By Michael Bradford

Published March 06, 2006

MONTPELIER, VT - Captive formations in Vermont have settled to a pace that captive managers and regulators expect will continue for a while.

The domicile issued 37 new captive licenses in 2005, down from 43 the previous year and well below the record - 77 - set in 2003. That pace is manageable without being burdensome, domicile sources suggest, and unless the traditional insurance market experiences a significant hardening, licensing activity is likely to tick along at a similar rate.

Formations in 2006 should total around the same as last year, said Leonard D. Crouse, deputy commissioner of captive insurance in Vermont's Department of Banking, Insurance, Securities & Health Care Administration in Montpelier. "Thirty to 35 is great growth," he said. "I think we'll have a good year; I don't see any reason why not."

Parent companies that established captives in Vermont last year range from very large organizations to smaller outfits, Mr. Crouse said. Looking ahead, he predicted that smaller businesses will drive formations.

"I think that the growth in this industry is going to be from mid-cap to small-cap, and probably more small-cap," Mr. Crouse said of parent companies. Such companies are doing well in the current economy and as they grow are expected to show interest in establishing captives, he noted.

Even so, the big players are not staying away from Montpelier. In 2005, Chevron Corp., DuPont Chemical & Energy Operations Inc., Nestle USA Inc., Sun Microsystems Inc. and Pfizer Inc. were among the parents establishing captives in Vermont.

One indication that there is expected to be plenty of business to go around in Vermont is the growth in the state's captive management community. Setting up new management offices in 2005 were Liberty Mutual Management (Vermont), HSBC Insurance Management, Arthur J. Gallagher Captive Services (Vermont) and Wilmington Trust Corp.

The state is holding its own at a time when domiciles have to prove their worth to captive parents, sources note. With so many states now having captive laws and offshore domiciles wooing parents, there are plenty of options for companies looking to set up an insurer.

"There is a lot more competition among domiciles," said Gary Griswold, director of captive operations at SB&T Captive Management Co. in Burlington. "Vermont is getting its fair share and it's getting very good ones, but it has more competition from a lot of states."

Vermont's regulatory environment has long been touted as its top drawing card. Managers talk of enjoying good relationships with regulators who are conscientious in supervising captives while remaining accessible and flexible when special circumstances arise. The domicile's regulatory environment is often referred to by Vermont sources as setting "the gold standard" among states hoping to attract captives.

"I think captives will always consider Vermont and will probably consider Vermont first, then look at other domiciles," said Roger D. Teese, president and chief executive officer of SB&T.

"You know what you're getting in Vermont," said Robert M. Gagliardi, assistant regional director of U.S. captive operations at AIG Insurance Management Services in Burlington. "You have so much history, so much experience, it's hard to look away from that."

Vermont has a "firm hand but is open to business," said Mr. Griswold. As for who gets in, "it really depends on the program. They're not going to accept programs that they're not sure about," he said of regulators. "If they believe it's a well-put-together program, then Vermont's a great place to be."

Weyerhaeuser Co. set up its Vermont captive in 1983 to reinsure some of the Federal Way, Wash.-based company's property coverages. The domicile is an easy place to do business because of the actuarial, banking, accounting and other services that are close together in Burlington, said John W. Lambdin, assistant treasurer and director of insurance at Weyerhaeuser. "And we don't have to travel internationally, which can be an advantage," he noted.

While there are closer domiciles to Weyerhaeuser's headquarters, "we're well established in Vermont and happy there," said Mr. Lambdin. "The benefit to moving to a closer domicile wouldn't offset the expense of the move."

Vermont ended 2005 with a net gain of 18 captives after 19 dissolved during the year, leaving 542 active captives at the year's close. Gross premiums reached more than $12 billion for 2005, regulators estimated, up from $10.9 billion in 2004.

A majority of the 37 new licenses - 26 - were issued to pure captives in 2005. Five risk retention groups were formed, as were three sponsored captives, which operate as cell companies, and two association captives were licensed. One license was issued to a branch captive.

