Fronts Squeezing Non-U.S. Captive Insurers
London Editor
London
For captive insurance companies domiciled outside the United States, a significant effect of the hard market has been the change in the attitude of fronting insurers, according to several captive experts.
Higher costs and more stringent requirements might be the catalyst needed for more creative uses for captives, these experts added.
"In the past, global insurers have been relatively relaxed about fronting the captives and not overly concerned about security," said Paul Bawcutt, chairman of IRMG in London, the international risk-consulting arm of Aon Captive Services Group.
"But because of the hard market, were now seeing global insurers with European captive clients insisting on letters of credit or [parental] guarantees, and also being much tougher on the reinsurance of captives themselves," he said. "Theyre saying they want letters of credit for the actual exposure of the captive."
Mr. Bawcutt explained that if a captive is taking 2 million (about $2.85 million) of each loss and 10 million (about $14.25 million) in the aggregate, fronting carriers want a letter of credit for 10 million.
Previously, letters of credit for captives were almost entirely restricted to the United States, where theyre required mainly for statutory or regulatory reasons, Mr. Bawcutt noted.
Fronting carriers are not only asking for letters of credit in terms of current-year exposures, but they also want protection for prior years, according to Malcolm Cutts-Watson, managing director of Willis Management Ltd. in Guernsey, who is also joint head of the global captive practice at Willis.
Many captives arent particularly huge organizations, so theres a limit to their assets to support these LOCs, Mr. Cutts-Watson said. "You can be paying up to 10 percent of your premium as a fronting charge," he explained.
Mr. Bawcutt said the situation could interfere with a companys investment strategy.
If a captive has to put up a letter of credit for 10 million, it means that it has to have available assets that could be used as collateral for the bank to actually be prepared to provide the LOC, he said.
If a company has the assets, it may or may not be a problem. For example, an organization that has part of the 10 million in properties would have to liquidate those properties "and put them into cash deposits in order to provide the collateral thats acceptable to the fronting insurer," he explained.
Further, Mr. Bawcutt said, fronting insurers are also adopting very rigid guidelines regarding the reinsurers behind captives. "They want single-A-rated security and upwards," he said, noting that some fronting companies are asking questions about some Lloyds syndicates and are rejecting their use as reinsurers to the captives.
"Coupled with captives being forced to take much higher retentions, which is another characteristic of the hard market, it means that you also have to put up letters of credit for what can be quite significant amounts," he said.
The solution is for captives to start writing directly, "in other words to get licensed to write the business directly," said Mr. Cutts-Watson. "In Europe, thats already happening because if a captive is licensed in one EU state, it can write in any other state."
Mr. Bawcutt said captive owners had little time to react to these trends in fronting at the year-end renewals. "Theyre currently coughing up, but I think the most significant development as a result of this will be people saying, Why dont I set up a direct captive?"
Dublin and Gibraltar are actively encouraging direct captive formation, he said, noting that a company with a large European operation could set up a direct captive in Dublin or Gibraltar, which would enable it to write into the European Union, which would reduce its reliance on fronting insurers.
Other captive-friendly jurisdictions, such as Sweden and Denmark, also would suffice, he noted.
For a large multinational, finding a jurisdiction where it can actually write in the majority of countries throughout the globe can be a problem, according to Mr. Bawcutt. "So maybe youd have to have a combination of a direct writer insuring risks direct wherever possible and using a fronting insurer in a more limited way," he said.
Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, March 4, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.
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