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Why Do Captives Get Credit Ratings?

Graph Abstract-SF
February 27, 2017

To successfully market their insurance products to the world at large, traditional insurance companies need to garner confidence and credibility. Their customers need confidence that the companies from which they buy insurance will have the financial wherewithal to pay claims when the time comes. One of the sources of this confidence is a strong credit rating bestowed on the insurer by a rating agency such as A.M. Best, Standard & Poor's, Demotech, Moody's, and, now, Kroll Bond Rating Agency. While the need for credit ratings is readily apparent for a traditional insurer, it is less so for most types of captive insurance companies.

Of course, group captives and risk retention groups compete to a degree with traditional insurers in the open marketplace, and strong credit ratings will assist them in this competition. On the other hand, since a single-parent captive is under the control of its policyholder, which exercises considerable influence over the degree of capitalization and premiums charged, the need for a credit rating is less obvious. Nevertheless, many single-parent captives are obtaining credit ratings. Since there are significant fees incurred for a credit rating process from one of the agencies, what motivates some captive owners to engage one of these firms to apply the process to their captives?

This question was broached by Tina Bukow, with Kroll Bond Rating Agency, and Nick Dranchak, of JLT Holdings, during the "Captives and Credit Ratings" session at the 4th Annual Texas Captive Insurance Association (TxCIA) Conference on February 16, 2017. One major reason captive owners are engaging the rating agencies is the drive to improve corporate governance. The independent third-party oversight of a rating agency can provide the parent corporation's board with much more confidence in the captive insurance company's operations. In essence, it validates that the captive is truly operating as an insurance company, using sound principles to manage the operations.

In fact, many captives are put through the credit rating process simply to learn more about the captive's financial health and any additional best practices that the agency might suggest be employed. In such cases, the motivation is not to obtain the actual rating and the rating is often not even accepted by the captive (and thus not published for the world to see). The speakers emphasized that the rating process should be approached as a partnership with free-flowing communication between the captive and the rating agency. When approached in this manner, the educational process for the captive's board and management team can be invaluable.

A second driver of credit ratings by captives is increased emphasis on transparency. Obtaining a rating allows the captive to benchmark itself against other captives that have also been rated. Additionally, of course, a rating can facilitate capital raising should the need arise.

The third motivation for captive insurance companies to obtain credit ratings is to reduce expenses. Having a credit rating from a third-party rating agency provides additional assurance to reinsurers and fronting companies that the captive insurer will be able to carry through with its obligations. As a result, it may be possible to negotiate lower fronting fee and reinsurance premiums.

The cost of a credit rating process varies significantly depending on a number of variables, explained Ms. Bukow. These variables include the size of the captive as measured by its capital and the overall complexity of the organization.

As a side note, Ms. Bukow's employer, Kroll Bond Rating Agency (KBRA), is a relative newcomer to the credit rating field, having been founded in 2010. It performs research across the structured finance, public finance, financial guaranty, financial institutions, project finance, and corporate sectors. Its analysts have published over 5,000 ratings across asset classes. KBRA is registered with the US Securities and Exchange Commission as a Nationally Recognized Statistical Rating Organization (NRSRO). In addition, KBRA is recognized by the National Association of Insurance Commissioners (NAIC) as a Credit Rating Provider (CRP).

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