Cell Captive Formations Are on the March in Vermont. Here’s Why

For companies that wish to avoid the start-up and carrying costs of a standalone captive, a cell captive might just be the answer.

By: Alex Wright | April 27, 2020

Captive insurance was originally set up as an alternative for companies struggling to find affordable coverage in the traditional insurance market.

But what about those small- to mid-sized businesses that don’t have the means to or want the commitment of forming their own captive?

The answer comes in the form of sponsored cell captives or rent-a-captive cells, which enable such firms to participate in a captive with other similar entities, often either of the same size or in the same industry.

A cell allows the insured to retain a proportion of its own risks and better manage losses and associated costs without the full start-up and operating expenses of a standalone captive, and the burden of running the day-to-day operations, including claims, underwriting and reporting.

And the cell owner’s assets and liabilities are also protected in an account that’s legally and contractually segregated from the other participants.

They particularly benefit companies with a better than industry loss history, those that want to segregate a portion of risk from their existing standalone captive program or need a short-term risk management solution, such as captives in run-off.

Sponsored Captives rising The concept isn’t new: Bermuda spearheaded the first cell captive more than 20 years ago. But it’s only really starting to take off now, with sponsored captives the fastest-growing segment of captive formation in Vermont.

The U.S. domicile licensed four sponsored captives last year, bringing its total cell facilities to more than 37 and comprising more than 200 cells.

“Large companies have historically been the greatest users of captive insurance as a means to support their risk management needs,” said Ian Davis, director of financial services at the State of Vermont.

“But, for obvious reasons, the resources required for formation and management of a standalone captive can be significant and, in some cases, serve as a barrier to entry for many companies.

“The introduction of sponsored captives has helped to change that by allowing for small- and mid-sized companies to participate in an arrangement where you have the convenience of being serviced while still receiving the benefits of captive insurance. It’s also all without the costs normally associated with owning and operating your own insurance company.”

The recent popularity in cell captives is being driven by a greater awareness among companies of captive insurance and the benefits and efficiencies that can be gained by middle market companies. After getting a taste of what it’s like to run one, many companies use these types of captives as a stepping stone to either setting up their own sponsored entity within an industry sector or a single parent captive.

The Domicile of Choice

Vermont, the largest U.S. captive insurance domicile, has become an increasingly popular domicile to join a sponsored captive because of its favorable laws, robust regulatory environment and extensive and experienced service provider network.

The biggest growth areas are in medical stop loss, commercial auto liability, general liability, workers’ compensation and property coverage, according to Davis. As far as industries are concerned, he said the use is across the board, from long-term care facilities to manufacturing, agriculture, insurance, real estate, religious institutions and energy.

“The range of applications is broadly similar to single parent captives,” said Davis. “We’ve also seen many employers provide medical stop loss, typically on a reinsurance basis, to the cell.

“Another popular use of cell captives is actually among insurance companies that may have brokerage accounts or agencies that have clients or agents. But, overall it’s a broad representation across all industries.”

Strategic Risk Solutions (SRS) manages nine sponsored captives domiciled in Vermont, with 22 active cells. The turn-key captive solution covers traditional property and casualty risk as well as providing group medical stop loss programs.

Dave Tatlock, chief financial officer at SRS, said the key benefits of cell captives are their speed to market, simplified administration and lower capital requirements compared to a standalone captive.

They also provide flexibility for a host of different applications from large homogenous groups of companies, each with their own cell, to an individual captive owner with multiple cells.

“Because there’s already a license in place, you can get it off the ground in a relatively short timeframe, as well as streamlining some of the administrative aspects of running your own captive,” said Tatlock.

“You also only require the basic risk capital and not any additional amounts sometimes associated with standalone captives.”

Tatlock said that Vermont was a domicile of choice for cell captives because of its strong track record of facilitating that business and the fact it has been built on legislation governing sponsored captives, taking on broad feedback from the industry.

A Transitioning Market

Nancy Gray, regional managing director, Americas, at Aon — which owns a White Rock Group sponsored captive that has 250 cells under management, writing more than $750 million in gross premiums, as well as managing a host of other sponsored captives in Vermont — said the growth in cell captives is being driven by the transitioning market.

Nancy Gray, regional managing director, Americas, Aon

She added that a company’s decision to stay with its cell captive or form a single parent captive afterwards is largely based on the reason why the cell was established.

“If you are going to be retaining risk in your cell, then it’s likely you will look to form a standalone captive,” said Gray.

“But if you’re just using it to gain access to the reinsurance market for additional capacity, then it’s less likely you will establish your own captive.”

A large proportion of the sponsored captives Aon manages in Vermont, Gray said, cater to the health care sector, where providers want to segregate professional medical liability risk in different cells rather than retaining it all in a single parent captive.

Among the main upsides of a cell captive, she said, are more flexible capital allocation, enabling companies to fund their own risk, and the fact that the sponsor takes care of corporate governance, freeing up its time and resources.

“Vermont is also a very stable domicile where the regulators have a great depth of knowledge and understanding of sponsored captives. Its whole approach and appreciation of the business needs behind forming and maintaining a sponsored captive is second to none,” Gray added.

