Zurich Insurance Company Ltd
Zurich’s Veronique Méautte-Evans puts forward the case for reinsurance captives to CIT
Zurich’s Veronique Méautte-Evans puts forward the case for reinsurance captives to CIT
What are the differences between a direct insurance captive and a reinsurance captive?
It’s usually a question of licensing. The risk management strategy of a customer will define what type of captive it chooses to use. Quite often, we see customers using the direct insurance captive structure in EU domiciles such as Ireland, Luxembourg, Gibraltar, Malta, etc. The reason why a company might decide on a direct insurance captive as opposed to a reinsurance captive is because they may wish to issue direct insurance paper to their company, and/or their company’s subsidiaries. On non-compulsory classes of business—if the licence permits it—a direct captive can issue insurance policies in the EU under freedom of services as their chosen risk management strategy.
A reinsurance captive would require a fronting carrier to issue the direct policies and would reinsure the fronting carrier for a portion of the risk, so this particularly works for compulsive class business where the direct writing captive would not be licensed to issue paper, and also for international programmes. For example, a captive may not be licensed to write a direct policy in numerous territories and the captive would need to use a variety of local insurers. This is where a global programme fronted by an insurance carrier can resolve a lot of issues and provide global compliance.
So ultimately, it’s a question of risk management strategy from the company that owns the captive in relation to its insurable locations.
Why types of clients would Zurich recommend the reinsurance captive structure to, and why?
I would recommend a reinsurance structure over a direct insurance captive any day. And the reason why is down to exit strategy. In some cases, customers do not plan for an exit strategy when they establish their captives. Years down the line, if the risk management strategy changes and the captive is no longer needed, it may be a lot easier to close a reinsurance captive down. A reinsurance captive may be the better option as it is a lot trickier to unravel a direct insurance captive than a reinsurance captive.
There are pros and cons. For example, if a direct writing captive is chosen, then the customer would not need to pay fronting fees to a fronting carrier, but when it comes to unraveling the captive at the end of its life, it can become a financial and legal nightmare.
So what appears as a cheaper option at first glance may turn into a costly approach in the long term when the need to close the captive down is there.
At Zurich, we work with around 200 captives worldwide and each programme structure is tailor-made to our customers’ needs, so every programme is different to the next.
What are the downsides to the reinsurance captive structure?
Customers would probably cite fronting fees and potential collateral requirements from fronting carriers. But having said that, if the structure covers UK exposures only (ie, not an international programme), then the fronting fee should be relatively low. Where it may become costly is when a company decides to cover a large international programme in multiple local jurisdictions, because an insurance carrier would need to get its network of local insurers to issue local policies to the local insureds, particularly where the captive is not licensed to write directly. The local insurers would need to be remunerated for the work done at the local level. This is the price to pay to have a compliant insurance programme.
I firmly believe that a reinsurance captive programme is worth the costs incurred because this is the way to ensure the compliance of an international insurance programme. A customer needs to be reassured that claims can be paid at the local level and be compliant with the local rules. And at the end of the day, insurance is about paying claims.
The other downside is the potential collateral required by the fronting carrier. This is because the insurance company is paying the losses and recovering from the captive within its allocated retention of the risk. The fronting carrier may need to cover its future liabilities to the captive. This applies particularly to a programme on a occurrence basis, where the fronting carrier insures long-tail liabilities. The insurance carrier needs to make sure that the captive will be there financially in the future to reimburse the claims within its retention. Collateral may generally take the form of letters of credit, parental guarantee, trust agreements or cash, among others, and in some cases there may be no collateral requirements at all. When the future credit risk is assessed, decisions can be made on the amount needed as appropriate.
