Captive Insurance Industry Not Immune To Bad Economy

Copyright 2009 Crain CommunicationsAll Rights Reserved Business Insurance

March 9, 2009

SPOTLIGHT: CAPTIVE INSURANCE; Pg. 9

1254 words

Captive insurance industry not immune to bad economy; Credit concerns, cost, capital supply taking their toll on captives

RODD ZOLKOS and MICHAEL BRADFORD

No different from virtually any other business sector, the captive insurance industry is feeling the effects of the economic downturn and the crisis in the financial services industry.

The high cost and short supply of capital, dramatic downturns in the investment markets and concerns about counterparty credit are affecting existing captives and discussion of new formations.

While saying his firm still is seeing considerable captive activity, Gary Osborne, president of USA Risk Group Inc. in Montpelier, Vt., also said, ``Capital and collateral are the big holdups.''

``Banks aren't giving out letters of credit freely,'' Mr. Osborne said. ``There's an awful lot of interest, but capital and collateral are sort of holding us back a little bit.''

Mark Bernfeld, vp in the consultative placement division of Towers Perrin Reinsurance in Boston, suggested that the soft insurance market has been the biggest factor slowing captive formations. ``The economy has certainly caused a shortage of capital, which is another thing that has made captive formation more difficult,'' he said.

Derek Patience, head of office at Marsh Management Services Isle of Man Ltd. in Douglas, Isle of Man, and chairman of the Manx Insurance Managers Assn., said the soft market has slowed new captive formations the past few years in Europe as well, and he's seeing little change in the climate. ``Forming new captives is a strategic decision, and evaluating a captive is well down the list of strategic decisions at the moment,'' he said.

Brady Young, president and chief executive officer of Strategic Risk Solutions Inc. in Concord, Mass., said several conditions have to exist for a company to consider forming a captive. ``One, they've got to have risks to which the traditional market doesn't respond,'' he said. ``And two, they've got to have cash.''

Mr. Young said some potential captive programs that SRS was working with late last year have ``effectively been put on the back burner,'' most frequently for construction-related or real estate-related businesses.

``The captives that have been hit the hardest are the homebuilder captives because they can't afford to maintain the capital in the captive as well as the collateral they need on their fronting programs,'' said Nancy Gray, executive director of North American operations at Aon Insurance Managers (USA) Inc. in Burlington, Vt.

Richard E. Rabs, vp-claims and risk management at Veolia Transportation Inc. in Chicago, a company that operates captives in Dublin, Ireland, and Guernsey, said capital always is a consideration in a captive program, though the case for committing capital to a captive should be easier if the traditional markets harden.

``No CFO wants to just throw out money without understanding the full value of it,'' Mr. Rabs said. ``That's a little tougher when the market's soft. Clearly, now as we see the market shift, it's going to be a little easier to justify the expenditure.''

While saying the economy isn't posing issues for his company's Cayman Islands-based captive, Scott H. Beckman, vp-risk management and insurance at Oak Brook, Ill.-based Advocate Health Care Network, said he suspects it is for some captives and their parents. ``If you start facing some adverse loss experience, do you have adequate capital at the parent to sustain the captive operation?'' he asked.

Conservative investment strategies that are typical among captives spared most from serious losses in the recent market downturn, according to captive industry experts.

``For some years, since the 1990s when there were some problems with bond prices, captives have followed very conservative investment strategies,'' said Dominic Wheatley, chief marketing officer for Willis Group Holdings Ltd.'s International Captive Practice in St. Peter Port, Guernsey. ``I don't think they can get any more conservative than they have been over the last eight to 10 years.''

Investment strategies are ``certainly on the agendas of the (captive) boards,'' said Markus Mende, managing director at Aon Global Risk Consulting in Basel, Switzerland. ``There have been some investment losses on the captive side, clearly. I don't know if they have changed their investment strategies, but they are more aware of volatility.''

Mr. Osborne said he's seen current market conditions make some clients of USA Risk even more conservative investors. ``Most of our captives are sitting in Treasuries right now and laddered (certificates of deposit),'' he said.

In addition, some parent companies are tapping their captives for cash.

``What we're seeing in our existing captives is some parental borrowing and some dividend payments,'' said Nicholas S. Dove, president of Quest Management Services Ltd. in Hamilton, Bermuda.

Many parent companies are asking, ``How much working capital are we tying up in the captive?'' said Aon Global's Mr. Mende, and some are pulling out cash that isn't needed in the insurer.

However, as Solvency II draws nearer, European regulators are looking more closely at captives' capital levels, he said. Solvency II's risk-based capital requirements might make loans from captives to their parents more difficult.

J. Howard Stecker, senior vp at SMART Business Advisory & Consulting L.L.C. in New York, said he would expect regulators worldwide to look closely at captive-parent relationships. ``My guess is they're going to scrutinize some of these situations more closely, and they're probably going to be more restrictive on requests for people to take money out,'' he said.

But many say they believe regulatory scrutiny of captives and their parents remains appropriate. ``As long as the captive has excess capital, there isn't any reason the regulator should be concerned,'' said Quest's Mr. Dove.

``The regulators have been on top of it,'' said Aon's Ms. Gray. ``I think in general, the regulators are focusing on the strength of the parent company.''

Steven Chirico, assistant vp at A.M. Best Co. Inc. in Oldwick, N.J., said regulators worldwide are taking a closer look at all the risk-bearing entities. But the scrutiny on captives is not overbearing, he said, and there have been no legislative changes increasing pressure on captives.

Despite the challenges in the current climate, many see opportunities for captives if markets harden as expected later this year.

Richard A. Stasi, chief operating officer Avizent Alternative Risk in Lexington, Ky., which operates a Bermuda-based rent-a-captive facility, said a rent-a-captive option might be a way for entities to gain the captive program advantages while avoiding capital obstacles.

``A rent-a-captive option allows a lot of the clients to not worry about the initial capitalization,'' Mr. Stasi said. ``I think that's definitely going to be more in play with the turning of the market and the financial crisis.''

``We are seeing people looking to significantly expand the role of their captive,'' said Mr. Wheatley. ``There also is a lot of interest in alternative structures, such as protected cell companies and incorporated cell companies, as opposed to full-blown captives.''

Mr. Mende said Aon also is seeing interest in protected cell companies-``the incubators that are the first step to a full-blown captive''-as well as reviving dormant captive programs.

Best's Mr. Chirico said he's seeing the economy prompting some companies to move programs such as property into their captives to maximize the return on the program's frictional costs. And employers increasingly are considering funding benefits in captives, he said. Art Caption: counting captives * Largest captive managers worldwide

March 13, 2009