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Why Use Financial Guarantees?
The majority of captives are non-admitted insurance companies.
In order to admit an unearned premium and loss reserve as an asset, the
fronting company needs a letter of credit or securities held in trust
to be held as collateral on behalf of the captive. Typically, fronting
companies require guarantees for unearned premiums ceded to the captive,
loss reserves for prior years and expected losses for the current and
coming year. There are three types of guarantees which can be used as
collateral:
Letters of Credit are commonly used as the
collateral vehicle. The state of New York has issued regulations governing
the form of letters of credit with which the fronted company must comply.
In short, the letter should be issued or confirmed by a bank which is
a member of the Federal Reserve, it should be clear, and it should include
a provision for automatic renewal.
Trust Agreements are admitted assets placed
in a trust account for the benefit of the fronted company. The trust agreement
should comply to New York regulation 98.
Funds Withheld is a method by which the
reinsurance cession is delayed by the fronted company for up to a year
or more. The balance sheet of the captive will show a reinsurance receivable
as an asset.
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