A captive insurance company is one that underwrites the risks of the affiliated entities of a common parent. In other words, instead of buying insurance from a commercial insurance company, an organization can create a new subsidiary that allows insurance to be effectively kept "in house".
Numerous jurisdictions worldwide authorize the formation of, and issue insurance licenses to captive insurance companies. Within the last decade, the majority of U.S. states have adopted so-called "captive enabling legislation" that allows the insurance department to issue captive insurance company licenses.
Some jurisdictions compete for captive insurance companies more aggressively than other jurisdictions. Vermont, for instance, has put in a great deal of effort to be a premier captive insurance jurisdiction, and for its efforts is now the second largest captive domicile in the world.
One of the states that in recent years has competed for captive business is Delaware, a state that aggressively competes for the formation of other businesses, such as corporations and limited liability companies. Indeed, for decades, Delaware's corporation laws set the gold standard and were adopted nearly verbatim by most states.
Delaware's experience with captive insurance hasn't been so good. Delaware's late entry into the captive market effectively ceded the large corporate captive market to Vermont, which has done an excellent job of protecting that market. Next, the Delaware Insurance Commissioner who first was faced with the issue fumbled captives badly, taking months to process applications and imposing certain restrictions that made little sense.
The Delaware captive insurance sector was revived largely to the efforts of one person, Mary Jo Lopez, who mended the bridges with captive managers, cheerfully attended captive events, and put Delaware back on the map. Delaware even made a little headway against other jurisdictions by allowing their Series LLCs to be licensed as, essentially, Protected Cell Companies (a/k/a "Cell Captives").
Unfortunately, there is a tendency for captive jurisdictions at some point to go "off the rails", and start becoming so bureaucratic or difficult to deal with that captive managers start thinking twice about sending business there. Examples in recent years include Arizona and South Carolina, which started out with a "we'll take anything" attitude, thereby took in a lot of business (much of it bad), changed their captive staff to clean up the bad business and which overreached to deter the good business too, and now are trying to find their way back to some equilibrium whereby they attract good business without accepting the bad.
An even better example is the British Virgin Islands. The BVI was one of the earliest domiciles to attract captives, and had licensed many hundreds of captives for U.S. businesses even before the IRS came down with their omnibus 2002 guidance. One day, however, the BVI changed their Insurance Commissioner to somebody who thought that his real job was to generate inane and nonsensical rules, such as significant restrictions on the types of assets that were permitted in captives which were inapposite to how even large non-captive commercial insurance carriers routinely invest their assets. Captive managers rebelled, and the BVI within a couple of years had faded as captive domicile.
Delaware appears to be on the cusp of its "BVI moment". Mary Jo Lopez has gone back to the private sector, and things have been sliding downhill ever since. Lately, captive insurance managers have been grumbling to me (off-the-record, of course) that Delaware is going backwards as a captive domicile.
The complaints seem to fall into two main categories:
First, that Delaware has been arbitrarily and nonsensically ordering examinations (an intense regulatory audit) of captives.
Most states require examinations of captive insurance companies every three years or so, and in fact extending those time periods is sometimes a point of competition between captive domiciles. Compared to simple audits, examinations are intense, time-consuming, and usually expensive affairs, which can cost the captive $15,000 and upwards. These examinations can be money-makers for the captive domiciles.
According to some captive managers, Delaware has been ordering examinations as early as the same year in which the captive is formed, which makes little sense -- if there was some issue with a captive that triggers an examination, the captive license probably shouldn't have been issued in the first place.
The second set of complaints is more amorphous, and goes to what seems to be general griping about Delaware's approval process, i.e., taking too long to approve captives, secondary requests for information that make little sense, and then just a general rudeness and arrogance by Delaware's captive staff. In Delaware's defense, this goes on to some degree or another in every domicile, and of course the captive staffs in various states could probably say the same thing about not just a few captive managers -- but here the volume is pretty loud.
At any rate, some captive managers have indicated that they are highly dissatisfied with Delaware and will be taking their business elsewhere. Empty threats? Who knows.
What we do know is that the captive insurance marketplace is more competitive than ever, and with the increased interest of states in collecting their various state taxes on premiums paid to a captive insurance companies domiciled outside their state, the idea of simply forming a captive in-state and avoiding those taxes (assuming of course the state has reasonable and reasonably enforced captive enabling legislation) is more attractive than ever.
While Delaware of course has a lot of businesses that are nominally formed in the state, they otherwise have relatively few companies that are actually running their business from Delaware, and which would naturally choose Delaware as their captive domicile. Thus, Delaware -- much like Vermont -- must compete for captive business from outside the state, and this is an area where an increasingly negative reputation among some captive managers will not be helpful.
Time will tell, but this is nothing like the first time that I've seen a domicile start a downhill slide. Since healthy competition among jurisdictions is good, and the more domiciles the healthier the competition, let's hope that they can get back on the right path soon.
This article at http://onforb.es/17dxEGL and http://goo.gl/VRVxbK
