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Reviewing credit risk on gross cessions and pure fronting
Following Captive Intelligence’s report on what lessons, if any, there are to learn from Trisura Group’s multi-million dollar write-down, Zurich’s Emma Sansom shares her thoughts on recent changes in fronting trends and the considerations for captive owners.
As we’ve seen a rise in gross cession structures and requests for pure fronting, the issue of credit risk is becoming more of a critical one, and there are some additional considerations for captives looking to benefit from using gross structures to access reinsurance markets.
Reinsurance overriders from these transactions can be seen as ‘risk-free’ income, but it’s not: aside from reputational risk at the front end if there are disputes with the claims handling process, then there’s operational risk, and of course credit risk.
Typically we tend to think of insolvency when we think of credit risk, but it can come from a variety of sources: insolvency of the counter-party, coverage disputes, or potentially even legal reasons (see Side A D&O).
Managing counter-party credit risk
Whilst diversification across a portfolio of risk is generally a good thing, with counter-party credit risk, having a large panel of reinsurers brings with it a host of additional considerations.
Concurrency of reinsurance agreements is key to ensuring there is back-to-back coverage for a captive, but negotiations with a large panel of reinsurers can be time consuming.
Contracts will need to be negotiated with the individual carriers, and potentially, subsequent changes to the underlying policies will also need to be negotiated with the panel, or at least the leading reinsurers. Small changes to claims cooperation clauses for example can have potentially far-reaching impacts.
Ensuring you understand the financial position of each carrier is important, as is ensuring you are making a provision in your pricing structure to cover counter-party credit risk.
Having highly rated capacity of say A- as a minimum is a good place to start. However, as we have seen, these ratings can change so it is important to be able to monitor the whole panel, and have provisions within the reinsurance contract enabling replacement of carriers where there is significant downgrade.
Other credit risk mitigants such as Letters of Credit (LoCs) are an option, but these also involve operational considerations and risks.
For example, an LoC is often a physical document that needs to be stored in a safe. If it needs to be drawn down on, then this means presenting it at the specified branch, which may mean physically going to the branch with the LoC.
So you need to make sure that firstly, the LoC is on demand and evergreen so that it can’t just be cancelled at renewal by the provider, and you have systems in place to respond at pace when you do receive a notification of cancellation or when you need to drawn down.
And then there’s the credit risk of the LoC provider itself. If you happen to be having an issue with a counter-party and the LoC provider is no longer there to provide the cash, then you may be left with outstanding reinsurance recoveries.
Tail risk
Finally a comment of the tail of risk. Predicting long tail risk is difficult to get right – and claims costs are only rising. Where reinsurance is aggregated, such as with mutli-year-multi line structured reinsurance solutions, this potentially leaves gaps in cover for captives where long-tail claims start making themselves known.
Ensuring reinsurance coverage in your excess layers is dovetailed with these types of insurance is critical – for example, if the SS capacity is completely eroded, do the excess layers drop down or stretch down? A drop down of the excess layers will likely be cheaper, but can potentially leave you exposed in the event this capacity is also eroded.
It can be time consuming so if you are considering switching to a gross cession form a net cession, then counter-party credit risk, concurrency, and a robust, gap-free structure should be the focus of the exercise, but this might not be the cheapest capacity.
There is a balance to be struck and if the risks are minimised, a gross cession can reap many benefits.
SRS appoints Ron Sulisz as president of global company
Strategic Risk Solutions (SRS) has appointed Ron Sulisz president of the global firm, a position he will assume from 15 May 2023.
Sulisz has been with SRS for 18 years and is currently CEO of SRS Cayman, having helped establish SRS as one of the leading captive managers in the domicile.
Jenny Pooley will be assuming the role of CEO in Cayman.
“I’m excited for this new chapter at SRS, and although I will be shifting responsibilities to Jenny, I’m remaining in the Cayman office, and available to my clients and the relationships that I’ve built over my years at SRS,” Sulisz said.
In his new role he will report to Brady Young, who will remain as CEO of the company. Sulisz will also serve on the board of SRS.
“As we continue to grow and expand, I recognised we needed more focus and resources to support operations and Ron will be perfect to lead this effort and focus on the corporate side of SRS, heading up the internal financial, operations, human resources, and information technology teams,” Young said.
“It will allow me to focus more on strategy and supporting our operating units and ensuring we maintain our customer focus.”
Captive Intelligence reported in February that New York-based private equity firm Integrum Holdings LLP had bought a significant stake in SRS.
Post investment, we understand SRS is looking to expand into new markets, both within and related to the captive management business, and is evaluating further acquisition targets.
Florida bill could have “devastating impact” on RRGs
A Florida bill that would harden certain financial standards for risk retention groups (RRGs) and surplus lines carriers could cause a “devastating” impact on most of the RRGs doing business in the state, the executive director of the Risk Retention Group Association (NRRA), Joseph Deems has said.
RRGs are regulated differently from captives and commercial insurers because they come under the Federal Liability Risk Retention Act (LRRA) of 1986.
