During my time at RIMS this year, I attended an interesting session at the RIMS HUB. Unlike most of the sessions at RIMS, which are held in the convention center’s meeting rooms, the RIMS HUB is located in the main Exhibit Hall in an area called the Thought Leader Theater. It offers attendees educational opportunities through a series of succinct, interactive discussions on a variety of topics.
On Monday afternoon I attended a really interesting presentation: “New Uses for Old Captives,” presented by Daniel Chefitz, a Partner at Morgan Lewis, along with Troy Chute, Manager of Discontinued Operations at PepsiCo. Captive insurance companies — insurance companies established by a parent group, especially to insure the risks of that parent group — gained popularity in the 1970s. It is estimated that more than 90 percent of the Fortune 500 have at least one captive. Most are domiciled in Bermuda or Cayman Islands, but increasingly they are found stateside, with Vermont and Utah being popular states.
The presenters first pointed out some of the risks associated with the older captives:
- Loss of institutional knowledge. Captives are complicated set-ups, and the initial knowledge, documentation and strategy may be lost over a period of decades.
- Reorganization. American companies are constantly buying and selling pieces of one another, and it is easy to lose track of captives in the mix.
- Exposure to long-tail claims. As for any older insurer, exposure to this class of claims — which continue to exceed all estimates of size and longevity — is a risk for captives.
- Unlimited liabilities. Some captive insured polices were written without aggregated limits, exposing the captive to unlimited liability.
The level of equity in the captive, relative to its risks, should be a subject of great interest. Too little equity is an obvious concern. On the other side, it is common for captives to have very healthy levels of equity from years of profitable underwriting — and finding a use for that equity presents its own challenges.
The presenters then outlined three options for managing legacy captives:
- Traditional Runoff
• Cease active underwriting
• Manage claims and reserves
• May take a long time and trap surplus equity in the captive
- Solvent Scheme
• Essentially a court-ordered novation
• Rhode Island and Bermuda have solvent scheme statutes
• Solvent schemes do achieve finality, but they can be very costly
- New Use for the Old Captive
• Embrace the captive to insure other legacy liabilities
• There can be potential to accelerate a tax benefit
• This is an efficient use of capital
• Perhaps realize cost savings from more streamlined management of legacy liabilities
Which option is best will depend on the nature of a company’s long-tail risks, the level of surplus equity in the captive, and whether the captive stopped writing coverage.
I was fascinated by this subject, and I hope to persuade Mr. Chefitz and Mr. Chute to write their own, more detailed guest posts here in the near future.