Hardening Market Heralds Rush to Alternatives

During the last hard market, much of corporate America wasted little time in stepping up the search for risk transfer alternatives to traditional commercial insurance. The current hard market appears to be no different if rates, premium growth and expanding books of business are any measure.

The alternative risk sector, once considered the source of unusual risks only for large accounts, now generates nearly half the estimated $300 billion in U.S. commercial property/casualty business, according to information contained in an A.M. Best report.

While the alternative risk market is at best only loosely defined, most agree that the term includes any mechanism used to substitute for traditional risk-transfer products offered by insurers. These mechanisms include risk-retention groups, wholly owned captives, rent-a-captives, purchasing groups and other risk-financing arrangements that employ elements of self-insurance. Actually the line between traditional insurance and the alternative markets continues to blur as most carriers now offer and write what previously were considered alternative coverages.

The last hard market in the 1980s drove a number of insureds to various commercial insurance alternatives. In the early 1980s, Vermont passed a law that allowed it to become the first domestic domicile that could compete with offshore captive venues. Interestingly the impetus underlying the early Vermont statute was from an agent based on Long Island who summered in Vermont.

Since then and since passage of the federal liability Risk Retention Act in 1986, Vermont and several other states have taken an aggressive position in seeking to become domiciles for Risk Retention Groups and for Purchasing Groups. States actively seeking the business in addition to Vermont include Hawaii, South Carolina, Arizona and Nevada among others.

While some industry insiders had predicted that interest in alternatives would wane in the 1990s, it has remained strong. A brief look at various components of the alternative market shows that activity is brisk and growing.

Risk Retention Groups
Annual premium generated by risk retention groups climbed 4 percent for 2000—from $769.5 million to $799.5 million, according to The Risk Retention Reporter, which reports on the risk retention marketplace. Presently 70 RRGs—including eight new formations in 2000—conduct functional operations in the U.S. largely from U.S.-based domiciles, with 44 registered to operate in Texas, according to the Texas Department of Insurance. (Texas has only one domiciled RRG, the American Contractors Insurance Co. Risk Retention Group.)

Two business sectors are dominating RRG growth, reports Karen Cutts, editor of The Risk Retention Reporter. “We are seeing fastest growth in the areas of contractual liability for homebuilders who issue warranties covering workmanship and major structural defects, and contractual liability for administrator obligators and dealer obligators involved in the selling and/or administration of automobile extended service contracts.”

Two other areas where RRG activity is reported as strong include liability coverages for trucking owners/operators and liability coverages for nonprofit organizations. Cutts said that with the hard market there is widespread expectation of a broadening of the business sectors that may consider turning to RRGs. “We could see a resurgence of interest from the medical sectors also, for instance,” she said.

The vice president and COO of States Self-Insurers Risk Retention Group Inc., David Drugg, goes even further adding that the RRG sector may experience growth in the areas of professional liability and workers’ comp. “If the rates go too high, RRGs may provide the best solution for WC coverage,” he commented. RRGs represent a healthy segment of the market in large measure because reinsurers have the capacity necessary to cover the risks. “And the alternative risk transfer facilities are poised to take advantage of this,” he said.

Drugg, who is also vice president of Berkley Risk Administrators Co. LLC, based in Minneapolis, further commented that Swiss Re may be tightening some on underwriting. “That means we may have to look for other markets.”

Echoing the observation that business is good for RRGs is Dan Carlisle, who runs the Iowa-based American Feed Insurance Company RRG. “Our applications for coverage are up,” he said. Carlisle is the past chairman of the board of the National Risk Retention Association, a nonprofit trade group dedicated to the development, education and promotion of U.S.-domiciled alternatives to traditional liability insurance.

Captives
Captives meanwhile still prefer to operate offshore. Bermuda has been rated the number one location for captive insurance operations, according to A.M. Best, which has reported a rise of more than 30 percent in captive formations for the year 2000 in the world’s key captive centers.

A.M. Best reports steady growth rates for captive insurance companies—between 4.5 percent and 5.5 percent over the past several years—with an acceleration in growth in 2000. Regulators and other independent sources in the various captive domiciles indicate that last year 245 new captives were licensed, while 170 were liquidated.

According to Best’s Captive Directory 2001 Edition, Bermuda now holds 31.5 per- cent of the world’s total captive market of 4,458 captives. Last year saw the formation of 51 new captives.

While Bermuda topped the tables, the Cayman Islands appear to be playing catch-up. Last year in the Caymans 48 new captives were set up, bringing the total in that jurisdiction to 535, although Bermuda has a much higher total number of captives (1,405).

