August 05, 2014

From Martin G. Ellis, Comerica Bank:

"Reg 114" trusts are generally much cheaper alternatives to letters of credit for securing the obligations of a captive insurance company to the ceding insurance company under a Reinsurance Agreement.

The term "Reg 114" is derived from Regulation 114 of the Official Compilation of Codes, Rules and Regulations (11 NYCRR 4) of the New York State Insurance Department and allows for trust agreements to be made and entered into among a Beneficiary (the ceding insurance company), a Grantor (the captive insurance company) and a Bank. The Bank must either be a member of the Federal Reserve System, or a New York State-chartered bank or trust company. The Bank that is designated trustee must not be a parent, subsidiary or affiliate of the Grantor or the Beneficiary.

Under the trust agreement, the Grantor delivers to the Bank securities with a market value of not less than the full amount of the Grantor's obligations due under the Reinsurance Agreement between the Grantor and the Beneficiary. Securities are limited to cash and equivalents, U.S. Treasury Securities, and fixed income securities rated A or higher. Reg 114 trusts are not allowed to hold equities. The Beneficiary can demand possession of the trust funds to pay or reimburse the Beneficiary for the Grantor's share under the Reinsurance Agreement regarding any losses and allocated loss expenses paid by the Beneficiary, but not recovered from the Grantor or for unearned premiums due to the Beneficiary, if not otherwise paid by the Grantor. The Trustee must then immediately deliver physical custody of the securities to the Beneficiary and notify the Grantor. The Beneficiary would then arrange to have the securities sold.

A letter of credit is sometimes preferred by the Beneficiary because the Beneficiary receives cash upon a draw as opposed to securities which have to be sold, and letters of credit are generally easier and less expensive to amend. Sometimes the captive insurance company prefers a letter of credit arrangement which generally has less restrictions on investments resulting in higher investment returns.