Brokers: A Buyer’s Market for Captives
Today’s market offers captive insurance companies a particularly advantageous time to upgrade their investment portfolios. However, they must be willing to give up unrewarding practices in favor of more ambitious opportunities.
“Simply put, it’s a buyer’s market,” said Boston-based Josh Stirling, managing director and senior vice president, U.S. insurance, Sanford C. Bernstein & Co. “If you’re a captive owner, it’s probably a good time to buy more reinsurance or buy down your deductible or self-insured retention.”
In this environment, Stirling said, captive buyers are seeing more competition from reinsurers and primary companies that want to help them manage their risks, offering them favorable coverage at lower prices.
“With pressure from carriers and reinsurers to compete for business, this provides captive buyers and their brokers substantial leverage to negotiate for better value with their risk-taking partners,” Stirling said.
“If you’re a captive owner, it’s probably a good time to buy more reinsurance or buy down your deductible or self-insured retention.” — Josh Stirling, managing director and senior vice president, U.S. insurance, Sanford C. Bernstein & Co.
“This will lead to more opportunities for brokers to create value by partnering with carriers and reinsurers to design new coverages to better protect captives,” he said.
Added Gary Greene, Franklin, Tenn.-based Raymond James & Associates senior vice president-investments and managing director: “Captives of all sizes need to have an asset strategy, and ‘parking’ cash in the bank is not an asset strategy.
“Captive owners tend to hyper-focus on their liabilities and miss the opportunities with their assets. In doing so, they run the risk that their assets are misaligned and may increase overall risk.”
Greene noted that, overall, he believed prospects for captive growth remain favorable.
But given that interest rates have remained subdued since 2008, many captives have experienced an interest income shortfall from their actuarial forecast, Greene said.
“As these shortfalls have persisted,” Greene said, “captives found themselves recognizing the importance of developing an appropriate asset investment strategy that complements their liabilities.”
Captive owners generally remain cautious about accepting investment risk, yet they find the option of sitting in cash unpalatable, Greene said.
“So we see captives moving cash away from bank accounts and into low-to-moderate-risk investments,” he said. “Things like government and corporate bonds, with some captives venturing into diversified equities portfolios.”
Tim DePriest, Glendale, Calif.-based managing director for Arthur J. Gallagher & Co., noted that a captive should have in place an appropriate level of excess insurance to protect the group should a large catastrophic loss occur, or if over the course of the year the aggregate dollar amount of losses exhausts the premium that has been collected.
“Transparency is very important in running a captive effectively,” DePriest said. “Members should be privy to the inner workings of the captive, such as service costs and the revenue that is derived by the administrator or broker, as well as regulatory requirements.
“Members are essentially ‘owners’ of the captive and therefore should understand their investment.”
DePriest also offered some advice on domiciles.
“Vermont and Bermuda in particular are attractive because of their favorable regulatory and tax environment,” he said.
“While other states in the U.S. are exploring ways to make themselves more attractive for captives, they do not see captive programs as a growth area.”
Sanford C. Bernstein’s Stirling said that one area for captives to explore in today’s market is working closely with brokers to take advantage of new sources of capital.
“For example,” Stirling said, “captives might consider going to the alternative markets and issuing a CAT bond, such as that issued by New York’s MTA after Hurricane Sandy, and captives with long-tailed reserves might look to partner with alternative managers offering reserve financings that allow the captive owner to profit from the alternative manager’s lower cost of capital.”
Stirling emphasized that, with the market in such a changing environment, it’s a very important time for someone who runs a large captive with a lot of money at risk, to optimize their product to take advantage of the low cost of capital that’s coming into the industry.
Bespoke Cyber Coverage
Raymond James’ Greene said that, “As our world expands, companies are being exposed to new kinds of risk that the commercial market doesn’t have the history to price efficiently.”
He cited cyber risk as a prime example.
“Cyber risk insurance is tremendously expensive to purchase, so very few companies, captives among them, are fully covered,” Greene said. “New technological developments are changing the way we live. Driverless cars, 3D printing, nanotechnology all promise an exciting future, but they also alter the environment for risk.
