Would Captive Owners Be Better Off In RRGs?

If you had a captive insurance company writing liability insurance for long-term care facilities in the early years of this decade, you had a good thing going, but because of dramatic changes that have taken place in the marketplace in the past few years, the reverse is true today.

At this point in time, your capital may be frozen, but you continue to pay into the captive for liability insurance protection. To make things worse, the return on your invested assets has sunk to around 2 percent or less.

As a single-parent captive, there are better uses for your invested capital than keeping your money tied up in the captive.

What to do? Financially strong risk retention groups may offer the answer. In the jargon of the insurance business, it's called a loss-portfolio transfer.

Take, for example, an RRG that provides liability coverage to long-term care facilities. A captive insurer that wants to get out of the business and free up equity capital could transfer its portfolio of losses and reserves to the RRG.

In this scenario, the captive would cease underwriting. The RRG would assume existing losses and offer stable, affordable coverage to facilities that were insured by the captive. Members of the captive would get their equity out of the captive.

While this may sound simple, however, it isn't. A high level of due diligence is required to protect both parties, but the end result can be well worth the effort.

MAKING IT HAPPEN

The critical elements in a loss-portfolio transfer (LPT) are an actuarial analysis of the reserves to be transferred and an underwriting audit of the years in question.

In addition to analyzing the existing claims, an estimate must be made of what is known as the incurred-but-not-reported, or IBNR claims.

With all this said, a well-researched LPT can provide substantial benefits for both parties: freed up capital for the captive's parent to invest in the company, and solid new business for the RRG.

Because of the striking changes that have taken place in the marketplace since these captives were formed, an LPT may be the way to get your money out, while still assuring liability protection to members of the captive at today's lower premium rates.

A major benefit of an LPT is that captive sponsors can use cash realized from the transfer for organic growth or operating expenses of the basic business. This is especially important today, when debt financing is costly and difficult to obtain.

At the same time, members of the captive are at lower risk of losing affordable liability insurance. The RRG takes over the portfolio of the captive, offering its members stable, affordable coverage.

What's more, because the RRG is owned by its policyholders, premiums are kept competitive. Members go from being shareholders of the captive to being shareholders of the RRG.

Those members of the former captive have secure insurance protection with a voice in the RRG and the potential for a seat on the board of directors.

With the right RRG, they also will have a good investment opportunity. At the health care RRG mentioned above, for example, the value of shares doubled over the last five years due to underwriting profitability.

The RRG will provide services customized to the needs of captive members, whether a single-parent or affinity group.

With liability insurance rate increases expected to escalate as the market hardens, it's a good time to dissolve the captive before an actuary prescribes following the market up and swallowing rate increases.

MORE ABOUT RRGs

If concerns about turning liability insurance protection over to an unfamiliar entity persist, learning more about RRGs may help.

Restricted to writing liability insurance, RRGs were created in response to the lawsuit crisis that caused many traditional insurance companies to withdraw from liability lines or jack up prices to prohibitive levels.

The federal Liability Risk Retention Act of 1986 was created to authorize business groups to form insurance companies licensed in a single state to operate in all 50 states without additional licensing.

From a modest beginning, the number of RRGs has grown to 246 today. The top-100 generated more than $2.6 billion of premium in 2009.

RRGs have become a stable, reliable source of liability insurance for business and professional groups. Many of those groups are in the health and long-term care field, and would otherwise be dependent on carriers that move in and out of liability lines at will. Choosing the right RRG for a LPT will help protect members.

REGULATORY ISSUES

If the captive is domiciled offshore, attention needs to be paid regulatory issues. The strong arm of the U.S. government is reaching out to bring offshore operations increasingly under federal control.

Take note of recently issued IRS Notice 2010-23, which relates to personal responsibility, commingled funds, and rules governing investment in private equity and hedge funds.

Some speculate that, while seemingly bland, this notice may be a prelude to exclusionary regulations. The Treasury Department's recent Notice of Proposed Rule Making issued Feb. 26 relating to filing requirements also indicates that the tax status of captives is under review.

With both the IRS and Treasury looking more closely at offshore businesses, plus the federal government's constant search for more revenue to make up for mounting deficits, offshore captives are likely to become targets. Maybe it's best to get out before the Fed's reach becomes deeper.

An LPT to a qualified, financially sound RRG may be the way to retrieve money from a captive, while providing competitive insurance coverage to members. It's certainly worth looking into.

Sanford “Sandy” Elsass is president-underwriting manager at Lewis & Clark LTC RRG Inc. in Atlanta, Ga. He may be reached at selsass@usre.com .