Expanding the Reach

To facilitate this growth of sponsored captives, Vermont introduced new legislation in April 2019 for the specific inclusion of sole proprietorships among eligible businesses to be cell participants.

There are also new proposals to change the minimum core capital requirement for sponsored captives from $250,000 down to $150,000, provide the flexibility to offer coverage for unaffiliated business in a cell captive in the same way as a standalone captive, and explicitly allow companies to form separate accounts within a cell.

“Now, years after having put the legislation in place for sponsored and cell captive formation, we are starting to see more and more companies reap the rewards,” Davis said. &

Alex Wright is a UK-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at [email protected].

Why Insureds Might See an Uptick in M&PL Claims

George Schalick, Jr., Senior Vice President of the Management and Professional Liability Division, Philadelphia Insurance Companies

The current soft market might come as a bit of a surprise as it does not track with previous underwriting cycles and economic conditions. Afterall, many privately held and non-profit organizations struggled during the early days of the pandemic with shutdowns and rapidly declining revenues. But the Government assistance programs, like the Paycheck Protection Program loans, helped keep many afloat during the tough times.

“During COVID many organizations stopped doing business until they were able to sort out all of the health and safety challenges,” Schalick said. “They were forced to lock down, but then all the government assistance programs allowed them to keep people employed. The increased volume of claims we anticipated we would see coming from the lockdowns and restrictions that were imposed upon businesses in the U.S. didn’t manifest at first.”

“Just because there wasn’t an onslaught of reported claims at the beginning of the pandemic, doesn’t mean the circumstances that would give rise to a claim being reported didn’t occur. Courts and the judicial system were closed or slowed and now that they are back open, we’re starting to see the circumstances that occurred during the COVID lockdowns becoming claims today,” Schalick said. “Litigation is progressing.”

Added to the delayed pandemic litigation is a concern over newer claims that might be filed as the country inches toward an economic downturn. Though a recession was avoided in 2023, experts think a soft dip could occur in 2024, with 76% of economists saying there’s a 50% or less chance of an economic downturn this year — that almost always results in more management liability claims.

“During the Great Recession in 2008, we saw an almost immediate spike in claims because of the economic conditions and the pressure it placed on organizations. They were making personnel changes with significant belt tightening almost immediately.” Schalick said.

What’s in Store for M&PL Policy Rates in 2024?

Despite an uptick in claims and increased economic uncertainty, management liability rates haven’t increased, resulting in market-wide pricing levels that may not meet the increased pressure of rising settlements and jury verdicts.

“Rates are going the other direction and settlement values are not falling,” Schalick said.

The mismatch between rates, claim frequency and severity is, in part, because carriers experiencing the dramatic soft market in the public D&O market are seeking premium gain in the private and non-profit market.

“In the public company market, the rates have been decreasing significantly. The rates were increasing in the private, not-for-profit market, and rightfully so, but there’s a desire to supplement overall mid-size D&O for carriers who also write private not-for-profit, and they see that as an opportunity to aggregate premium,” Schalick said. “So the always competitive landscape in the private, not-for-profit market has dramatically increased in the last 18 to 24 months.”

Still, companies of all sizes and types should be concerned about management liability rates in the future. Legal system abuse is resulting in increases in both the amount of litigation and the size of verdicts plaintiffs are receiving.

Certain areas of the country are particularly vulnerable to this type of legal system abuse. As a result, insureds in these localities are likely to be vulnerable to rate increases.

“The environment is so positive for the plaintiff that forces premium increases so carriers are able to stay in that market long term,” Schalick said.

Why a Tenured Carrier Partner Can Help Insureds Navigate An Uncertain Market

It’s clear that insureds are facing an uncertain M&PL market over the next few years. Fortunately, carriers with a long history in the M&PL space will be there to offer stability.

Philadelphia Insurance Companies has been supporting this market for 35 years. PHLY is committed to offering long-term rate stability, even as economic and claims trends start to push premiums upwards. They have an appetite for all sorts of companies, large and small, for-profit and nonprofit alike.

“We’ve been at this game for a long time and are one of the most tenured underwriters in this space,” Schalick said. “We like to stay very consistent.”

PHLY has worked with both for-profit and non-profit on management liability policies. With dedicated M&PL teams throughout the company’s 13 regions, PHLY provides the support agents and brokers are looking for on behalf of their clients. The teams know their regions well and can respond to local trends. They’re also dedicated to making the renewal process as easy as possible for their partners and policyholders.

“We have real confidence in our results, so we focus a lot on making the renewal experience as painless as possible for all agents and insureds,” Schalick said.

The company is also investing in tools to help insureds avoid losses. Earlier this year, they launched a new online risk management platform, PHLYGateway, which offers resources for insureds on how to create an employee handbook and trainings on issues such as recognizing workplace sexual harassment and discrimination.

If insureds have questions, they can consult a Best Practices Help Line, provided via the platform. That way, they can get on the spot risk management guidance to help them prevent claims.

To learn more, visit: https://www.phly.com/mplDivision/managementLiability/default.aspx.

This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Philadelphia Insurance Companies. The editorial staff of Risk & Insurance had no role in its preparation.