Are Captives the Answer for Uninsured HOAs? Utah Opens Door

When actuary Greg Fears attended a Western Region Captive Insurance Conference in April, he expected to learn and share information about emerging uses of captives for commercial risks, including trucking captives—a recent focus of his attention.

But during the last session of the conference, Fears, a director and consulting actuary for Pinnacle Actuarial Resources, heard something he hadn’t heard in his 20-plus years of captive advisory work. When Utah’s representative spoke up at that final panel, consisting of a group of regulators reporting new developments in their state, Utah’s captive director said his state passed legislation to allow homeowners associations to form captives in Utah.

Fears checked the law after the session. As of May 1, 2024, Utah Code Section 31A-37-202 states that “if approved by the commissioner….an association captive insurance company that satisfies the requirements of this chapter may provide homeowners insurance.”

“This is a monumental change in the captive insurance market,” Fears wrote in a blog post on the Pinnacle website that he penned after the captive conference to deliver the game-changing news. Noting that there are 30 or 40 states that have captive legislation, “what hasn’t been included in the past in that captive legislation is allowing personal lines type insurance,” he told Carrier Management during a recent interview.

There’s only one exception that’s come close previously—laws allowing tenant legal liability insurance for captives owned by landlords—”but typically it’s a fronted program with an A-rated carrier, and the captive is assuming part of the risk,” Fears said.

Utah is different. Utah is allowing captives in response to the current struggles of homeowners in any catastrophe-prone states where traditional residential insurance coverage is becoming increasingly unaffordable—and unavailable. “You are seeing traditional insurance companies pull out of Florida, pull out of California, or send nonrenewal notices to reduce the writings in those states. Some customers are going bare with their insurance,” Fears said.

The director of Utah’s Captive Insurance Division, Travis Wegkamp, who spoke at the captive conference, confirmed to Carrier Management that this opens up opportunities for HOAs in wildfire-exposed areas of California as well as Utah, and even those located in hurricane-exposed regions of Florida. “The captive itself would be a Utah entity but the parent company or the association can be from anywhere in the world really,” Wegkamp said.

Fears, stopping short of predicting that HOA captives will be the next big trend in the captive insurance market, said that availability and affordability issues have spurred the development of commercial property and commercial auto captives in recent years. “If we continue to see the traditional insurance companies pulling out of states where there are those catastrophe exposures or they’re writing exclusions on all that cat exposure, you could see captives starting to step in to fill that insurance need for homeowners,” he said.

William Wilt, president of Assured Research, took a bolder stance after reading about the Utah law change, ironically, in the blog item posted by Fears. “If other states follow Utah’s lead, it could represent an existential threat to homeowners insurers,” Wilt wrote in a research report he published in June. “If you need to prove to a bank that you have homeowners insurance (or simply want to protect your most significant asset), what other options do you have?” he asked.

What does the regulator that prompted the predictions think?

“I see where they’re coming from. At this point. I wouldn’t agree that it’s an existential threat,” said Wegkamp. “However, you could say it’s a crack in the door. It’s slightly open now.”

“That said,” he continued, “it’s certainly not a free for all. It’s limited to associations, and we’re going to take a close look at what the proposal is and make sure that we’re comfortable with it,” Wegkamp said.

Utah Responds to a Need

Providing some of the backstory of the revision in Utah’s insurance code, Wegkamp said the department was aware of the hard homeowners insurance market that developed over the last several years. “And certainly, in the last year, we’ve heard a lot of horror stories of people not getting renewals for their homeowners policies or just exorbitant rate hikes. A lot of those stories [are] coming out of Florida in the coastal areas, as well as California, [growing] with the fire dangers and what appears to be a rise in the amount and severity of those fires happening, particularly during the summer months.”

“Utah has seen some of that as well in those high-threat fire areas,” he said.

Comparatively, CoreLogic, a risk modeling firm estimated in its “2023 Wildfire Risk Report” that Utah ranks ninth among 14 wildfire-exposed states with 68,135 homes at risk for a total reconstruction cost value of $32.8 billion. California, ranked first, has almost 1.3 million homes exposed with a total reconstruction cost value of $760.8 billion.

Travis Wegkamp, Utah Captive Division

Members of the Utah Captive Insurance Association were among those sharing concerns about homeowners availability. “We got to thinking about whether there was something maybe captives could do out here in Utah to help alleviate that, [to] provide an alternative,” Wegkamp recalled, noting that he proposed the idea to the commissioner. The regulators ultimately decided to “start slowly” with an enabling rule for association captives.

