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Captive insurance groups help avert major risks

Three significant, recent captive formations in Vermont highlighted the evolving market for alternative-risk strategies at the 17th annual Vermont Captive Insurance Association conference in Burlington, Vt, according to Captive.com.

The most famous of the three--the Equitime risk retention group formed by the Air Transport Association--was designed to provide third-party terrorism and war-risk liability coverage for the ATA's member airlines. It was licensed in Vermont earlier this year. Also relatively new to the Vermont scene is Buena Vista, a captive created by Walt Disney Co. to provide the media giant with some tough-to-find coverages. And Wall Street investment bank Goldman Sachs & Co. developed Pearl Street Insurance Co. to finance Goldman Sachs' hazard and operational risks.

Jeff Johnson, an attorney with the Montpelier, Vt.-based law firm Primmer & Piper, said that Equitime is "about Sept. 11." The risk-retention group is an innovative solution by the airline industry to provide a specific type of coverage that would be difficult or too expensive to obtain in traditional markets, he said.

“Here we had 75 companies which are in brutal competition with each other. The task was to come up with structure they can agree was fair,"

"Airlines cannot fly without insurance; there's just too much exposure with each flight," he said. "And since Sept. 11, the cost of insurance has become very expensive. So the question was, how can we insure airlines with less cost and more efficiency? The choice was a risk-retention group, which when it domiciled in Vermont, could instantly operate in all 50 states."

Johnson said the airlines, about 75 of which are expected to participate in Equitime, settled on a reciprocal format for Equitime, which is slightly more tax-efficient. The reciprocal format is created by contract, with the members appointing an attorney in fact--in this case Equitime Point Services, based in Vermont--to administer the contracts. "Here we had 75 companies which are in brutal competition with each other. The task was to come up with structure they can agree was fair," said Johnson.

Under the reciprocal structure, there are Class A and Class B members, which contribute amounts of money depending on their size. Class A participants, which contribute more, also have more control over Equitime.

Thomas M. Jones, an attorney with the Chicago firm McDermott, Will & Emery, said that with reciprocals, the participating attorneys often are involved on a for-profit basis, giving the negative connotation that they are "milking funds" out of the insurance program. But there are tax advantages to the participants in a reciprocal risk-retention group, he said, and it became clear to Vermont regulators by 1997 that it makes sense to condone reciprocals.

"Every owner must be an insured, and every insured most be an owner," said Jones of the statutory structure of reciprocals. "Hospitals and other tax-exempt organizations might come together to form a risk pool, but they would have to pay taxes on that. Federal code allows reciprocals to calculate profit at the end of the year, and by the following March 15, they can make a bookkeeping entry to allocate proceeds, with tax savings."

The federal government will provide reinsurance to Equitime if losses exceed a designated amount.

So why would the federal government allow for-profit airlines to form a reciprocal group? "Airlines are essentially tax-exempt, since most of them operate at a loss year after year," Jones said. "The goal is to push that taxable income down to the participants, which essentially lowered tax impact. Vermont statute recognizes GAAP accounting rules related to risk-retention groups, rather than some NAIC guidelines--and something the IRS recognizes."

Jones added that acceptance of the Equitime model shows flexibility on the part of both Vermont and the federal government. "Here, the industry takes the initiative to essentially get the government out of the reinsurance business," he added.

 America's airlines, faced with spiraling prices and reduced coverage on insurance policies formed the Air Transport Association (ATA), a trade organization of U.S. airlines, and created Equitime, to provide terrorism insurance to airlines, protecting against acts of terrorism. Equitime will be a federally backed insurance company to handle the risk themselves.

The program’s first layer provides coverage up to $300 million by Equitime.  The Federal Aviation Administration will provide a second layer up to $2 billion.   If there are no terrorist attacks in the first four or five years, the program will then become self-funded.  This solution could ultimately save the airline industry hundreds of millions of dollars and protect against possible future government bailouts of the industry, according to the Captive Review.

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