Companies Rethink Financing of Captive Insurers

Facing tight credit that's likely to become costlier still and the need to find cash to fuel renewed economic growth, companies are looking at their captive insurance programs to identify ways to make better or more efficient use of the funds deployed in those operations. That's the finding of this year's captive insurance benchmarking study by brokerage Marsh.

Companies want to reduce the amount of money that's tied up in posting collateral and meeting the capital requirements of regulators, says Scott Gemmell, a senior vice president at Bermuda-based Marsh Captive Solutions Group and author of the survey.

The most common strategies include "captives returning surplus funds to parent companies through the use of intercompany loans, captives investing in parent company commercial paper, and captives setting up lease-back deals for fixed assets and equipment of the parent company," says Gemmell.

When it comes to the collateral that captives post for the insurance companies they deal with, Gemmell says, letters of credit are growing in popularity over setting up escrow accounts, which can lock up funds and make them unavailable for other uses. Other ways of reducing the amount of money tied up as collateral are reinsurance trusts and parental firm guarantees. The Marsh study found that 59% of companies with captives currently use letters of credit as collateral. Trusts and escrow accounts each account for 19% of captive collateral, while only 3% of captives use parental company guarantees as collateral.

Gemmell says that growth in reinsurance trusts may actually be outpacing growth in letters of credit. Trusts make more sense when the collateral requirement is larger because they generally have a flat fee. Letters of credit, which carry interest rates that in some cases can range as high as 5%, generally make more sense when the amount of collateral required is relatively low.

Samuel Jones, manager of South Carolina captive operations for Captive Management Services of South Carolina, notes that it's important to find the right bank when obtaining a letter of credit as captive collateral. "The cost in interest rates and fees can be prohibitive at some banks," he says, adding that "not all banks are that familiar with captive insurance."

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