That means “everybody involved has some skin in the game,” he said, explaining the limitation to association captives. “Each member has some say or some ownership in the association that they’re getting the insurance from,” he said, contrasting the association structure to “a pure captive arrangement where they’re insuring their own risks.”

The law, however, is not explicitly limited to HOAs, he stressed, explaining that the decision not to be that specific allows “other communities or other like-minded individuals to get together to form an association to insure their risks.”

What Wegkamp describes as having “skin in the game,” in Fears’ view, could translate into the HOAs requiring homeowners to engage in loss mitigation activities—a potentially big benefit of getting insurance through a captive. “There are various risk mitigation techniques that could be required if you’re a homeowner,” Fears said, referring to activities such as trimming vegetation around the house or having a special coating applied to the roof of each house in wildfire-exposed communities. “If everyone in your neighborhood is doing that, it should cut down on the risk if there is a wildfire event—prevent it from spreading as dramatically as it might had you not done those things.”

There are also disadvantages for homeowners considering participating in association captives, Fears noted. “In the traditional insurance market, insurers are protected by guaranty funds. So if the traditional insurer goes insolvent and can’t pay claims, there’s a backstop.” In the captive space, “it’s the money that you have in the captive from capital, from surplus, from premium—that’s what pays claims. And if you run out of money, you can’t pay claims….”

That’s a risk that, until now, most states haven’t put in the hands of insurance buyers who are not managers of sophisticated commercial enterprises. Wegkamp explained the reluctance: “We don’t want captives involved with general public risk, partly because they’re not regulated as heavily as a commercial carrier, don’t have those accreditation standards when it comes to doing those reviews, don’t have the admitted assets to make sure that they’re really conservative in their financial approach. We don’t look at RBC [risk-based capital] and certain ratios nearly as much.”

He reiterated that the Utah department alleviated those concerns by experimenting with association-type captives first. “We can’t force everybody to know exactly what they’re doing when they get involved with the captives, but hopefully by being an association member, they’re privy to that information and they can go into it with their eyes open and know what they’re potentially getting into.”

Fears believes HOAs have the sophistication needed to build captives. “It’s a natural progression because you already have a board, you’re already setting rules, regulations, guidelines for all the association members. You’re collecting dues, you’re dealing with budgets, you’re managing the property, you’re managing service providers for the property”—all providing a solid basis to running a captive insurance business, he said.

The minimum capital requirement for association captives in Utah is $750,000, which Wegkamp confirmed is a level of capitalization that makes the most sense for wealthy homeowners. “That was initially what we envisioned this to be—for high net worth individuals that likely don’t have a mortgage and can go out and do things like this….However, giving it some thought, we decided that in the code we’re not going to limit it. We’ll go ahead and leave it open so potentially other communities where most people do have a mortgage could do this as well.”

Wegkamp offered advice for those in the second group. “You don’t want to go down the path of spending all this money and expense in developing a business plan and getting a feasibility study just to find out that the bank, the mortgage holder, isn’t going to accept paper from a captive. They need to be aware of that and get all their ducks in a row before they pursue an association captive,” Wegkamp said.

He added that in these circumstances, Utah regulators will “do a deep-dive review,” probably making sure that some captive members have gotten OKs from mortgage lenders. “Maybe not all of them. Who knows how many will be out there in a certain community. But we’re going to look into that and make sure that those things were clarified and gotten approval for—and just make sure that everybody’s quite aware of the captive situation.”

“We’re going to do our due diligence with those that don’t have mortgages as well….But there would definitely be less concern,” he said, noting that Utah is already engaged in discussions and fielding proposals, without disclosing which types of homeowners are involved.

Pinnacle Actuarial Resources, which provides feasibility studies, funding studies, reserving analysis and statements of actuarial opinion for captives, has seen interest building on the high-end of the spectrum. While Fears couldn’t disclose much information because of confidentiality agreements, he said one client is a group with multimillion dollar houses in California.

“We’re looking at both the traditional way insurers would rate homeowners insurance with the HO3 insurance, and then also looking at the catastrophe risk, looking at cat models for wildfire risk specifically in this area of the country, to blend that with commercial insurer rates” for pricing indications, he reported.

