Fitch: Captive Insurer Intercompany Loans Pose Potential Liquidity Risks

Fitch Ratings believes pure captive insurers potentially increase their liquidity risk when they make intercompany loans to their parent company sponsors, according to a report.

This liquidity risk can weaken the credit profile and rating of the captive. However, this incremental liquidity risk can be mitigated via sound loan structuring.

Intercompany loans can be material, often exceeding 95 percent of a corporate-sponsored captive's invested assets. Additionally, the terms of such intercompany loans vary from captive to captive, or sponsor to sponsor. Thus, an understanding of the particulars of the specific loan agreement and how those terms interact with the claim profile of the captive is important in drawing any conclusions.

"The presence of material intercompany loans highlights the linkage between the solvency of the captive and the solvency of the parent company sponsor. This linkage makes it difficult, or even impossible, to develop a credible opinion about the captive's credit profile without a thorough understanding of the sponsor's credit profile," said Donald Thorpe, Senior Director, Fitch Ratings. "Intercompany loans present a potential liquidity risk that could arise if claims volume rose unexpectedly."

When an intercompany loan is a material portion of a captive insurer's invested asset base then the terms and conditions of the loan can have a critical effect on the credit risk of the captive. Fitch further believes well thought-out, comprehensive loan agreements that provide captives with liquidity across a broad spectrum of possible claims scenarios - both expected and severe - represent the lowest credit risk to a captive. Conversely, loan agreements that limit a captive's liquidity in times of stress can impair the captive's credit profile.

This incremental risk can be either magnified or diminished depending on the type of insurance written by the captive insurer. For example, property catastrophe insurance is vulnerable to sudden, unexpected, large losses. This can increase an insurer's need for liquidity. Conversely, liability insurance claims tend to develop over time and are often characterized by more predictable claims payout patterns. This tends to make it easier for an insurer to plan its liquidity needs.

If the claimant of the captive is its sponsor, liquidity may be less important if the captive has the ability to net claims payments against the intercompany loan. The ability to net claims against outstanding loans, if any, is likely to vary depending on the loan agreement, the insurance policy, regulatory policy, the type of coverage and the captive's claims handling practices. Each situation needs to be judged given its unique circumstances.

Other mitigating factors include liquidity that may potentially be available via bank letters of credit or reinsurance policies.

A full report is available at fitchratings.com or by clicking on the link above.

Additional information is available at 'fitchratings.com'.

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