Deems highlighted that by imposing a requirement of an AM Best “A” rating and a minimum financial size of $100M in capital surplus in order for an RRG to write commercial auto liability in Florida, the Bill unlawfully seeks to regulate RRGs, and unlawfully discriminates against those RRGs that do not obtain such ratings.
“If passed, Florida Bill 516 will have a devastating impact on not only trucking and transportation risk retention groups registered in Florida, but actually every RRG writing commercial liability, including auto,” Deems said.
“Hundreds, if not thousands of RRG owner-insureds could lose their coverage.”
The Bill’s passing may also open the door to significant threats to RRGs in other states.
If passed, starting 1 July 2023, Bill 516 will potentially impact 96% of the 140 risk retention groups registered in Florida from continuing their business, according to NRRA.
“If history is any example, regulatory intervention calculated in response to the bill could actually disqualify or interfere in a number of ways with RRG commercial liability insurance,” Deems said.
The Florida House Commerce and Senate Appropriations Committee hearings are set to take place 10 April and 12 April respectively.
“We need to stop this bill before it passes because, if it passes, suing the state will take years and will be too late to help these impacted RRGs,” Deems said.
Captives “booming”, EB trending away from global underwriting – Ludovic Bayard
Businesses have become more likely to go straight into a captive structure when centralising international employee benefits programmes, rather than pursuing global underwriting first, according to Ludovic Bayard, CEO of Generali Employee Benefits.
Bayard was guest co-host of GCP #82, in which he discussed GEB’s own portfolio, where he sees most growth and the opportunities for captive EB programmes to contribute to group ESG and DE&I initiatives.
He also reflected on GEB’s move to Luxembourg to become a regulated reinsurance company in 2018.
Generali Employee Benefits has had a focus on captive business for more than 20 years and Bayard said it’s portfolio today totals approximately €1.6bn in gross written premium across captive, pooling and global underwriting structures.
Of the €1.6bn, 50 captives programmes account for around €700m in annual premium, while €500m is from pooling clients and €400m is from global underwriting and reinsurance only clients.
Bayard said the captive segment is the fastest growing of the three.
“It’s fair to say that we see a bit of decreasing of interest in the global underwriting,” he explained.
“We start to see again an increase of interest in the pooling. It was flat in the last two, three years, but it’s starting again, while on captives it’s really booming. I would say it’s double-digit growth since at least five years.
“On global underwriting, there was a huge interest 10 years ago. Those who started from the very beginning are now ready for the captive. So in the recent two, three years, many of these global underwriting clients have switched to the captive concept.
“The most recent ones are still, let’s say, discovering the world and the difficulties of EB. But we don’t see many new requests on the global underwriting.”
It was previously expected, and often experienced, that clients would go through the full journey of first pooling international employee benefits, before participating in global underwriting for a more centralised buying approach and ultimately ending up with global EB in a captive.
Bayard said, however, that nowadays it is more common for companies to head straight for the captive approach but it still varies from case to case.
“It really depends on the DNA, on the culture of the company,” he added.
“You can have companies who jump to the captive directly, maybe because they already have the P&C mindset and the structure. You have clients who shift from pool to captive.
“There is no average pattern. It’s really about the culture, also the people involved in the programme that make the difference.”
In the full podcast interview, Bayard also discussed some of the challenges businesses must overcome to pursue and implement a captive-backed international employee benefits programme, how GEB is tackling data management and the opportunity for captives to contribute to group ESG and DE&I initiatives.
Listen to the full GCP #82 episode here, or on any podcast app. Just search for ‘Global Captive Podcast’.
Labuan, Singapore add eight new captives in 2022
Asia Pacific’s largest captive domiciles, Labuan and Singapore, added eight new captives between them in 2022, with Labuan adding five new captives and Singapore licensing three last year.
The number of captives domiciled in Labuan at the end of 2022 was 67, while the total number of captives in Singapore at the end of 2022 was 82.
At the end of 2022, Singapore had one life captive insurer, 77 general captive insurers, and four composite captive insurers.
All three of Singapore’s new captives in 2022 were general captive insurers.
Captive Intelligence reported last month that Singapore-domiciled Odeon Insurance Re Pte Ltd had become the first Asian captive to become a signatory of the United Nations Principles for Sustainable Insurance.
At the end of 2022, Labuan’s 67 captives included 39 pure captives, 15 rent-a-captives and 13 protected cell companies (PCC).
Labuan also had 24 individual cells at the end of 2022.
One captive domiciled in Labuan surrendered its licence in 2022, while Singapore had surrendered five captive licences in 2022.
Luxembourg regulator open to PCC discussions in domicile
Valérie Scheepers, head of the non-life and reinsurance department at the Commissariat aux Assurances, has said the regulator is open to discussing the possibility of introducing protected cell companies (PCCs) in Luxembourg if there is industry demand.
With Gibraltar leaving the European Union with the United Kingdom post Brexit, Malta is now the only EU state that has PCC legislation. The concept has proved popular in the domicile with 14 PCCs currently active.
Speaking in an interview on episode 82 of the Global Captive Podcast, Scheepers said the onus was industry to present a real business case so rules could then be developed.