As Carrier Management has reported separately, California currently doesn’t allow traditional insurers to use catastrophe models in ratemaking—a restriction that is set to change under California Commissioner Ricardo Lara’s Sustainable Insurance Strategy. (Related article, ‘Sorry, Wrong ZIP Code: Regulators Move Forward With California Reforms“)

Utah would be the primary regulator for any groups of California homeowners that set up Utah captives, Wegkamp confirmed, but he could not speak with certainty to the question of whether California regulators would maintain oversight into the use of models in ratemaking. “I just don’t know. [But] that might be another reason why they’d want to limit this to individuals that don’t have mortgages. Presumably, [if] they want to get insurance from a captive, there wouldn’t be any sort of regulation in that regard because they’re not protecting a mortgage lender if it’s just their own coverage,” Wegkamp speculated.

Beyond High Net Worth: $40B+ Premiums

Carrier Management asked Fears how the economics of traditional insurance coverage stacks up against those of a captive. Comparing premiums paid to traditional carriers with the capital, fees and costs of services that go into setting up a captive, does the tradeoff make sense?

“They were looking at starting their own E&S carrier before,” said Fears, referring to his current client looking to insure multimillion dollar homes. “I don’t know that cash is an issue. They just want insurance.”

Speaking more generally, Fears said that the biggest cost difference lies in the expense loads that go into the premium calculations. In the traditional market, profit contingency margins and overhead expenses can account for 30 percent of the premium—a much higher expense load than a captive load, even after adding the cost of reinsurance, he indicated.

Greg Fears, Pinnacle Actuarial Resources

Also, “in the traditional market, the majority of the time, you’re rated on the carrier’s book of business. What do their losses look like? Maybe it’s tailored specifically to your industry, to your geographic location, or how expensive your house is. But ultimately it’s what is in their book—what losses they have sustained as a whole goes into what you pay in premium.”

In the captive scenario, actuaries will look at what the traditional market is charging for insurance, but they can also look at a group’s actual claims experience history. “You can really tailor the premium more to your loss experience rather than Allstate’s experience or The Hartford’s or State Farm’s….If you have favorable claims experience, you could pay less in premium.”

“Ultimately that premium is your dollars paying the premium for your claims,” Fears said.

Although Wegkamp and Fears both thought that communities of high-net worth homeowners were most likely to consider the captive alternative, Wilt at Assured Research sees reasons for the movement to spread further. “It feels to us like the public backlash against homeowners insurers (over high prices and availability shortfalls) is growing,” he wrote, suggesting that’s why homeowners might opt to control their own insurance destiny.

Wilt’s report tallied up estimates of the number of people living in homes governed by HOAs—roughly 76 million, or 23 percent of the population (based on data from a realtor website, checked against data from the Census Bureau’s American Housing Survey). He intersected that data with insurance data to conclude that $40 billion homeowners premiums—or more—”could, in theory, be subject to disintermediation.”

“We don’t like to engage in hyperbole and recognize that a lot has to happen before homeowners insurers face meaningful risk of disintermediation from captive HOAs, even if other states follow Utah’s lead,” Wilt wrote, noting that there are operational issues that argue against this, such as captive capital requirements and insufficient spread of risk. “We’re inclined to think, however, that there could be cadres of (re)insurance and brokerage professionals sufficiently intrigued by this development to invest time contemplating ways to tap into this potentially large addressable market,” he wrote.

When Carrier Management described the Utah law change to the leader of a traditional homeowners insurance organization, and shared Wilt’s supposition that it could be an existential threat to the industry, Bill Martin, president of Plymouth Rock Home Assurance, flagged insufficient spread of risk as a “fundamental problem” for captives. If a captive is created from a neighborhood in a wildfire zone, then “the sum of all the values in that neighborhood is the likely loss in a wildfire,” he said.

“That’s way more than you’re going to charge everybody…. You’ve concentrated the risk. All of it’s going to get hit by the same catastrophe if it gets hit, and immediately you’re going to be insolvent.”

“Financially,” Martin said, “I don’t understand how the local aggregation of risk could possibly be more affordable than the spread of risk that we provide in the regular industry where I can take one home in separately exposed neighborhoods and combine them together. My worst loss in any one event is one of those homes or two of those homes, not 50 of them.”

“The math gets really difficult,” he said. “My guess is they’re going to turn around and buy reinsurance and have somebody to manage those programs and end up being in the same economics that we are. That puts them at a disadvantage because there’s no scale and no buying power and no ability to retain some portion of the risk.”

Related article: Read about Martin’s innovations at Plymouth Rock Home Assurance in a profile soon to be published in the third-quarter print edition of Carrier Management.