“But a captive insurance company can be a great vehicle to finance cyber risk,” Greene added. “Since the captive is a private insurance company insuring risk only for the parent company, the captive can structure a bespoke coverage that specifically fits the parent company and charge an appropriate premium based upon the company’s actual risk mitigation policies.”
“As our world expands, companies are being exposed to new kinds of risk that the commercial market doesn’t have the history to price efficiently.” — Gary Greene, senior vice president-investments and managing director, Raymond James & Associates.
Additionally, if the parent does a good job managing the risk, they can potentially see return of those premiums back to the parent, Greene said.
He also noted that there is one major hurdle on the near-term horizon that will significantly change the way many captives operate.
That hurdle, said Greene, has a date: Oct. 14, 2016.
“As we have seen, captives have a propensity to avoid investment risk by maintaining very high levels of cash-type investments,” he said. “A favorite cash alternative investment has been money market funds. Captives have long used these funds because of their perceived stability and safety.”
But on Oct. 14, new regulations will go into effect that will significantly change the way money market funds operate, and in turn how many captives handle their investments, Greene said.
“These changes include requiring money market funds’ values to float like any other mutual fund,” he said.
“Additionally, money market funds may impose redemption fees or so-called ‘liquidity gates’ that could be triggered if the liquidity levels of a specific fund fell to specified levels.
“Developing a strategy to deal with these events is going to be a challenge for many captives.” &
Despite the rising tide of political and economic turmoil in the world, the cost of buying political risk coverage and trade credit insurance is declining even as demand is sharply increasing.
“The pricing has become much more competitive,” said New York-based Lila Rymer, head of U.S. underwriting for political risks and trade credit at Beazley. “A lot of new entrants and more capacity in the market has driven this competition.
“So it’s a very good time for clients to consider buying political risk and trade credit insurance because the terms are quite favorable,” Rymer said.
New York-based Stuart Barrowcliff, senior underwriter, political risk for XL Catlin, added that capacity is growing because it is a way for insurers to diversify and expand offerings beyond P&C “where there’s obviously lots and lots and lots of capacity and tremendous pressure on premium.”
A report by Marsh noted that political risk insurance capacity has steadily increased over the past decade, particularly since the financial crisis. In some cases, market capacity for a single policy now exceeds $2 billion, nearly double the available capacity just six years ago, the report said.
Likewise, the increase in trade credit insurance in that period has grown considerably, driven by — among other things — E&S insurers entering the market, as well as banks, other financial institutions and Lloyd’s syndicates making major inroads in this market.
“You also see some of the private equity companies, hedge funds and others who are looking at putting together funding vehicles to invest in trade finance assets and they can come to the trade credit insurance markets to sit behind them,” said Jeff Abrahamson, Baltimore-based global head of supplier trade credit for XL Catlin.
In years past, companies and financial institutions might typically buy stand-alone political risk coverage, said Owings, Md.-based James Daly, president and CEO of Euler Hermes Americas.
“But the trend today is to purchase comprehensive coverage, which includes protection against both trade credit losses and political risks,” Daly said.
“Traditional trade credit insurance adds another layer of comfort, protecting against bad debt losses when a customer simply does not pay its bills.”
Political risk insurance protects foreign assets held by multinational corporations, financial institutions, investors and project contractors against the risks of confiscation, expropriation, contract frustration and nationalization, Daly said.
“In addition to providing protection for trade transactions, it may also cover production facilities, equipment, offices, refineries and other fixed assets and equity investments,” Daly said.
Political risk circumstances usually include war, terrorism, riots and actions by local governments, such as changes in export or import regulations that affect the outcome of a transaction.
“Traditional trade credit insurance adds another layer of comfort, protecting against bad debt losses when a customer simply does not pay its bills.” — James Daly, president and CEO, Euler Hermes Americas
Fredrik Murer, New York-based head of Americas, political and credit, for Chubb, noted that political risk and trade credit insurance offer balance sheet protection in an uncertain world.
“Tremendous volatility entered world markets when the commodity super cycle burst,” said Murer.
“The rapid drop in oil prices created upheaval in country and corporate balance sheets alike, creating both political and credit risks in the process.
“Foreign exchange fluctuations add to the stress on U.S. dollar payment obligations. What started as an economic risk may quickly become a political or credit risk as countries act to protect their local interests.”