Also featured in the A.M. Best ratings of new captive formations were Guernsey, with 24 new captives in 2000, Luxembourg with 10, Barbados with 9, the British Virgin Islands with 42, Ireland with nine and the Isle of Man with two.

A.M. Best said the market for captives will continue to grow in 2001, due to a continued firming trend in prices in commercial lines, and in spite of pressures from a deteriorating stock market and regulatory authorities.

The president of the Captive Insurance Companies Association, Michael Mead, feels the significant uptick in interest in captives is also due to a shift in attitude of the Bush Administration. Mead is president of M.R. Mead & Co., Chicago, a full service insurance intermediary which operates in all 50 states and many foreign countries.

“The Clinton Administration had been moving toward a position of making tax avoidance a difficult thing to accomplish,” said Mead, who added that “the new Administration recognized that tax avoidance has always been a legitimate enterprise.”

Because of their offshore domiciles, most captives are able to avoid U.S. tax consequences.

“And now that the Bush Administration has said it is not interested in dictating tax rules to sovereign nations, captives will experience an increase in business activity,” Mead said.

Mead also cited two court cases which have had favorable consequences for the captive sector of the industry. One case was heard in Oregon and the other is a tax appeals case involving UPS. “Both have been good for captives.”

Mead also pointed out that in early June the IRS advised it would no longer pursue the family argument against captives, which essentially held that tax treatment of captives should be based on ownership.

The 30-year-old CICA is also concluding a national effort to increase its size and reach. Mead said the initiative was started because of the estimated 4,000 captives in the world, the CICA has only about 110 members.

Good news for traditional insurers
A recent strong surge in captive interest has may be good news for the traditional insurance market. Most captives are seeking risk partnering, commonly referred to as “fronting,” because much of the administration of the facilities must be handled by traditional carriers.

“This is more than fronting,” Mead said. “In fact I’d like to do away with the term ‘fronting’ altogether.” He explained the services provided by traditional carriers is so much more than simply “hanging paper.”

Fronting is a procedure under which a primary insurer cedes a portion of the risk that it has underwritten to its reinsurer, who could be the captive insurance company. Under this arrangement, the ceding company (the front) executes appropriate security for projected losses under existing regulations but works with the captive and its owners to obtain maximum risk finance leverage. While retaining primary responsibility for regulatory and statutory compliance, the primary insurer provides a small, controlled amount of the actual risk.

Although general liability, business auto and workers’ comp are the primary lines of insurance, there were more than 50 coverages identified by the captive respondents to a recent survey conducted by the CICA. Property, professional liability, EPLI and medical malpractice were also frequently mentioned coverages under the captive.

Not surprisingly, over 90 percent of those surveyed stated that their primary reason for using a fronting carrier was to maintain substantial control over their own risks while forming a solid partnership with an established carrier.

There were 25 fronting carriers identified in the survey; however, seven fronting carriers were mentioned frequently. These include ACE, AIG/Lexington, DiscoverRe, Kemper, Liberty Mutual, Old Republic and Zurich.

Mead added, “We believe that now is the time and opportunity for forward-looking carriers to work with financially capable captives to provide both enhanced options and relieve their own surplus issues. The survey results indicate a fronting marketplace in a state of challenge and change.”

Purchasing Groups
Insurance companies that provide liability coverages to purchasing groups are taking a hard look at both existing PGs as well as submissions for new PG formations, reports the R R Reporter . GE Westport Corp. and Employers Reinsurance Corp., which together insure more than 45 PGs, are not currently in a growth mode, according to Richard Kasyjanski, vice president with GE Westport which is affiliated with ERC Group.

He commented that while PGs can offer lower pricing, they also must serve as an efficient mechanism for insurance. He said his operation anticipates phasing out 10 percent of the PGs now insured. “High risks will either be gone or pay to stay,” he said.

At the end of July, the R R Reporter listed 784 purchasing groups. Among the most active lines for which coverage is being sought is the residential apartment building industry. Interest in recent months has taken off, according to Cutts. Property owners and managers are being forced to scramble for coverage.

Joseph Elmasri, president of the New York City-based Aramarine Brokerage Inc., is quoted in the R R Reporter as saying that there has been a tremendous influx of inquiries from both the PG’s members and others who are interested in finding coverage. Aramarine is the broker for the NNA PG, which is a purchasing group responsible for placing insurance for its membership.

Elmasri reports a similar situation for ARA PG Inc., the purchasing group representing owners and operators of mostly commercial properties such as office buildings and shopping centers. Elmasri may be reflecting a general trend when he says that following an internal adjustment, underwriting will be more rigorous and pricing steeper than in the past for PG business.

Topics Carriers USA Texas Legislation Pricing Trends Market AM Best Vermont