The competition: Offshore

US Captive looks at the history of the captive movement and considers other jurisdictions that vie with the United States to attract captive insurers.

April 2006

No business is likely to succeed if it ignores the competition. Although the US is now home to two dozen captive jurisdictions, many of the individual States are playing catch-up with the major offshore jurisdictions.

The idea was as good as money in the bank, but was not producing any. In the early 1960s, Reiss, lawyer Sidney Pine and others could not convince a single company to be the first to step into a new age of self-insurance. Tucker, Pearman and Graham, each a pioneer and a man of proven vision, all reluctantly turned their back on the idea of captives and sold their holdings to Reiss in what would later become an extraordinarily profitable enterprise indeed. Each of the three came to benefit in other ways from captive insurance, as did Kempe, but as late as New Year’s Eve of 1962, there was no such thing as a captive insurance company in operation.

Captive insurance has been practiced since the late 1880s, although the very earliest companies would have been single examples built to meet a particular purpose, rather than representing a trend of any sort. The first captive as we know it was formed in Guernsey in 1922, according to insurance historian Michael A. Ward.

Guernsey’s early captives supported the oil and energy industries, the only companies large enough at the time, and sufficiently global, to be able to take advantage of what was then a novel idea, with sufficient risk to make the concept work, but without the support services today’s captives take for granted.

Frederick (Fred) Reiss of Youngstown, Ohio is referred to as “the father of captive insurance”. He doggedly persisted in bringing his idea to the marketplace and is credited with coining the term “captive”, in the process of forming an insurance subsidiary for an industrial client in the United States, as early as 1952. His legacy to the corporate world includes International Risk Management Group which, from its Bermuda home office, operates dozens of offices around the world as part of the Swiss Re group.

By 1961, Reiss had more or less formulated the rudiments of his plan, but had not yet settled on a jurisdiction from which to do it. As chance would have it, he met Bill Kempe, of Bermuda lawyers Appleby, Spurling & Kempe at a weekend event in Sussex, in England. At dinner, Reiss outlined his thinking. Kempe said he thought Bermuda could help and suggested a meeting after he returned to the Island a week or two later.

By the time Kempe got home, Reiss had beaten him to it, and contacted David Graham at Conyers, Dill & Pearman. Graham had established a useful relationship with Samuel Montagu, a London merchant bank he had engaged in the mid-1950s to help with the shipping proposition that kick-started Bermuda’s international business sector, using Graham’s extraordinary global network as kindling to spread the fire.
Montagu owned two large insurance broking firms in London. In 1962, at Graham’s suggestion, Reiss expounded to the bank the notion of establishing a captive insurance market in Bermuda. The bank responded favourably and proposed that Reiss join one of its broking subsidiaries.

This was no mean offer, but Reiss wanted to develop the business on his own. He, Jack (later, Sir Henry) Tucker, Graham, and his partner James (later, Sir James) Pearman formed a Bermuda company to begin the promotion of captive insurance business in Bermuda. Its prospects looked bright, but to the principals’ consternation, the new company failed to get off the ground. Insurance companies have always been of necessity the most conservatively-managed organisations, and everyone in their networks to whom the four men spoke replied that only when others had shown an interest and backed that attention with capital, would they follow suit.

Everyone agreed that captive insurance was a good idea, but no one was prepared to take the first step toward making it a reality. Reiss remained utterly convinced of its feasibility and bought out the shares of the others in the newly-formed promotional company.

Like all great ideas, the initial concept Reiss formulated was simplicity itself. It is said that there are no new ideas, only new connections. The connections Reiss made between existing insurance industry processes contained the seed of what has become a multi-billion dollar international industry.

If the parent company were large enough, Reiss argued, and its captive insurance subsidiary sufficiently well-managed, it would be possible for the subsidiary, in the fullness of time, to retain for its owners the brokerage fee and the element of profit contained in every insurance premium, instead of letting others earn that profit. If insurance professionals managed the captive, the service Reiss proposed to offer in Bermuda, the captive’s economic activity could effectively mimic that of the outside insurer who had hitherto received the premiums and provided the coverage.

The captive’s efficiency would be even greater than that of established North American and European insurance companies if the captive were located in a jurisdiction with a low incidence of, or no, direct taxation. The company’s tax-free status would act to speed up the rate at which the subsidiary retained its profits and enable it to build more quickly a core of capital to meet future contingencies.

No profit comes without risk, but a captive company, like any other properly-established insurer, need not bear the brunt of the risk it accepts in return for the premium it receives. Reinsurance is a device by which companies, for a price, can lay off their bets with other insurance companies. The overall risk a captive company, or any insurance company, actually lives with can thus be reinsured down to a manageable size. The average buyer of insurance has no idea that a dozen companies might carry the coverage he has purchased.

What Reiss had crystallised was a system which promised very real enhancements to the profitability of larger companies around the world. With hindsight, it seems remarkable that the idea did not catch on at once. Reiss was undeniably its architect and driving force. Those who knew him speak of his intense drive to succeed and an unshakable—and entirely justified—belief in the merits of captive insurance. Everyone shared the view that captive insurance would work and that Bermuda would prove an apt cradle. Unlike his Bermuda associates, however, Reiss was not well-off and therefore, one might argue, better motivated to succeed.

Even if, at this stage, companies could not be persuaded to insure their interests in Bermuda, the insurance establishment quickly enough saw the threat if the idea were to catch on. The mechanics of reinsurance suggested that the real danger would accrue to the brokers who earned a fee for bringing clients’ business to the insurance companies. Graham and Reiss between them fended off objections, first from the brokers and then from a major US insurer, all of whom were concerned that the new idea would somehow come out of their slices of the business.

History proved the two men right. Most of the brokers manage captive insurance companies these days. Far from suffering, the use of reinsurance has helped the primary insurers to thrive. By “joining the party”, in Graham’s words, all have been able to increase their wealth and reach.

Reiss succeeded in setting up the first Bermuda captive insurance company in 1963. The business grew slowly and six years later he was managing just 14 captives. History records that captive insurance came into its own in the 1970s and has retained its attraction ever since.

Bermuda’s early success did not go unnoticed, and soon other jurisdictions began to offer captive facilities. Bermuda remains the largest jurisdiction, with the Cayman Islands experiencing several years of powerful growth to put them in a strong second place. The British Virgin Islands and Barbados are not too far behind, among the Caribbean domiciles.

Guernsey, Luxembourg, and Ireland are the market leaders in Europe. Almost 40 domiciles are now available, spanning the globe, with Malta and Panama among the newest. In the Middle East, Dubai and Bahrain are both hoping to emulate the Bermuda model.

Estimates suggest that more half the world’s captives are US-owned. As the technique of self-insurance develops further, and word of mouth spreads the idea even farther afield, it is likely that the US will be among the market leaders. But captives are not easily uprooted or redomiciled, so the US jurisdictions will have to grow by attracting new business, rather than luring away companies from other markets.

With the momentum very clearly in the US’ favour, prospects for the American captive industry look bright—providing the US domiciles do not take their eyes off what the competition is up to

“Bermuda’s early success did not
go unnoticed, and soon other jurisdictions began to offer captive facilities. Bermuda remains the largest jurisdiction, with the Cayman Islands experiencing several years of powerful growth to put them in a strong second place. The British Virgin Islands and Barbados are not too far behind, among the
Caribbean domiciles.”