Corporations and banks are the major buyers of trade credit insurance.
“Banks might buy an annual trade credit policy that we have the option of renewing,” said Beazley’s Rymer.
“When a company is selling goods to a buyer, for example a Brazilian buyer, a bank might purchase the receivables from the supplier. If the supplier is due to get paid in 60 days, the supplier might say, ‘I want to be paid tomorrow.’
“By selling the receivables to a bank, the bank can cash out the supplier up-front and then the buyer owes the money to the bank.”
Rymer added that when banks invest in bigger projects in emerging markets, say a mine or an oil field, they are likely to seek political risk coverage or more comprehensive credit insurance on the investment they’re making.
XL Catlin’s Abrahamson said that other clients are non-bank financial institutions that are providing working capital for corporate clients.
“Banks are using trade credit insurance as a real driver on the trade risk receivables side,” he said.
“A lot of banks will finance receivables for their customers and procure insurance on that financing. This can help them more efficiently utilize their capital.”
For corporations, maintaining trade credit insurance and often political risk coverage along with it has become an increasingly important way to expand their business.
“It’s not just about mitigating risk, but very often trade credit insurance helps companies grow their business, so they can increase their lines of credit and expand the business they are already doing,” said Rymer.
“It might help a company access financing through their lending bank. By having trade credit insurance on their buyers they’ll be able to get bigger lines of credit from their lending partners.”
Or if a company is internally very comfortable with a certain limit to a buyer where they see an opportunity to grow, they can credit insure those receivables, which may enable them to extend a bigger line of credit to that buyer and grow overall sales, she said.
Chubb’s Murer noted that political risk coverage and trade credit insurance provide a company with more certainty.
“With this insurance, if the unexpected happens you know there’s a level of protection against an outcome that can be catastrophic to your continued operations,” he said.
“A company can invest and grow its sales base with more certainty and lenders can benefit as they support the continued expansion of their corporate customers.”
Added Gregg Badger, COO for international food merchant Ronald A. Chisholm Limited, “If we did not have trade credit insurance and political risk coverage we would be hard-pressed to do any borrowing against our non-North American receivables.”
Badger said that 60 percent to 80 percent of Chisholm’s business is outside of North America and the company needs that working capital to keep it operating and growing. Chisholm actively does business with hundreds of companies in 50 to 60 countries, he said.
When the company’s salespeople are out looking for new customers and trying to open up new markets, one of the first steps they take is to see whether the customer they’re calling on is creditworthy, i.e., insurable or whether it’s on open credit or on secured terms, Badger said.
Managing the risk of accounts receivable, customers and processes allows the company to assure its banking syndicate that the receivables are insured, he said.
Panama Papers Reveal Hidden Art Assets
A Panamanian law firm that created offshore tax havens for a host of well-known world leaders, entertainment celebrities and wealthy individuals has its tentacles deeply rooted in the international art market, according to the International Consortium of Investigative Journalists’ inspection of 11 million documents leaked from that law firm, Mossack Fonseca.
Locked in the so-called “Panama Papers” files, in addition to revelations of a circuitous trail of $2 billion in assets leading back to Vladimir Putin, evidence of tax-haven profiteering by Britain’s Prime Minister David Cameron and incriminating information about the tax-haven holdings of soccer superstar Lionel Messi, there are answers to mysteries involving Rembrandts, van Goghs, Matisses, Chagalls, Modiglianis and other masterpieces, according to the Australian Financial Review.
The “Panama Papers,” reported the ICIJ, also shed light on the real story behind Christie’s milestone 1997 Ganz collection auction, which is credited with starting the art market’s wild enthusiasm for modern art.
These and other art-related disclosures in the Mossack Fonseca treasure trove of documents have raised important art insurance issues.
“The ‘Panama Papers’ have brought to light an unprecedented public, moral hazard that will no doubt increase governmental scrutiny on art ownership and title.” — Robert Read, head of art and private clients, Hiscox London Market
First and foremost is the matter of art title insurance.
Lawrence M. Shindell, New York-based chairman of ARIS Title Insurance Corp., a wholly owned subsidiary of Argo Group, said, “The ‘Panama Papers’ highlight the growing need for transparency in the international art industry. The less the transparency, the greater the title risks with high value, highly mobile art and collectibles.”