Among the new formations, "the most popular line was general liability," with 17 companies forming to cover that exposure, said Derick A. White, director of captive insurance with the Vermont Department of Banking, Insurance, Securities & Health Care Administration. Professional liability, automobile liability, workers compensation and property coverages rounded out the new formations in order of popularity.

The number of captives formed to write medical malpractice insurance "keeps rising," said Mr. White. "We have about 85 med mal captives; about half are groups and half are pures," he said. Those captives generated around $1.2 billion in premiums last year.

Interest in captives to fund employee benefits continues in Vermont but formations are few. Employers are getting more comfortable with the idea, captive managers agree, but in many cases they face internal obstacles to putting the companies together.

Parents that have gained U.S. Department of Labor approval to fund benefits in their Vermont captives include Archer Daniels Midland Co., International Paper Co., Sun Microsystems Inc. and others.

There remains something of a "cultural divide between risk management and benefits" that can make formation of a captive to fund benefits a slow process, said Mr. Teese of SB&T. Benefit managers don't generally have the same knowledge of captive operations as risk managers, he said, and therefore they need time to become comfortable with how captives operate.

"Getting the risk manager to talk to human resources" can be a challenge in some organizations, said Andrew Sargeant, president of USA Risk Group of Vermont in Montpelier. "We have a number of clients talking about that," he said of benefit captive formations, with group life and disability coverages among those most talked about as a fit for captives.

"I think it's going to be an area where we are going to see some growth but slow," said Nancy L. Gray, executive director at Aon Insurance Managers (USA) Inc. in Burlington.

Risk managers have focused on property/casualty exposures more intently than benefits issues during recent hard-market years, Ms. Gray said. And they have "taken a very cautious attitude toward it in determining whether it would make sense" to fund benefits in a captive, she said.

Vermont regulators are hopeful that a report issued by the U.S. Government Accountability Office in September will lead to uniform standards in the regulation of risk retention groups and eliminate some of the headaches of overseeing companies licensed in other states.

Vermont has licensed 77 RRGs, which are multiple-owner captives that are allowed under the federal law that authorized them to provide coverage to policyholders in any state after meeting the licensing requirements of one state.

The 120-page GAO report, which was requested by Rep. Mike Oxley, R-Ohio, recommends that states and the National Assn. of Insurance Commissioners adopt a set of uniform regulatory standards for RRGs.

The report pointed out, among other things, that widely varying state regulations allow capitalization and financial reporting under less-than-stringent laws in some states, and some domiciles "may be relaxing chartering or other requirements to attract RRGs."

"I thought it was a very good report with a lot of good recommendations," said Mr. Crouse. "My question is, when is Congress going to take a look at this, and, if they're going to do anything, when are they going to do it? I just hope this doesn't sit up there for a number of years without any action."

Mr. Crouse said he believes there "have to be some uniform standards in this business," because, as it stands, states have no authority to keep out risk retention groups that regulators believe to have been organized under weak laws. "Why should states have to take something that their laws don't accept?" he asked.

"Existing risk retention groups are looking at that very carefully, considering the domicile that they're in and how those suggestions might impact them," Julie Boucher, managing director at Marsh Management Services Inc. in Burlington, said of the GAO report. But formations are not halting from a fear of tightened regulations, she said, because insurance needs in many cases are driving the decisions to set up RRGs.

The report has caused some domiciles to rethink their licensing procedures, according to Ms. Gray of Aon. "I think we've seen the effect of the GAO report in some of these domiciles, because it is taking longer to license risk retention groups," she said, as regulators take a closer look at how the groups are structured.

"If you look at the number of risk retention groups that were formed last year, the numbers are down," said Ms. Gray. "I think that is a result of the GAO report."

The Vermont Captive Insurance Assn. is a strong supporter of uniform regulations for RRGs, said Molly Lambert, president of the Burlington-based group, while "at the same time, appreciating that risk retention groups are not traditional insurance companies" and should not be regulated as such.

"They are part of the alternative infrastructure," Ms. Lambert said of RRGs, "and it is very important to understand their unique structures and regulate them accordingly."

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