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2018 Vermont Report

Vermont: A Domicile For Captive Innovation

Cyber, trucking and terror risk in property are finding alternative risk homes.
By: | April 9, 2018 • 6 min read

As America’s largest on-shore domicile for captive insurance, and one of the first, Vermont is home to some of the oldest and largest captive insurance companies, as well as some of the country’s most knowledgeable and experienced regulators.

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It is a combination that provides a hospitable environment for captives looking to innovate in a rapidly changing world.

“Vermont’s been doing this for 30 years, so the regulators have the experience,” said Brady Young, president and CEO, Strategic Risk Solutions.

“They can sniff out a deal or some structure that doesn’t make sense, and if they don’t like it, they’ll let you know. But if it makes sense, generally they’re pretty supportive of letting people do it.”

That regulatory culture is evident in Vermont’s relatively open mind toward captive innovations in response to a number of emerging risks as well as emerging opportunities — like the growing trend of companies seeking to transform their captives from a cost center to a profit center.

“They’ve built up a surplus in a captive over the years, because very often companies will price their premiums at market rate,” said Dave Provost, Vermont’s Deputy Commissioner of Captive Insurance.

“They’re in a captive because they think they’re not getting a good deal in the market and so they do build up profits over the years.” Once a captive has built up that surplus, Provost said, the owner has a dilemma: “What do we do with it?”

Increasingly, the answer is to expand the captive’s offerings to include insurance products for clients, members, suppliers, etc., which are outside the company but related to it.

Avenues of Expansion

“States like Vermont have the flexibility to say, ‘Look if it’s controlled and related to your business — and the keywords are controlled and related — we’re comfortable that the risk that you’re putting in your captive is in a good business and solid business.’ They are supportive of allowing companies do it,” said Young.

Bill Mourelatos, managing director, Captive & Insurance Management, Aon Global Risk Consulting

Such expansions often take the form of extended warranties and service contracts.

“When it comes to vendors and suppliers, there is an opportunity for an owner of a single-parent captive to offer some insurance products to unrelated parties that they work closely with,” said Provost.

“We call it controlled unaffiliated business. You may not have legal ownership control, but you’ve got some effective control. If you’re either their largest customer or their largest supplier, you can exert some influence on them, and if you can do that, then you might be able to share risk with them in your captive.”

Other innovations arise in response to emerging risks from technology or sociopolitical developments.

“Captives have been insuring terrorism risk since 9/11,” said Bill Mourelatos, managing director, Captive & Insurance Management, Aon Global Risk Consulting.

“One advantage of putting some of the risk into a captive is that they can participate in the federal backstop or the TRIA Program. But I think another innovation, at least with terrorism, is that they’re including nuclear, biological, chemical and radioactive cover, which typically is excluded from commercial coverage,” he said.

“Since the federal government started backstopping terrorism insurance, captives have been utilized by property owners and other businesses, both large and small, that have a lot of risk in that area,” said Richard Smith, president, VCIA.

This is particularly helpful for utilities or high-profile real estate that might otherwise have trouble finding coverage.

“A major office building near Broadway sold for $800 million to a group of investors,” said Young, citing one example.

“Since the federal government started backstopping terrorism insurance, captives have been utilized by property owners and other businesses, both large and small, that have a lot of risk in that area.” — Richard Smith, president, VCIA

“They couldn’t find $800 million in terrorist protection. It wasn’t even a question of price, they just couldn’t find it, because everybody that writes property insurance for office buildings was already loaded up. We worked with them to use their captive to solve that problem.”

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Captives are often formed in response to risks that insureds feel aren’t accurately understood or priced by the marketplace.

“Everyone obviously is talking about cyber in every facet of business these days,” said Mourelatos.

“I think the captives will have a part in providing coverage in cyber, either through a gateway to the reinsurance markets or by retaining certain levels of risk.”

“Putting cyber coverage in your captive is something that the Vermont regulators are very open to and adept at approving,” said Smith.

“There are certainly a lot of products in the traditional insurance world that people are accessing, but many people prefer to put cyber within their captive program because of the flexibility and better understanding of their own risk profiles.”

New technologies like self-driving cars bring other challenges and, with them, captive innovations.

“The things that make it difficult for an insurance company to operate will all be present with driving cars: no pricing model, no certainty of where things attach, no history of court cases.

