Parked Captives are Worth the Upkeep

In a soft market, it's up to risk managers to find new ways to make use of their captive.

By CYRIL TUOHY, managing editor of Risk & Insurance®

In a soft market, it's not easy for risk managers to make a case to keep a captive insurance vehicle active or even dormant. Why should the CFO bother with that Utah or Delaware captive when rates in the traditional market are softer than melted Cabot cheese?

Serial Deal Sealed? (08/01/11)
Teeing It up (08/01/11)
Alternative Risk (08/01/11)
A Series of Fortunate Formations (08/23/11)
Dialing Into Captive Profits (08/01/11)

It's because the market is going to turn again, though no one quite knows when. The day rates go back up is the day risk managers who hastily closed their captive wished they'd just left it alone, nursed it for a few years until the C-suite was ready to take the wraps of the financial vehicle once more.

Shutting down a financial vehicle like a captive insurance company because rates are soft in the traditional market reminds me of General Motors Corp. turning off the ignition on the EV 1, the first mass-produced electric vehicle designed to run on electric power. GM ended the EV 1 program in 1999 after three years, only to find itself--12 years later--launching the Chevy Volt.

In truth, any skilled captive manager will tell you that for the parent company it's expensive and more trouble than it's worth to shut down a captive. Risk managers are better off consulting with their broker or captive managers about new and imaginative ways to make use of their captive ? if only to mitigate the fees incurred by the parent to keep the captive alive.

Now comes another silver lining in the captive insurance story: the debate over the use of a captive to draw on low-interest loans from a Federal Home Loan Bank, as reported in this month's cover story.

In an era of tight credit, the captive could pass on the advances to their parent companies in the form of loans or dividends to fund the expansion of operations, allowing the parent company to grow.

Or the captive could invest the borrowed money in a vehicle that would generate a higher rate of return than the interest owed on the advance. The captive could even use that float to help pay claims.

There are plenty of uses for captives and it is up to the risk manager to take advantage of this special financial structure until the market turns one more.

When it does, and risk managers find themselves without a captive to cover risks that the traditional market is unwilling to bear at a fair price, then the CFO is going to ask questions about why the captive was ever shut down in the first place ... like executives at GM who've wondered why they didn't park their EV 1 instead of driving it off the cliff.

March 1, 2011

Newsletter Sign-up