup milestones and how to achieve them is a must to minimize the time needed for a captive’s startup phase. Even with the best of planning, a captive’s startup phase typically takes from 2 to 5 years to complete.

For this reason, it is critical that captive owners engage the right service providers from day-one to properly formalize all processes and procedures needed for efficient future operation.

describe the image

 

Lifecycle of a Captive -- For an informative review of the three lifecycle phases or stages of a captive insurance entity, download “Lifecycle of a Captive.”

 

Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.

 

Documenting a New Captive

Documenting a new captiveAlthough a new captive becomes operational when capitalized, its proper documentation is a key factor in its ultimate success.

A hasty move to actual operations without carefully thought-out documentation can cause significant problems over time. From the beginning, owners should focus careful attention on the content and structure of required organizational documents such as:

  • Bylaws or operating agreements
  • Articles of incorporation
  • Agreements with services providers (such as captive manager and Registered agents)
  • Executed policies
  • Investment policy
  • Code of ethics
  • Executed conflict of interest policy statements

Whenever possible, owners are encouraged to avoid using standard templates. A more prudent course is to prepare each document keeping in mind the captive’s optimum future form and goals.

Because of the importance of this process, owners should look for documentation assistance from service providers and business partners such as their attorney and captive manager. Professional guidance in the documentation phase can pay major dividends over time.

Other critical external documents and relationships include executing the necessary reinsurance agreements, as well as setting up banking and investment relationships. 

Once in final draft form, all organizational documents should be carefully reviewed and completely executed by those ultimately responsible for the captive’s operation. 

Inattention to documentation details can lead to major problems down the road. For this reason, extra care and time should be taken to scrutinize all organizational documents before captive operations begin.

describe the image

 

Lifecycle of a Captive -- For an informative review of the three lifecycle phases or stages of a captive insurance entity, download “Lifecycle of a Captive.”

 

Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.

 

Capitalizing a Startup Captive

Capitalizing a captive

Before “opening for business”, the final decisions in a captive’s organizational startup phase are the amount and form of its capitalization.

During this process, owners must answer three key questions:

  • What is the "best" place to domicile the captive?
  • How much capital will be needed?
  • What form of capital is best?

Depending upon the location chosen for the captive or alternative risk transfer vehicle, domicile differences can greatly impact the amount of capitalization needed, and the form it may take. Important questions include:

What is the “best” place to domicile the captive?

From a capitalization standpoint, a particular domicile might be the optimum location for a particular captive, yet a poor choice for another.

As more US states have entered the captive insurance marketplace, most have crafted their captive laws and regulations to set themselves apart from other domiciles. These rules can have an impact on the amount of capital required, as well as the amount of regulatory and administrative reporting needed.

For example, a captive domiciled in the State of Vermont is required to maintain unimpaired capital and surplus of $250,000. In addition, its regulators will monitor parameters such as the premium-to-capital, surplus, and solvency ratios.

How much capital will be needed?

As a general rule of capitalization, captives typically begin life with solvency ratios somewhere between 3:1 and 5:1. 

For example, a pure captive with a solvency ratio of 5:1 and a written premium of $3,000,000 will require capital and surplus of $600,000. Included in the $600,000 would be the $250,000 required unimpaired minimum in the previously mentioned Vermont example.

What form of capital is best?

Most domiciles allow options such as cash, letter of credit, surplus note, or a combination of the three.

There is no single “best” form of capital for every captive. Each form of capital has its own advantages and disadvantages. It is important for the captive owner to carefully analyze the impact of each form of capital being considered, and choose the option that provides the most economical solution over-time.

 

describe the image

 

Lifecycle of a Captive -- For an informative review of the three lifecycle phases or stages of a captive insurance entity, download “Lifecycle of a Captive.”

 

Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.

 

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