If it’s a completely self-driving car, who’s responsible? If it’s a partially self-driving car, what responsibility does the driver, if there is somebody identified as the driver, have? Even identifying ‘who’s the driver?’ If the car came to pick you up, who owns the car? So there’ll be a lot of questions and that will create some opportunity for captives,” said Provost.

Mourelatos agreed: “With the self-driving vehicles, captives will be at the forefront, because like anything, when there is a risk that tends to be somewhat unknown or uninsurable, it tends to go self-insurance first before the commercial markets get in,” he said.

“They understand the algorithms and the risks better than the commercial markets.”

Emerging Opportunities

Technologies like blockchain and cryptocurrencies are also sparking innovations among Vermont’s captives.

According to Smith, captive owners as well as traditional insurers are exploring the use of blockchain to protect important policies and documents that flow between organizations and clients.

Richard Smith, president, VCIA

“Vermont has actually been leading in terms of creating the structure for institutions to use blockchain for records management,” said Smith.

“Is there a place for captives as a tool to help mitigate the risk within a blockchain program? That is an area that we’re looking at very closely.”

Similarly, while the industry explores the use of cryptocurrencies for premium or claims payments, there may also be a role for captives in insuring them.

“We have had some discussions with cryptocurrency markets about ways that captive insurance might help indemnify some of their risks, in the event of some sort of market failure or loss,” said Smith.

Smith has discussed the area with Vermont’s lead regulators.

“They are open. They’re interested,” he said. “They’re going to be careful … to see where this goes, but they definitely are willing to have discussions about it.”

Other developments that may present a niche for captive innovations include the marijuana industry and its unique legal status.

“These owners are depositing their cash typically in a bank account, but most federally chartered banks will not take their money, so state-chartered banks are stepping up, but they’re not getting the FDIC Insurance and that’s where captives are being formed to provide that insurance,” said Mourelatos.

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“And that’s just one aspect. So I think there’s going to be a lot of captive play in the marijuana industry just because commercial insurers don’t have necessarily an appetite and because of the contradiction in the federal law.”

More mature sectors also turn to captives in response to issues with supply or pricing in the marketplace.

“Trucking and transportation-related risk is a challenging area right now,” said Young.

“Prices are going up, supply is going down, and clients are being forced to take more of the risk themselves.”

He cites a similar dynamic in liability and workers’ compensation coverage for nursing homes. &

Jon McGoran is a novelist and magazine editor based outside of Philadelphia. He can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Risk Focus: Workers' Comp

Do You Have Employees or Gig Workers?

The number of gig economy workers is growing in the U.S. But their classification as contractors leaves many without workers’ comp, unemployment protection or other benefits.
By: and | July 30, 2018 • 5 min read

A growing number of Americans earn their living in the gig economy without employer-provided benefits and protections such as workers’ compensation.

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With the proliferation of on-demand services powered by digital platforms, questions surrounding who does and does not actually work in the gig economy continue to vex stakeholders. Courts and legislators are being asked to decide what constitutes an employee and what constitutes an independent contractor, or gig worker.

The issues are how the worker is paid and who controls the work process, said Bobby Bollinger, a North Carolina attorney specializing in workers’ compensation law with a client roster in the trucking industry.

The common law test, he said, the same one the IRS uses, considers “whose tools and whose materials are used. Whether the employer is telling the worker how to do the job on a minute-to-minute basis. Whether the worker is paid by the hour or by the job. Whether he’s free to work for someone else.”

Legal challenges have occurred, starting with lawsuits against transportation network companies (TNCs) like Uber and Lyft. Several court cases in recent years have come down on the side of allowing such companies to continue classifying drivers as independent contractors.

Those decisions are significant for TNCs, because the gig model relies on the lower labor cost of independent contractors. Classification as an employee adds at least 30 percent to labor costs.

The issues lie with how a worker is paid and who controls the work process. — Bobby Bollinger, a North Carolina attorney

However, a March 2018 California Supreme Court ruling in a case involving delivery drivers for Dynamex went the other way. The Dynamex decision places heavy emphasis on whether the worker is performing a core function of the business.

Under the Dynamex court’s standard, an electrician called to fix a wiring problem at an Uber office would be considered a general contractor. But a driver providing rides to customers would be part of the company’s central mission and therefore an employee.

