Alternative Risk Management

Repurposing Aging Captives

Companies that let their captives gather dust could be missing out on savings opportunities.
By: | November 2, 2016 • 6 min read
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Many companies could be losing out on thousands or even millions of dollars in tax benefits as well as significant cash flow and cost savings by neglecting or leaving their old captives dormant, according to industry experts.

Captives are effectively insurance subsidiaries used by a parent company to insure against its own and affiliates’ risks.

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Such is their popularity, particularly in property and casualty, that it’s estimated that more than 90 percent of Fortune 500 companies now have at least one captive.

However, there are many dating back to the 1970s, domiciled offshore in places like Bermuda or the Cayman Islands, that are no longer used or have been put into runoff.

The risks of having an older captive are numerous — exposure to long-tail claims, the loss of institutional claims knowledge and records, and many are written without an aggregate limit.

But increasingly now instead of putting the captive into runoff or a solvency scheme, risk managers are starting to use them as part of a broader risk management strategy to deal with their legacy and emerging liabilities.

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As a spin-off, this enables companies to potentially derive an accelerated tax benefit if the captive is properly structured, increase their cash flow, use their capital more efficiently and see significant cost savings.

“It’s fundamentally about using the captive to provide a dedicated funding source to meet legacy liability claims in a tax-efficient manner,” said Daniel Chefitz, partner at Morgan Lewis & Bockius.

Dormancy Risks

Michael Serricchio, senior vice president of Marsh Captive Solutions’ captive advisory group, said that the main reason for a captive becoming dormant is a company not realizing its intended purpose or value.

“Maybe there’s been a change of risk manager or the management team and whoever set up the captive is no longer there and the captive is sitting there doing nothing because there’s no perceived value or it’s not properly understood,” he said.

“But even if the captive is just sitting there dormant or it is in runoff, you are still incurring running costs and claims, not to mention the capital that’s tied up in it.”

Chefitz said that among the main risks associated with a dormant captive are obligations to meet new legacy claims, a lack of control over the flow and handling of claims following a merger or acquisition, and exposure to liability from released trapped equity.

Sean Rider, executive vice president and managing director of consulting and development at Willis Towers Watson, said that the biggest risks of having a dormant or older captive were adverse claims development and investment outcomes.

“The main risk is leaving it dormant for too long. Then it’s ultimately harder to get it started up again and ready for when you really need the coverage.” — Gloria Brosius, corporate risk manager, Pinnacle Agriculture Holdings

Gloria Brosius, corporate risk manager at Pinnacle Agriculture Holdings and a RIMS board member, said that the longer a captive is left dormant, the harder it is to get it up and running again.

“The main risk is leaving it dormant for too long,” she said. “Then it’s ultimately harder to get it started up again and ready for when you really need the coverage.”

Call to Action

Chefitz said that dormant captives are often revived because of a need for additional insurance to cover legacy liabilities such as asbestos, product liability, toxic tort and environmental claims.

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“Typically this arises when a company has a large reserve on its books, and a need for additional risk transfer,” he said.

But oftentimes risk managers and companies will be prompted into action when a loss occurs, said Jason Flaxbeard, executive managing director of Beecher Carlson.

“What will usually happen is that something bad occurs,” he said. “Companies will then start to question why they have that captive and that’s when decisions need to be made. But a well-managed captive shouldn’t have that issue.”

In this situation, Serricchio said that it was essential to undertake a thorough strategic review of the captive.

Sean Rider, executive vice president, Willis Towers Watson

Sean Rider, executive vice president, Willis Towers Watson

“The first question you need to ask is, ‘Does it make sense to keep the captive or even have it in the first place?’ ” he said.

Rider said that risk managers need to decide whether these older or dormant captives can be used as an execution tool within the company’s risk financing strategy.

“It’s really about understanding the captive’s role in facilitating an evolving risk financing strategy and how it can be used going forward,” he said.

Managing Legacy and Emerging Liabilities

The main advantage of resurrecting a dormant captive is for a company to deal with its legacy liabilities by fully insuring against any outstanding or future claims, said Chefitz.

This can be achieved by using the captive to establish a dedicated funding source to supplement the existing insurance coverage or to fill in any gaps in a tax-efficient manner, he said.

It also enables the company to maximize the value of its historical insurance coverage by smoothing the cash flow, he added.

“If a company has legacy liabilities, rather than trying to avoid or defer it, a sensible approach is to use the situation to your advantage by fully funding the legacy liability. This will then enable you as a risk manager to focus on your emerging and ongoing liabilities instead.”

Serricchio said that a dormant captive could also be used for writing emerging and non-traditional risks such as employee benefits, supply chain, cyber security, medical stop-loss and environmental risks.

Flaxbeard added that the current soft market allowed risk managers to be more creative with their captives through the sale of add-on products.

“Many companies are going into ancillary products that they can sell to their clients alongside their core products, such as extended warranties,” he said.

Tax Benefits and Issues

If qualified as an insurance company for tax purposes, captives can also provide a host of other benefits, said Chefitz.

