Collateral Remains Biggest Concern For Captive Owners, CICA Survey Finds

Since the fronting company is technically still on the hook for claims, even though it passed almost all of the risk onto the captive, the front requires collateral–often in the form of a letter of credit from a bank–to guarantee reimbursement of the front's costs.

In past years, particularly during hard markets, captive owners complained about the cost of fronting, or finding fronts at any price. But with the precarious financial state of many banks these days, finding collateral to satisfy fronts has become the bigger problem for captives, CICA found.

"I think there is still unhappiness with fronting, but it's not the primary issue any more," said Michael Mead, who has spearheaded the CICA survey and coordinated a panel discussion of the results.

The survey panel pointed out that one insurer in particular is specifying which banks they will and will not accept collateral from. "That's huge," Mr. Mead told National Underwriter. "If you say to a big corporation, you have to change your banking relationship for your captive, that's a big deal."

He said the results partly reflect the sophistication of survey respondents, who are looking at broader issues facing their captive–with the biggest issue this year being collateral.

In the 2008 survey, the biggest challenges to captive owners were service concerns (36 percent), tax concerns (22 percent), reinsurance (13 percent) and fronting (9 percent).

In 2009, those challenges changed dramatically. Collateral concerns (22 percent) led the list, followed by expanded utilization concerns (18 percent), fronting concerns (14 percent), service concerns (14 percent), taxes (12 percent) and reinsurance (8 percent).

This year, collateral was cited as the biggest concern by an even bigger margin (27 percent), followed by regulatory issues (16 percent) and policyholder retention/growth (16 percent), with tax, fronting and expanded utilization all at 7 percent.

In this year's survey, 93 percent of respondents said collateral was required, compared to 85 percent the previous year.

When asked what kind of collateral was required, 76 percent said letters of credit; 40 percent said trust accounts; and 28 percent said cash, with 8 percent naming parental guarantee. (More than one kind of collateral could be selected.)

Among some of the other survey highlights:

• Eighty-five percent of respondents listed admitted paper as one of their primary reasons for using a fronting carrier, with regulatory compliance as the next highest reason at 46 percent.
• One hundred percent of respondents rated the overall level of importance of fronting to their captive as either "very important" or "important," while 78 percent listed having an A-rated fronting company as "very important."
• Eighty-nine percent of respondents characterized the price of fronting as "reasonable," while 11 percent called it "expensive."
• Sixty-three percent characterized the value of their fronting relationship as "excellent," with the other 37 percent listing it as "moderate." No one rated the value as "low."
• Forty-eight percent of respondents reported no change in the cost of fronting from the prior year, while 30 percent reported an increase in costs of less than 10 percent and 20 percent reported a decrease.
• Twenty-four percent of respondents said they considered the price of their reinsurance to be "expensive," 67 percent reported it as "reasonable," and 9 percent as "inexpensive."
• Nineteen percent of respondents said their reinsurance costs are the same as the prior year, with 43 percent reporting an increase and 38 percent reporting a decrease.
• A majority (53 percent) of respondents reported investment yields of 2-to-3 percent, with another 13 percent reporting investment yields in the 4-to-5 percent range. Twenty-two percent of respondents reported yields of zero-to-1 percent, but no one reported less than zero percent.

The survey was drafted and approved by a CICA committee and was conducted by the independent consulting firm of Veris Consulting, LLC, of Reston, Va.

About 89 participants were solicited through communications from CICA and through the collaborative efforts of a number of captive domicile trade associations. The results were compiled without identifying any of the participants.

A majority of respondents represented single-parent captives (53 percent), followed by risk retention groups (18 percent), segregated cell captives (16 percent) and association captives (13 percent).

Of respondents, 73 percent reported being domiciled in a U.S. jurisdiction, with 27 percent domiciled offshore. Seventy-one percent of respondents have been in existence for six or more years, 27 percent in existence for one-to-five years, and 2 percent for less than one year.