Despite the California ruling, a Philadelphia court a month later declined to follow suit, ruling that Uber’s limousine drivers are independent contractors, not employees. So a definitive answer remains elusive.

A Legislative Movement

Misclassification of workers as independent contractors introduces risks to both employers and workers, said Matt Zender, vice president, workers’ compensation product manager, AmTrust.

“My concern is for individuals who believe they’re covered under workers’ compensation, have an injury, try to file a claim and find they’re not covered.”

Misclassifying workers opens a “Pandora’s box” for employers, said Richard R. Meneghello, partner, Fisher Phillips.

Issues include tax liabilities, claims for minimum wage and overtime violations, workers’ comp benefits, civil labor law rights and wrongful termination suits.

The motive for companies seeking the contractor definition is clear: They don’t have to pay for benefits, said Meneghello. “But from a legal perspective, it’s not so easy to turn the workforce into contractors.”

“My concern is for individuals who believe they’re covered under workers’ compensation, have an injury, try to file a claim and find they’re not covered in the eyes of the state.” — Matt Zender, vice president, workers’ compensation product manager, AmTrust

It’s about to get easier, however. In 2016, Handy — which is being sued in five states for misclassification of workers — drafted a N.Y. bill to establish a program where gig-economy companies would pay 2.5 percent of workers’ income into individual health savings accounts, yet would classify them as independent contractors.

Unions and worker advocacy groups argue the program would rob workers of rights and protections. So Handy moved on to eight other states where it would be more likely to win.

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So far, the Handy bills have passed one house of the legislature in Georgia and Colorado; passed both houses in Iowa and Tennessee; and been signed into law in Kentucky, Utah and Indiana. A similar bill was also introduced in Alabama.

The bills’ language says all workers who find jobs through a website or mobile app are independent contractors, as long as the company running the digital platform does not control schedules, prohibit them from working elsewhere and meets other criteria. Two bills exclude transportation network companies such as Uber.

These laws could have far-reaching consequences. Traditional service companies will struggle to compete with start-ups paying minimal labor costs.

Opponents warn that the Handy bills are so broad that a service company need only launch an app for customers to contract services, and they’d be free to re-classify their employees as independent contractors — leaving workers without social security, health insurance or the protections of unemployment insurance or workers’ comp.

That could destabilize social safety nets as well as shrink available workers’ comp premiums.

A New Classification

Independent contractors need to buy their own insurance, including workers’ compensation. But many don’t, said Hart Brown, executive vice president, COO, Firestorm. They may not realize that in the case of an accident, their personal car and health insurance won’t engage, Brown said.

Matt Zender, vice president, workers’ compensation product manager, AmTrust

Workers’ compensation for gig workers can be hard to find. Some state-sponsored funds provide self-employed contractors’ coverage.  Policies can be expensive though in some high-risk occupations, such as roofing, said Bollinger.

The gig system, where a worker does several different jobs for several different companies, breaks down without portable benefits, said Brown. Portable benefits would follow workers from one workplace engagement to another.

What a portable benefits program would look like is unclear, he said, but some combination of employers, independent contractors and intermediaries (such as a digital platform business or staffing agency) would contribute to the program based on a percentage of each transaction.

There is movement toward portable benefits legislation. The Aspen Institute proposed portable benefits where companies contribute to workers’ benefits based on how much an employee works for them. Uber and SEI together proposed a portable benefits bill to the Washington State Legislature.

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Senator Mark Warner (D. VA) introduced the Portable Benefits for Independent Workers Pilot Program Act for the study of portable benefits, and Congresswoman Suzan DelBene (D. WA) introduced a House companion bill.

Meneghello is skeptical of portable benefits as a long-term solution. “They’re a good first step,” he said, “but they paper over the problem. We need a new category of workers.”

A portable benefits model would open opportunities for the growing Insurtech market. Brad Smith, CEO, Intuit, estimates the gig economy to be about 34 percent of the workforce in 2018, growing to 43 percent by 2020.

The insurance industry reinvented itself from a risk transfer mechanism to a risk management mechanism, Brown said, and now it’s reinventing itself again as risk educator to a new hybrid market. &

Susannah Levine writes about health care, education and technology. She can be reached at [email protected] Michelle Kerr is associate editor of Risk & Insurance. She can be reached at [email protected]