Captives Put Surplus Capital To Work

by Leroy Baker, Tax-News.com, New York

06 May 2010

Firms with captive insurance companies are examining a full range of opportunities to put surplus capital to work within their organizations, according to a new report 'Single Parent Captive Benchmarking: Capital and Collateral' released by Marsh at the 2010 Annual Conference of the Risk and Insurance Management Society, Inc.

The report examines how owners of captive insurance companies in all parts of the world are tapping into surplus funds while continuing to comply with local regulations governing the capitalization of their captives. The report focuses on activities in the past year of more than 750 businesses that own captive insurance companies.

Regardless of geography, intercompany transactions continue to be the most common use of captive investment assets, as captive owners strive to find efficient methods of returning excess funds to the parent company, said the report.

According to Marsh, related party investments that could include intercompany loans, the purchase of parent company commercial paper, or accounts receivable factoring are the most common use of funds, regardless of where a captive is located. These approaches are most widely used by captives based in the US, with nearly 70% of their assets invested in these transactions.

"Not surprisingly, intercompany transactions have become increasingly popular in the current economic environment," said Scott Gemmell, a senior vice president in Marsh's Global Captive Solutions Practice and author of the report. "Many parent companies can get a much better return by reinvesting this capital in their own operations than from pursuing outside investment strategies."

Generally, Marsh's report finds that captives tend to be capitalized in excess of the statutory minimums regardless of where they are domiciled. In meeting these requirements, offshore captives tend to have higher premium-to-capital ratios than those domiciled onshore in the United States or the European Union.

"One reason for the higher ratios is that intercompany loans are slightly less common in the offshore domiciles," said Gemmell, "As a result, captives in these locations may be more likely to return excess capital to the parent company by way of dividends than those in the US or EU domiciles."

He added that in the Cayman Islands, a large number of captives operate with only the minimum capital of USD120,000, reflecting the fact that many of these captives have retrospectively rated insurance programs. These programs provide for automatic adjustments in premium based on a captive's loss experience.

Among captives, letters of credit (LOCs) remain the most common method of providing collateral to fronting insurance companies, representing more than half of all collateral instruments, followed jointly by trusts and escrow accounts. Typically secured with cash and certain allowable investments from the captive, an LOC is provided by banks for a fee and guarantees the ability of the captive to meet its obligations to the insurer, said the report.

Property insurance was the most popular form of coverage provided by captives, followed by general liability, workers’ compensation or employers’ liability, professional indemnity, and auto liability.

Meanwhile, casualty coverages accounted for nearly 70% of the insurance policies for which the captives provide collateral. Of those, almost 45% are for workers' compensation/employers' liability and auto liability. Property insurance, written by almost 35% of the captives, is less likely to have any collateral requirements.

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