“We are absolutely open to the development of new activities if there is a real demand for it,” Scheepers said.
“We have a preference for developing the rules when dealing with practical cases. Otherwise, we have the risk of having an overly burdensome and not appropriate regulatory regime.
“So should we receive a case, then we will consider it. We are absolutely open to it, but we we need a practical case.”
One of the sticking points for developing an attractive PCC offering in Luxembourg is the fact that the regulator is most comfortable regulating reinsurance captives, rather than direct writing captives which cells are often used for.
If a direct writing captive is established in Luxembourg, then the CAA requires it to be supported by a reinsurer.
“It might be a challenge for us because we prefer to have a composite of a direct captive and then the reinsurance after,” Scheepers added.
“But, once again, if we have an example we are really open to analyse it. But as of today, we were not approached with a real case.”
There was nine new reinsurance companies licensed in Luxembourg during 2022, bringing its year-end total to 195. The vast majority of those are captives.
Although applications to form this year would usually begin arriving in the summer, Scheepers said 2023 is already proving “very much different”.
“We already have now regular meetings with new candidates,” she added.
“The demand is quite high, we see it, it’s clear, and it starts early in the year, so that it is very likely that 2023 will be even better than 2022 in the creation of new companies. So I am quite positive at the moment.”
GCP #82: GEB’s Ludovic Bayard and Luxembourg captive regulator Valérie Scheepers
In episode 82 of the Global Captive Podcast, supported by the EY Global Captive Network, Richard is joined by guest co-host Ludovic Bayard, CEO of General Employee Benefits, and Valérie Scheepers, head of the non life and reinsurance department at Luxembourg’s Commissariat aux Assurances.
Ludovic discusses Generali’s employee benefits captive portfolio, some of the challenges and opportunities he sees in the space, as well as GEB’s own move to Luxembourg five years ago.
Valérie will bring us up to speed on recent and future captive licensing activity in the EU’s largest captive domicile, imminent changes to captive regulation in Luxembourg and also has some very interesting comments regarding the prospect of cell companies being introduced in the jurisdiction.
For the latest global captive news, analysis and though leadership, visit Captive Intelligence.
DARAG Bermuda concludes agreement with Cayman captive
Legacy acquirer DARAG has concluded an agreement between an undisclosed Cayman-domiciled captive and its Bermudian insurance carrier, DARAG Bermuda.
The agreement allows the counterparty to release capital back to members of the wider group.
Joel Neal, executive vice president, M&A, at DARAG North America, said: “It’s a pleasure to renew this business with our Cayman-based partner.
“In doing so, we are enabling them to concentrate on their primary business operations and underwriting profitability, freeing up trapped capital and improving efficiency. Our pipeline for 2023 exceeds expectations and we look forward to announcing further transactions.”
The transaction structure is a renewal of a previous novation agreement, with DARAG Bermuda assuming additional policy years.
Through this, the captive is able to achieve full legal finality for its workers’ compensation, general liability and auto liability lines of business for the added policy years.
Tom Booth, CEO of DARAG said: “DARAG’s exceptional track record as a trusted partner in servicing small to mid-sized captive and self-insured portfolios in North America is a testament to our expertise in this niche market.”
Kate Storey departs Walkers, becomes full-time NED
Guernsey lawyer Kate Storey has chosen to become a full-time non-executive director (NED) for captive insurance and investment fund structures domiciled in Guernsey.
Storey had been a partner at Walkers since 2018, having previously worked at Appleby, but has opted to focus on NED positions. She will also offer services as a legal and regulatory consultant.
Asked why she was keen to pursue more NED opportunities and depart full-time law, Storey told Captive Intelligence: “It’s an opportunity to have a much deeper involvement in businesses than you have as an external legal advisor, and directing strategy rather than merely advising on it is more interesting to me at this stage of my career.”
The Guernsey captive community has launched two educational initiatives concerning insurance management and NEDs this year – an updated course in international insurance management and the Non-Executive Director (NED) Development Programme.
As captives have become more sophisticated, taking on more risk and writing new lines of insurance, the demands and profile of NEDs are only expected to increase.
“Captive governance requirements, as for any other financial services business, are ever increasing, for example in the area of climate change and broader ESG considerations,” added Storey.
“However, Guernsey is outside of Solvency II and therefore has been able to develop its own proportionate, risk based approach to regulation and governance, aligned with IAIS standards.”
Captive Intelligence hosted a podcast discussion in December 2022, which addressed the varied requirements and definitions of NEDs, also known as board directors, between international captive domiciles.
Andrew Bradley, formerly head of group risk services at Nestle and now an outside board member of a captive, said in the podcast that he does not believe the true value of outside board members is currently being realised.
“Outside captive board members aren’t necessarily taken up and included in a board unless it’s required by the local captive domicile,” he said.
“I found a few cases where forward thinking companies have expressly gone out to have not only one, but sometimes two outside board members to challenge what they do and have that extra experience in managing the company.
“So I think this is still very much work in progress and an important part of captive governance, but I think people somehow need to see the value of outside board members because I’m not sure whether that’s coming through just at the moment.”