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Alabama: can captives fill the gaps?
A relatively recent newcomer to the captive world,
Alabama is a hotbed of captive creativity.
Roger Crombie reports
April 2007
The effects of Hurricane Katrina continue
to reverberate though the coastal region
that took the brunt of the storm, and also
through the insurance markets. While the
decision of Florida Governor Charlie Crist to
socialise homeowners’ insurance captured
the headlines, developments in the captive
market in Alabama may well have broader
implications.
The use of captives is being put forward as a means of providing an
alternative system to Governor Crist’s that would equally alleviate the
crisis in insurance coverage that has existed since Hurricane Katrina
put the wind up traditional insurance markets in the region.
South Alabama Regional Planning Commission executive director
Russ Wimberly and former Foley Mayor Tim Russell have been
promoting the use of a captive insurance company to provide cover for
commercial properties in the area. Russell resigned from his mayoral
post to pursue the captive proposal.
The two men initially approached five local governments in south
Alabama in a bid to raise $20 million to fund their captive concept.
At least two local governments indicated a general acceptance of
the idea, although the reception in Baldwin County was reportedly
lukewarm.
The move followed disruptions in the insurance markets following
2004 and 2005, when extraordinary hurricane losses in the coastal
region changed the dynamic of insurance coverage, especially for
coastal residents. Some insurance companies realigned their coverage
to reflect new standards, while others simply stopped writing coverage
for the region altogether.
The initial approach by Wimberley and Russell met with an optimistic
response. State Senator Bradley Byrne, who sponsored the Bill last
year to allow captive insurance in Alabama, expressed his approval
of the idea and offered to help in any way he could. The Alabama
Department of Insurance voiced no objection to the proposal.
It says a great deal for the distance captive insurance has travelled
since the first captives were formed in the 1950s that State governments
would embrace the concept. The whole point of alternative risk financing
is to fill gaps that the commercial markets do not or will not. Providing
a captive is managed according to best underwriting principles, it can
prove to be the exact solution for a particular problem.
Wimberley and Russell have been educating officials about the
captive process as they bid to raise the necessary capital. Their
recommendation to the local governments was that they should issue
tax improvement district bonds. Debt repayments could be made from
revenue generated by the captive.
The captive would be financed like any other insurance company,
through premiums on the properties it covers. A reinsurer would
assume part of the risk and help the captive stay afloat in the case of
catastrophes that cause losses of a size similar to those incurred by
Katrina or Ivan. Eventually, the captive could serve businesses and
cities throughout the State.
Supporters of the captive concept argue that it is the best way to ease
the insurance crisis at a local level in south Alabama as traditional
insurance companies reduce their local commitment and residents
face increased premiums from companies not regulated by the State.
The provision of reliable and affordable insurance, following this
argument, would in turn protect city, county and State revenues by
maintaining property values and easing the path for development that
is currently hindered by high insurance costs.
The danger in the proposal is that insuring only coastal Alabama is
a greater risk than insuring, say, all of Alabama or the entire US. The
law of large numbers at the heart of insurance requires the risk to be
spread across as large a pool as possible. The Alabama coast has
recently proved itself to be a dangerous place, and the insurers argue
that their premiums merely reflect a reality that cannot be ignored.
The proposal is for a business model new to the captive world, albeit
one based on traditional principles. After incorporation, the South
Alabama Regional Planning Commission would manage the captive
through a chief executive officer. Elected officials from governments
that invest in the captive would be asked to serve on the company’s
board.
The captive would receive a licence from the State Department
of Insurance, which would also set the dollar value of premiums it
could write based on its capital profile. Gaining commitments from
governments and establishing tax improvement districts to offset the
debt incurred by those entities would allow governments to tax entities
served by the captive in order to cover the debt and build capital,
Russell told a reporter.
The proposal would allow the captive to add on to a State premium
tax that is lower for captives than it is for standard policies. Alabama
currently taxes standard policies at 3.6 percent and captives at 0.4
percent. Parties in tax improvement districts that were insured by the
captive would pay 3.6 percent, with 0.4 percent going to the State and
3.2 percent to the captive.
Once the captive is established, businesses would be able to apply
for coverage. They would contribute to the captive’s capital, based on
actuarial calculations of risk. The structure of the coverage would vary,
depending on the property. In some cases, for example, the captive
would be able to cover the first $1 million in claims over the deductible,
and in others, it might choose to divide the risk with the reinsurer on
a percentage basis.
A captive is not a magic wand. The promoters of the Alabama
captive understand this and have proposed pushing for stronger
building codes and understand the need for the captive to buy
reinsurance. Leading reinsurance brokers have been contacted, and
have evaluated the region and the proposal. A greater understanding
of the risks attendant on coastal development is one of the dividends
of the process.
While the property captive was being pursued, State legislators
separately proposed a Bill that would remove prohibitions against
captive insurance companies offering homeowner and automobile
liability coverage. The Bill was read and forwarded to the Senate
Committee on Banking and Insurance. Senator Byrne is sponsoring
the legislation and State Senator Ben Brooks, whose district includes
much of Mobile County’s waterfront, is the Bill’s co-sponsor.
The Alabama Department of Insurance and many in the insurance
business were averse to allowing captives to cover residential property
and cars when captive insurance was introduced in Alabama, but
business models proposed by some captive managers have eased
those concerns. Plus, the industry’s voice is now muted. Even the
Department of Insurance is on board.
By the time the insurance situation in the US is fully stabilised,
those who live in the most affected coastal regions will have had to
learn that theirs is an expensive lifestyle. The insurance companies
are not wrong when they try to point that out. Insurers, by tradition,
are not a popular crowd, especially in the South, but their behaviour
is understandable. Had they understood and admitted the true cost
of insuring hurricane-prone areas sooner, some of the bitter dividend
they are now yielding might have been averted.
Part of the problem stems from inadequate construction techniques
used in the public and private sectors that have been encouraged by
tax revenue-hungry local authorities.
Free markets, the notion runs, set their own rates. In Florida,
intervention by politicians has created a structure that is thoroughly
unsound. In Alabama, and in other States such as South Carolina
that are showing interest in the idea, the politicians may have come
up with a better mousetrap.
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