By insuring these existing reserves on a company’s balance sheet with a captive, they are then effectively moved from the parent to the captive’s balance sheet, he said.

Daniel Chefitz, partner, Morgan Lewis & Bockius

Daniel Chefitz, partner, Morgan Lewis & Bockius

He added that the loss reserves from a captive were immediately deductible, thus accelerating the tax deduction within the parent’s consolidated group and monetizing the associated deferred tax asset.

Furthermore, the premium paid to a captive is also tax deductible if certain tests are met, he said.

“The increased cash flow as a result of the accelerated tax deduction can be invested in a tax-efficient manner and used to support the treasury goals of the organization,” he said.

When added up, all of these deductibles could potentially provide companies with thousands or even millions in tax benefits.

Meanwhile, another advantage has been provided under the recent 831(b) tax code change, with the annual limit at which captives and insurers can elect not to be taxed on their premium income being increased from $1.2 million to $2.2 million, effective from 2017, said Gary Osborne, president of USA Risk Group.

“This is a real opportunity for companies to put some good risks into their captive and to derive the tax efficiencies,” he said.

Domicile Choice

Another key consideration for companies looking to redomicile their captive is the self-procurement tax under the Nonadmitted and Reinsurance Reform Act for surplus and excess lines, said Flaxbeard.

“This is a problem for many companies who may look to redomesticate to their home state,” he said.

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“Some have got around this by setting up a branch to write direct policies to the parent company incurring captive premium tax rather than a self-procurement tax.”

Among the other factors when considering a domicile are the captive’s legal, management and operational structure, as well as its capital use, said Chefitz.

Ultimately though, Rider said, companies need to consider whether it’s worth changing the captive’s structure or moving it at all.

“You need to consider whether the original domicile is still the best domicile and whether the original structure is still the best structure for you, or should you abandon the captive altogether and transfer the liabilities to a new one,” he said. &

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Alex Wright is a U.K.-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at [email protected]
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Risk Insider: Joe Tocco

Expanded Canal Creates Greater Opportunities … and Risks

By: | July 6, 2016 • 2 min read
Currently Chief Executive of the Americas for XL Catlin’s insurance operation, Joe Tocco has enjoyed three decades in the insurance industry at various organizations. He is also a veteran of the U.S. Navy, where he served as a nuclear field service engineer. He can be reached at [email protected]

An international consortium of companies built a new third lane and set of locks at the Panama Canal that doubles its capacity.

Like other massive infrastructure projects, the expansion effort faced an assortment of challenges. Nonetheless, on June 26, the Chinese container ship Costco Shipping Panama became the first vessel to pass through the new third lane; its name was changed to respect the honor of being the first “New Panamax”-sized ship to transit the canal.

Building Bridges

Doubling the capacity of the Panama Canal should increase trade flows between Asia and the Americas, as well as between Latin America and North America.

For example, about 10 percent of the Asia-to-U.S. container traffic could shift from the West Coast to the East Coast by 2020. A larger Panama Canal also offers an attractive alternative for shipping bulk commodities from the U.S. heartland to Asia via the Mississippi River.

For starters, bigger ships mean more accumulation risk. It’s estimated that the additional cargo moving through the canal each day will be worth about $1.25 billion. And that figure doesn’t include the vessels queuing at both ends of the canal.

And as natural gas production has surged in the U.S., producers are looking to develop new markets in Asia; an expanded Panama Canal could help facilitate that.

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For Latin America, the canal’s greater capacity could lead to increased deliveries of agricultural and other products to Asia. Similarly, we could soon see more shipments of perishable products like meat and fish, fresh produce and cut flowers from Latin America to North America.

A More Complex Risk Landscape

Doubling the canal’s capacity will also alter the risk landscape in Panama and elsewhere.

For starters, bigger ships mean more accumulation risk. It’s estimated that the additional cargo moving through the canal each day will be worth about $1.25 billion. And that figure doesn’t include the vessels queuing at both ends of the canal.

Operational risks at the canal are also potentially greater. In the original locks, electric locomotives on the lock walls pull the vessel along. In the new third lane, tugs positioned fore and aft will escort ships through the locks.

While canal pilots and tugboat captains have undergone extensive training, concerns have been expressed about the possibility of a tug losing control of the tow, resulting in damage to the lock as well as the ship. The maneuverability of the tugs selected for this task has also been questioned.

Given the Panama Canal’s prominent role in today’s supply chains, the impacts of an incident that takes the third lane offline would ripple quickly through the global economy, especially if the shutdown is protracted. Latin American companies shipping perishable products to North America, for example, could be especially affected by such an event.

Ports that have expanded, or are being expanded, to handle New Panamax (and larger) vessels also face greater accumulation and operational risks. And for ports on the East Coast of the U.S., the risks are amplified by the ongoing threat posed by hurricanes.

While it is too soon to determine how this expansion effort will reverberate throughout the Americas and across the globe, the canal should nonetheless continue to play a significant part in the ongoing march to a smaller world and a larger global economy.

