History of Captives

Historical Snapshot on the Captive Insurance Industry

It is generally believed that captives originated over 500 years ago in the 1600s ship owners in London met in Lloyd’s coffee shop to write down their names and value of cargo. Even earlier, shipowners in Italy’s seaport villages were making similar risk sharing arrangements. These are believed the first private agreements to share risks associated with shipping fleets and cargo. In the 1800s, New England textile manufacturers formed a group to share risks due to high fire insurance rates. In the early 1900s, the Episcopal Church formed the Church Insurance Company to cover risks associated with member churches. At the end of World War II, the use of captives expanded with the industrial boom.

The term “captive” was coined in the 1950s by Fred Reiss, known as the father of captive insurance, when in 1958 he formed American Risk Management. During this time, U.S. regulations made it prohibitively expensive to form and operate captives in the US. Bermuda in 1962 assisted Reiss in forming what is believed to be the first modern day captive.

By the end of the 1960s, there were approximately 100 captive insurance companies. Bermuda was the clear leading domicile and it and the Cayman Islands emerged as global financial centers accomodating these and other sophisticated hybrid legal vehicles. /1

By 1978, Bermuda became the first country to formalize the captive industry with comprehensive legislation and standardize licensing and oversight procedures. Cayman Islands immediately followed and wrote captive legislation targeting the healthcare industry. Harvard’s medical hospital formed one of the first pure Cayman Islands captives to supplement and control professional and medical liability risks due to increasingly expensive commercial market insurance and to improve claims and loss control.

By the end of the 80s, approximately 1000 captives were operating, nearly all formed and domiciled outside the USA.
Vermont was the first US state to promote its captive insurance statutes enacted in 1981. Vermont has grown into the leading US domicile today both in numbers of captive and total premiums written. Many additional US states (over 30) have enacted captive insurance company statutes, most since 2000.

Despite decades of losing tax disputes in court cases, it was not until 2002 that the US IRS finally agreed with the business validity and need for captives insuring the risks of their owners. In 2002 the IRS releasing 3 safe harbor rulings which are very important to this day. See Captive Taxation for more information on the US history of captive taxation.

As of 2011 over 30 US states authorize and regulate captive insurance companies. Determining which domicile or combination of domiciles work best for your situation is an increasingly difficult science only a small handful of professionals can truly navigate today. /2

As of 2010, approximately 6000 captives operated worldwide, responsible for more than $9 billion in annual premiums. /3

The captive industry is still, in many respects, in its infancy.

Rapidly Expanding Market

When Harvard University wanted to create a medical malpractice captive for its teaching hospitals, the Cayman Islands emerged as the domicile of choice as they enacted legislation that allowed them to write coverage for their hospitals as well as individual practitioner malpractice insurance. As of 2011, the Cayman Islands remains the leader in healthcare related captives and its role will likely expand due to increasing costs and complexity associated with healthcare coverage.

In the 1980s the US insurance market was troubling. Major corporations, big cities and even non-profits found insurance unavailable or terribly expensive. Hundreds of captives were formed in response. With expertise in the design and management of captives increasing, the use of captives is spreading throughout the private and public sectors globally.

Current Trends in Captive Insurance Industry

Captive insurance company growth in the US today is led by smaller companies and successful professionals using 831(b) captives to protect businesses. This special incentive to help make formation and operation cost effective for small insurance companies was enacted in 1986 during one of the US’s more troubling economic times marked by difficulty in finding affordable business insurance.

Most of the smaller captives formed today insure previously self-insured risks of affiliated businesses, generally not replacing commercial insurance programs. It usually takes these small insurance companies 2 to 3 years to mature and begin reducing commercial insurance expenses if accumulated loss reserves and surplus allow increasing deductibles and self-insured retentions on commercial coverages. In the event of hardening commercial markets, ownership of an affiliated captive could prove essential to ongoing viability of affiliated enterprises.

2007 began another period of financial trouble in the US economy including the technical insolvency and near failure of some large insurance companies. These companies today are increasing insurance costs and reducing the quality of coverage available. With rapidly rising health care costs, captives beginning in 2014 will very likely be increasingly used by small business to control rising employee health benefit costs while also achieving other objectives including strengthening and proctecting businesses.

Captive Market Size Today

There are now nearly 100 domiciles that license and regulate captives today all around the world. As of 2010 there were an estimated 6,000 captives globally. 831(b) captive growth should continue as the nearly 100,000 mid-market sized companies become aware of the benefits of captive insurance programs.

Health insurance related captives are anticipated to be a robust growth sector for captives due to expected increases in health care costs and related insurance. Domicile’s with related healthcare captive expertise, like the Cayman Islands according to Les Boughner, will be at the forefront of this important area.

Click here for more interesting background information on the captive insurance industry
Click Here for the 2010 leading domiciles in premiums, captive assets, number of captive insurance companies operating, and new captives admitted in 201

Notes and Reference Sources:
1/ The Cayman Islands and Bermuda emerged as global financial hubs not merely because of favorable tax laws and banking privacy practices as most believe. This occurrence was largely due to the global expertise of the professionals who chose to reside and do business there, and the impact that business expertise has had on the decisions made by government officials. Information technology and electronic banking advancements have also increasingly blurred the lines between nations and where one should conduct business and invest capital.
2/ Captive Best Practices Guidelines, (c) CICA, 2008
3/Rosemary McAndrew, Captives: Here To Stay, 2000