Across the many kinds of title risks associated with art and high-value collectibles, whether or not a property insurer has paid insurance proceeds covering the physical loss, clear legal title goes to the core of asset value, which is what enables an artwork to be freely marketable, Shindell noted.
“Hiding away a work of art only compounds the title problems, increases the reality as well as the perception of title risk in an increasingly risk-averse world and impacts object value,” Shindell said.
Diane Jackson, Washington, D.C.- based COO and head of day-by-day operations for Huntington T. Block art insurance brokerage, noted, “In the case of disputed art revealed by documents leaked from Mossack Fonseca and possibly other tax-haven creators, the holders of the art may be asked to provide proof of clear title because the law firm set up the account offshore strictly for hiding purposes.”
If it is determined that art has been hidden in an offshore account, but then the art comes to light publicly, this may well result in a lawsuit being filed by somebody who claims rightful ownership, Jackson added.
“This is typically what happens when heirs will do research to determine if the art belongs to them,” Jackson said. “If they can provide proof that the art was wrongly taken from their family, as in the case of some contested Nazi art, they could dispute the ownership of the art in question. The individuals who have been hiding the art would then need to show how and when they acquired it.
“If a resolution is not reached between the two parties, then the courts would determine who the true owner is,” observed Jackson.
As for storage possibilities for art registered in offshore tax havens, Robert Read, head of art and private clients at Hiscox London Market, said, “Depending on the circumstances of ownership, there are a number of likely storage options for artworks owned by clients the likes of Mossack Fonseca. If the circumstances relate to tax planning, it is likely artworks will be held in a Freeport or under an alternative ownership structure, though it is feasible that such works would be on display in private homes.”
Whether artwork is held in one of the growing number of art warehouses around the world or kept in an owner’s home, property insurance for this art may be provided by law firms like Mossack Fonseca or it may be taken out from an insurance company by the holder of the artwork, Read noted.
If a work of art that has been stolen at some point suddenly comes to light as a part of Mossack Fonseca revelations or by some other means, Chicago-based Scott Hodes, senior counsel at Bryan Cave LLP, said this presents yet another kind of major art insurance-related matter.
“A collector needs to ensure that missing or lost artwork is listed in the records of the Art Loss Register as soon as possible and that the FBI is notified when the loss or disappearance occurred,” said Hodes. “These actions will help establish the collector’s timely claim.”
Hodes added that the collector needs to review the art insurance policy in force at the time of the loss and focus on the definition of “loss” in the insurance policy.
“A financial loss may not be covered,” said Hodes. “But if a theft or mysterious disappearance of the artwork is covered, was the insurance company notified when the loss occurred or was discovered? If so, then the insurance company should be contacted immediately if the policy provides that the insurance company is required to represent the collector in any effort to recover the artwork.”
The collector should check to determine if the policy allows reimbursement of legal fees and costs or provides that the insurer must represent the collector, Hodes said.
“Potentially, this could be a big money saver for the collector,” Hodes noted.
Lastly, Hodes said, the collector may need to act quickly through his or her counsel to file a lawsuit in the proper venue to sequester the artwork and enjoin any sale or disposition of the artwork until a court has ruled on lawful ownership.
But insurance companies themselves may have a means to pursue recovery of stolen or lost works of art that may suddenly come to light in LLCs held by Mossack Fonseca or firms like it.
“Some insurance companies may have already paid claims under terms of the art policy when an insured art collector was the victim of a theft or a mysterious disappearance,” Hodes said.
“As a consequence, the insurance company that paid off the initial claim may now be in a position to sue a LLC to recover the work of art if it turns out that the missing artwork is an asset of the LLC.”
Looking to the future, Hiscox’s Robert Read observed, “The ‘Panama Papers’ have brought to light an unprecedented public, moral hazard that will no doubt increase governmental scrutiny on art ownership and title, but this alone will not be sufficient to force behavioral change among owners. The only way this will affect the art market is if governments enact laws which render current ownership arrangements illegal.”
Finally, Read noted, “The art market typically follows the lead of other established asset classes, so as long as the storage of art in international Freeports behind complex ownership structures continues to be legal, it will likely remain in practice for the purposes of both tax planning and privacy.”