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Pulse Survey Analysis: Collateral Alternatives

 In partnership with, Towers Watson conducted this pulse survey to take a look at the issues involved in reinsuring your captive.

This analysis was written by analysts at Towers Watson.

This September Pulse Survey asked a series of questions involving collateral and captives. The survey elicited 43 responses: 46.5% from single-parent captives and 53.5% from group captives.

Respondents report a heavy need to post collateral. For single-parent captives, 84.2% said they were required to post collateral, whereas 90.9% of group captives had to post collateral.

Of the single parents, 64.3% use only letters of credit, just 14.3% use only trusts, and 21.4% use both. Groups said 73.7% use only letters of credit, just 5.3% use only trusts, and 26.3% use both. (The remaining 5.3% used cash.) Towers Watson is not surprised about the mix of collateral between LOCs and trusts, though we found it interesting that a quarter of the respondents used both. We suspect that sometimes it is required to have both in play, as the fronting insurer may insist that some collateral is from an LOC, as it is more readily accessible for near-term claim payments and not subject to possible bankruptcy constraints. We also expect that the reason fewer group captives use trusts is the difficulty in funding a trust because the ownership structure makes using trusts more complicated.

However, the survey revealed an increasing concern of letter-of-credit users. For the 14 respondents from single parents, 50% said they are getting expensive, 50% said the amount required by insurers is getting too high, and 28.5% said they are getting hard to arrange with banks. Another 7.1% said it is difficult to administer the LOCs. Only 14.3% had no problem with them. [Note: Multiple responses to this question were permitted.]

Groups had similar concerns. For the 19 respondents, 52.6% said the fees charged are getting too expensive, and 47.4% said the amounts required are getting too high. Only 10.5% said they are hard to arrange, much lower than with the single-parent captives, and just 5.3% said they are difficult to administer. Just 15.8% had no problem with them. [Again, multiple responses were permitted.]

In the lead article in Captive Insurance Company Reports in August, “Trusts as Collateral Alternatives,” these concerns were cited as the bases for why trusts are increasingly being looked into as an alternative to an LOC, as banks now have to load credit-risk factors into their pricing for LOCs. Also, the question involving difficulty in administering LOCs had to do with the issue of stacking of collateral over several years of open reserves, which is a problem (or at least a nuisance) for many organizations. As such, the fact so few listed this as a problem is noteworthy.

Accordingly, there has been a shift toward considering, if not actually using, trusts. In fact, 57.1% of single-parent captives responding to this survey have looked at trusts, while 70% of group captives have done so. However, just 12.5% of single parents and 38.5% of group captives said they liked what they saw.

The concerns cited by single parents included, among others, uncertainty of its value (12.5%), their insurer wouldn’t accept them (25%), and concerns about the terms and conditions (another 25%).

Groups were more accepting, though they too had concerns, a few of which follow: 15.4% of the 13 respondents were uncertain of the value, 15.4% felt it would be difficult to sell to their treasurers/finance, 15.4% were concerned about a trust’s costs and the terms and conditions, and 7.7% said their insurer wouldn’t accept a trust.

So why haven’t the others looked at a trust? For both single-parent and group captives, the significant majority said it was mostly because they didn’t understand them. Half also said they didn’t see how the benefits were more than what they had now.

Towers Watson is not surprised that many still don’t understand trusts. For most, LOCs have been the common approach to collateralizing, but as LOC problems continue, we expect more and more captive practitioners will become educated about the alternatives to letters of credit. That was the reason behind the lead article in the August issue of Captive Insurance Company Reports, “Trusts as Collateral Alternatives.”

In that article, the primary arguments put forth in favor of trusts were that trusts can save money versus an LOC, they don’t tie up valuable credit lines, and a trust can convert “contingent liability” (which LOCs are) to “restricted assets” (which trusts are). There were a few other administrative advantages cited in the article as well, supporting use of a trust.


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