“We’re likely going to want to see it be a large HOA that maybe has a pretty significant-sized community” to minimize the prospect of being wiped out by one single catastrophic event, said Wegkamp, responding to a question of whether groups of HOAs forming captives together might develop instead. “That’s a good question,” he said, pausing thoughtfully. “There may not be one single community that unless they’re very wealthy individuals [is] willing to reserve for the potential of a mass loss. It’s doable, but it’s more likely that you get maybe a homebuilder who brings together all their HOAs from around the state or other states that come together,” he said, reiterating that the law change does not restrict the captive option to HOAs.

William Wilt, Assured Research

“We want to allow these organizations to come together potentially and help diversify risk,” he said, noting that proposals bringing together Florida coastal communities with areas of California and those in the mountains of other westerns states have been talked about.

As for the appetite of the reinsurance market, Fears said the reinsurance and the excess markets have been challenging in the commercial property space. “It’s been getting better, but it definitely was in a hard market” making it difficult for commercial businesses to fill out their towers, he said.

Whether reinsurers will be willing to entertain “something new and different” in the form of homeowners captives is a big question, he agreed.

More Captive Mechanics

Asked about traditional insurance companies, Fears also agreed that carriers could take on the types of roles they play now in commercial insurance captive scenarios—providing paper in fronting arrangements (ceding the risks back to the captive), or providing claims handling services.

“It’s creative and it’s interesting,” said Martin, speaking generally about the Utah law change. “If [captives] get a regulatory advantage, my guess is that there will be some insurers jumping in to try and help people set these things up. It’ll be an ironic way for insurers to avoid the regulatory disadvantages of being a normal old mean ‘you-have-to-say-no insurer,” he said.

Bill Martin, Plymouth Rock Home Assurance

Asked about the idea that the ability to use cat models for pricing California risks might be a regulatory advantage, Martin noted that California will soon allow carriers to use them if they agree to write a certain share of risks in wildfire-distressed areas. “Cat models will enable the insurers to ask for more when there’s been a relatively calm cat period. Right now, [homeowners] just can’t get insurance, so they’re paying a lot just to get the rare one that’s available. And there’s no competition. It’s a competitive failure.”

“Once you have the competition back and you’re allowing models, your rates won’t go up and down with short-term events as often,” he said, offering the theory of California’s in-process regulatory change.

For associations that want to take advantage of Utah’s recent law change, Fears listed several questions to consider as they evaluate the idea of starting captives:

• How much capital will be required? Beyond the minimum capital requirement, HOAs will start by considering the total insurance values of each home, and any deductibles that might be applied.
• How much reinsurance is appropriate? How much risk does the homeowners association want to take on? How much risk do the policyholders want to take on? Does reinsurance need to be A-rated?
• What will be the adoption rate within the association? Do you need a certain percentage of your homeowners to say they’re going to contribute and purchase insurance from the captive? Does the association require everyone to join?
• Will everyone have to engage in risk mitigation techniques even if they don’t purchase insurance from the captive?
• Will the captive also cover communal properties—the club house, golf course, grounds, community pools, etc.—managed by the HOA?

In his blog post, Fears also added D&O insurance for the HOA board and workers compensation deductible reimbursement insurance for community staff as possible coverage options to consider adding to the captive.

Carrier Management asked Fears about the possibility of that a captive might provide wildfire-only coverage in situations where traditional carriers might provide homeowners insurance excluding wildfire. Fears said he’s seen that in the commercial lines market, where commercial property insurers are increasing wind hail deductibles or excluding wind hail, and insureds are looking to captives to take on those excluded claims. In the homeowners situation, however, there would be a challenge for coordinating the people who have that particular exclusion on their current policy or who are insured by a certain carrier that excludes wildfire, and then pricing the specific catastrophe risk, he said.

What about auto insurance?

While consumers are also facing affordability issues with auto insurance, Fears said that historically, captives fill a void when both affordability or availability issues exist together. For auto, “I don’t know that there’s an availability issue,” he said, pointing to the existence of nonstandard auto carriers.

For now, only Utah has opened the door for homeowners, but should the movement spread, there are other reasons to consider Utah, Wegkamp said when asked about the state’s captive environment. “We try to be a cost-effective state. One key benefit to having your captive in Utah is there are no state premium taxes. It’s just a flat license fee of $7,500,” he said, noting that the combination is appealing to small and large captives. “Without the state premium tax, there’s really no punishment for growing your program. You can do premium of a million or a hundred million, and you’re just going to pay that $7,500 fee,” he said.