A Look Ahead: What’s in Store for Captives in 2019?
Despite a persistent soft insurance market, ever-increasing global regulation, states taking a renewed look at procurement taxes, record-setting natural disasters and increasing cyber and other technology risks, the captive insurance industry remained strong in 2018. How will these issues impact our industry in 2019? What new issues may push today’s headlines off the front pages?
JLT Insurance Management (USA) LLC’s Thomas P. Stokes, Managing Senior Partner, and Executive Vice President and Captive Practice Leader Anne Marie Towle examine these and other issues that may have an effect on captive insurers in 2019.
By Thomas P. Stokes and Anne Marie Towle
Last year was eventful for the captive insurance industry. Court cases continued to test the legitimacy of micro captives and cash-starved state jurisdictions have begun to take a new look at procurement tax laws that have been on many of their books for decades. Will these events continue and will new issues get our attention? What will happen that affects captive insurance in 2019? Let’s take a look.
Taxes and Regulations
Count on taxes and regulations to continue playing a major role in the industry, perhaps more so than at any time in recent memory. With a full year of lower US tax rates under their belts, we expect U.S.-headquartered companies to continue redomesticating their offshore captives, especially if taxes remain stable.
A bigger issue when it comes to taxes and regulations is the renewed interest of states in procurement taxes on captives that have insureds in their states but are domiciled elsewhere. The most blatant example is in Washington, where the state negotiated a settlement with Microsoft’s Arizona-domiciled captive to pay back premium taxes, penalties and interest on premiums paid for Washington-based risk.
Disturbingly, Washington has indicated it will look back at least 15 years for other insurance underwritten in the state by captives domiciled elsewhere, announcing it will give these captives 18 months to self-report in return for reduced penalties and interest.
We expect legal action against Washington, if not first in similar cases in New Jersey and elsewhere. Affected captive owners should work with their captive managers and other counsel to determine their best course of action.
Micro/Small Captives, Group Captives and Cells
The past year began with the buzz still lingering over the Avrahami 831(b) court case, and it ended with potential class action brought by Arizona businesses against Arthur J. Gallagher Company and its subsidiary, Artex Risk Solutions, again revolving around micro captives.
Without opining on either of these cases, we can tell you the same thing we tell our clients. If you are considering the establishment of a micro captive, make sure you can document the legitimate insurance reasons beyond the action of electing tax code section 831(b).
As an aside, the years-long battles over micro captives have prompted many organizations to take another look at group captives. Some companies are reconsidering them to replace the micro captive variety. These organizations would rather avoid costly potential court action involving micro captive-related issues while, at the same time, previous concerns over segregating risk via group captives and cells have eased. Let’s not forget, either, that risk retention groups continued a strong run of profitability in 2018.
Where are Rates Headed?
In 2018 the insurance industry as a whole continued to sport significant capacity in most lines and, according to Fitch, commercial insurers’ profitability actually rebounded last year. It is in specific lines where we see a bump up in rates, which we expect will continue in 2019. However, we are beginning to see that the increasing unpredictability in certain high risk areas are causing investors to question potential returns, which could cause a withdrawal of available insurance capacity next year and beyond.
We have already seen a rise in cyber-related insurance claims coinciding with rampant cyber attacks and identity theft, but commercial capacity remains robust and rates have stayed stable. However, the flood of harassment claims in so many parts of business may bring Employment Practices Liability Insurance (EPLI) to the forefront if there is a corresponding increase in claims and judgments.
One area with the potential to introduce the most uncertainty in the market is technology, where drones, self-driving cars, and artificial intelligence are making the transition from theory to practice. As with any new development, traditional and captive insurers will need to closely monitor and quantify the risks and costs of potential claims in these new areas.
We are seeing a few companies write these risks into their captives. With captives helping individual companies look at their cyber risks through advanced analytics to fill gaps commercial insurance doesn’t address, we expect to see opportunity grow in this area. New technology risk is the Y2K of this generation.
Finally, reputational risk has become intertwined with technology, as social media and the Internet are 24/7 realities. How do companies track, respond to and change social media interaction when necessary? What are the associated costs when things go awry and do you have the policies to respond swiftly and efficiently? Captives are ideal for risk-aware companies to recoup related costs in a much more efficient manner than from a traditional policy.
Climate and Supply Chain
While we rightly pay much attention to the staggering direct costs of catastrophic weather, supply chain interruption is an often overlooked casualty of these cat events. Whether you believe record-breaking floods, hurricanes and fires are cyclical or a symptom of climate change, you can’t separate the billion-dollar impact of property damage and supply chain disruption. The captive insurance industry is well positioned to respond to these twin threats.
Healthcare stop-loss captives
Obamacare is the government-subsidized health insurance program that seemingly won’t die. Going into 2019, it has fewer subscribers, with the individual mandate now history, but additional states have opted to provide subsidized health insurance for lower-income taxpayers.
Meanwhile employers still provide most working Americans with access to health insurance, and it has been these employers who have pioneered stop-loss captives to slow healthcare’s increasing cost, sometimes carving out prohibitively expensive medical procedures to slow premium increases. Expect more uncertainty among insurers – captives and otherwise – until a more permanent health insurance solution becomes reality.
The industry is consolidating, of which we are intimately aware. In the past, big-name mergers and acquisitions usually triggered a “Can you top this” rush to follow, regardless of industry. As we said earlier, change is constant and it is often good. As in the past, we believe consolidation in the industry not only won’t adversely affect the quality of service, but it will increase creativity and provide even more opportunity for captives and their owners.
And There’s More . . .
Unemployment finished 2018 at a record low rate, and the Department of Labor’s Bureau of Labor Statistics reported there were now more job openings than candidates for those jobs. In times like these, a robust menu of employee benefits can make the difference in companies’ attempts to attract and retain the most qualified workers. While not ideal for all benefits, a captive may help employers reduce the cost of some benefits (compared to the traditional market) in some lines.
Another area to monitor is the Terrorism Risk Insurance Act (TRIA), which expires near the end of 2020. Expect to begin hearing about the urgency of revisiting this federal backstop sometime near the end of 2019, only to wait until Congress acts at the last second to approve – or not – some version of it.
A Look Ahead
Risks evolve over time, and only the most prepared will efficiently recognize, limit where possible and finance the risk that remains. As always, we believe captive insurance companies are best positioned to meet any risk challenges they encounter.
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JLT Insurance Management is a trading name of various JLT reinsurance broking entities and divisions globally and any services provided to clients by JLT Re may be through one or more of JLT’s regulated businesses.
Please note that JLT Insurance Management does not provide any accounting, legal, regulatory or tax advice and this material does not constitute such advice. Statements or analysis made by JLT Insurance Management in connection with this material which concern or incorporate accounting, legal, regulatory or tax matters should be understood to be general observations based solely on JLT Insurance Management’s experience as a reinsurance intermediary and risk consultant and may not be relied upon as accounting, legal, regulatory or tax advice, which JLT Insurance Management is not authorized to provide. All such matters should be reviewed with your own qualified advisors in these areas.