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Sponsored Content by Nationwide

Hot Hacks That Leave You Cold

Cyber risk managers look at the latest in breaches and the future of cyber liability.
By: | December 1, 2016 • 5 min read

Nationwide_SponsoredContent_1016Thousands of dollars lost at the blink of an eye, and systems shut down for weeks. It might sound like something out of a movie, but it’s becoming more and more of a reality thanks to modern hackers. As technology evolves and becomes more sophisticated, so do the occurrence of cyber breaches.

“The more we rely on technology, the more everything becomes interconnected,” said Jackie Lee, associate vice president, Cyber Liability at Nationwide. “We are in an age where our car is a giant computer, and we can turn on our air conditioners with our phones. Everyone holds data. It’s everywhere.”

Phishing Out Fraud

According to Lee, phishing is on the rise as one of the most common forms of cyber attacks. What used to be easy to identify as fraudulent has become harder to distinguish. Gone are the days of the emails from the Nigerian prince, which have been replaced with much more sophisticated—and tricky—techniques that could extort millions.

“A typical phishing email is much more legitimate and plausible,” Lee said. “It could be an email appearing to be from human resources at annual benefits enrollment or it could be a seemingly authentic message from the CFO asking to release an invoice.”

According to Lee, the root of phishing is behavior and analytics. “Hackers can pick out so much from a person’s behavior, whether it’s a key word in an engagement survey or certain times when they are logging onto VPN.”

On the flip side, behavior also helps determine the best course of action to prevent phishing.

“When we send an exercise email to test how associates respond to phishing, we monitor who has clicked the first round, then a second round,” she said. “We look at repeat offenders and also determine if there is one exercise that is more susceptible. Once we understand that, we can take the right steps to make sure employees are trained to be more aware and recognize a potentially fraudulent email.”

Lee stressed that phishing can affect employees at all levels.

“When the exercise is sent out, we find that 20 percent of the opens are from employees at the executive level,” she said. “It’s just as important they are taking the right steps to ensure they are practicing what they are preaching.”

Locking Down Ransomware

Nationwide_SponsoredContent_1016Another hot hacking ploy is ransomware, a type of property-related cyber attack that prevents or limits users from accessing their system unless a ransom is paid. The average ransom request for a business is around $10,000. According to the FBI, there were 2,400 ransomware complaints in 2015, resulting in total estimated losses of more than $24 million. These threats are expected to increase by 300% this year alone.

“These events are happening, and businesses aren’t reporting them,” Lee said.

In the last five years, government entities saw the largest amount of ransomware attacks. Lee added that another popular target is hospitals.

After a recent cyber attack, a hospital in Los Angeles was without its crucial computer programs until it paid the hackers $17,000 to restore its systems.

Lee said there is beginning to be more industry-wide awareness around ransomware, and many healthcare organizations are starting to buy cyber insurance and are taking steps to safeguard their electronic files.

“A hospital holds an enormous amount of data, but there is so much more at stake than just the computer systems,” Lee said. “All their medical systems are technology-based. To lose those would be catastrophic.”

And though not all situations are life-or-death, Lee does emphasize that any kind of property loss could be crippling. “On a granular scale, you look at everything from your car to your security system. All data storage points could be controlled and compromised at some point.”

The Future of Cyber Liability

According to Lee, the Cyber product, which is still in its infancy, is poised to affect every line of business. She foresees underwriting offering more expertise in crime and becoming more segmented into areas of engineering, property, and automotive to address ongoing growing concerns.”

“Cyber coverage will become more than a one-dimensional product,” she said. “I see a large gap in coverage. Consistency is evolving, and as technology evolves, we are beginning to touch other lines. It’s no longer about if a breach will happen. It’s when.”

About Nationwide’s Cyber Solutions

Nationwide’s cyber liability coverage includes a service-based solution that helps mitigate losses. Whether it’s loss prevention resources, breach response and remediation expertise, or an experienced claim team, Nationwide’s comprehensive package of services will complement and enhance an organization’s cyber risk profile.

Nationwide currently offers up to $15 million in limits for Network Security, Data Privacy, Technology E&O, and First Party Business Interruption.

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Products underwritten by Nationwide Mutual Insurance Company and Affiliated Companies. Not all Nationwide affiliated companies are mutual companies, and not all Nationwide members are insured by a mutual company. Subject to underwriting guidelines, review, and approval. Products and discounts not available to all persons in all states. Home Office: One Nationwide Plaza, Columbus, OH. Nationwide, the Nationwide N and Eagle, and other marks displayed on this page are service marks of Nationwide Mutual Insurance Company, unless otherwise disclosed. © 2016 Nationwide Mutual Insurance Company.

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This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Nationwide. The editorial staff of Risk & Insurance had no role in its preparation.




Nationwide, a Fortune 100 company, is one of the largest and strongest diversified insurance and financial services organizations in the U.S. and is rated A+ by both A.M. Best and Standard & Poor’s.
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