Category Archives: Captives

Risk Link Roundup

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Here are a few articles that caught my attention during the past week highlighting some interesting issues impacting the world of risk and insurance. They include tips on handling cyber disputes, news about the coming El Niño, Department of Labor remote work policies, how students at Butler University are establishing a captive insurer and an interesting look at potential FCPA lessons learned from the July death of Cecil the Lion.

5 Tips for Success in Cyber Litigation

Insurance Thought Leadership: Many insurance coverage disputes can be, should be and are settled without the need for litigation and its attendant costs and distractions. However, some disputes cannot be settled, and organizations are compelled to resort to courts or other tribunals to obtain the coverage they paid for, or, with increasing frequency, they are pulled into proceedings by insurers seeking to preemptively avoid coverage. – See more at: http://insurancethoughtleadership.com/5-tips-for-success-in-cyber-litigation/#sthash.m6sFEr8X.dpuf

El Niño and La Niña: Weather Patterns that Could Impact Your Business

Interstate Restoration: “…the Godzilla El Niño.”“All Signs Indicate a New Monster El Niño is Coming.” These quotes aren’t from a new action movie. They are just a couple of examples of the dramatic headlines and descriptions about the potential of this year’s El Niño. Since most of the stories hearken back to the El Niño of 1997 – 98—the strongest on record—it’s understandable if you’re concerned about the potential impact that of this year’s El Niño on your business. But depending on where you’re located, you may or may not need to worry.

DOL Forcing Everyone to Change Remote Work Policies: Pitfalls to Avoid

HR Morning: If the DOL’s new overtime regs go through as written — and there’s every indication to believe they will — employers of all stripes will have much more than just classification issues to contend with.

Grant Helps Butler Create Student-Run Insurance Company

Butler University Newsroom: The Butler University College of Business will establish a student-run insurance company with the goal of having the company fully operational by the 2019–2020 academic year, thanks to a $250,000 gift from MJ Insurance and Michael M. Bill.

On the Death of Cecil the Lion and the FCPA

Compliance Week: Cecil the Lion was shot and killed in July. What does the death of this well-known and well-beloved lion in Zimbabwe have to do with the Foreign Corrupt Practices Act? More importantly, what are the lessons to be learned by any chief compliance officer or compliance professional from this event? Much more than you would first think, actually.

A Race against the Clock to Address TRIA Issues

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Failure by the Senate to reauthorize the Terrorism Risk Insurance Act (TRIA) has left unanswered questions for insurance buyers facing renewals on terrorism coverage—which some in the insurance industry are scrambling to answer.

Because TRIA renewal was recently passed by a majority in the House of Representatives, the industry was optimistic about its renewal before its expiration. But at this point, the Dec. 31 deadline looms large.

AIR-Worldwide explained in an email notice that commercial insurers will no longer be required to offer terrorism coverage beginning Jan. 1. Without a federal backstop, they said, insurers may seek to limit underwriting for high concentrations of risks in major cities. This could cause terrorism insurance coverage to become unavailable or unaffordable.

AIR continued:

Insurers that do continue to offer commercial terrorism insurance would likely be required to maintain higher capital standards in order to avoid negative rating implications. Where coverage for terrorism-related events is still available, prices for this coverage will increase.

In the absence of TRIA, the workers’ compensation insurance market would be particularly vulnerable to terror attack losses. State workers compensation statutes offer insurers less flexibility to control terrorism risk through modifications such as policy limits or coverage exclusions. With or without TRIA, it is mandatory for U.S. employers to provide workers’ compensation coverage. If coverage is not available, employers may be forced to purchase insurance in the residual markets or self-insure.

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This could result in large amounts of risk being transferred to the residual market in a few states.

Allowing TRIA to expire would have widespread implications, not only for the insurance industry, but also for the broader economy. Construction and real estate business sectors may be unable to obtain financing without adequate terrorism coverage in place. If insurers limit underwriting following an expiration of TRIA, businesses with high concentrations of employees could have difficulty obtaining coverage for workers’ compensation, including higher education institutions, hotels, airports, hospitals, and financial services, among many others.

In an advisory to its clients, Willis addressed considerations and offered preliminary guidance.

The broker noted several scenarios, depending on how a company has organized its terrorism risk transfer program:

• For terrorism coverage that is currently embedded in all-risk property, liability and workers compensation programs there are three potential scenarios:

1. If there are no sunset clauses–contract provisions which may allow the insurer to exclude coverage for terrorism in the event that TRIA is not reauthorized–or reservation of rights clauses related to TRIA expiration, the program will run until its natural expiration. Market disruption may impact renewal pricing if no action has been taken on TRIA.

2. If there is a TRIA-related sunset clause, the terrorism coverage will expire after Dec.

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31. Policyholders should assess the need for insurance coverage and seek stand-alone coverage or a sunset clause extension.

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3. If there is a reservation of rights which allows carriers to modify the terrorism coverage as a result of TRIA expiration, a coverage extension should be negotiated if possible, and stand-alone alternatives should be sought.

• Stand-alone Terrorism coverage – In this case, Willis said it does not anticipate immediate changes due to TRIA’s expiration. This is because most stand-alone placements do not have sunset clauses or reservation of rights endorsements related to TRIA expiration. While there may be market disruption to consider at renewal, for the time being, TRIA is a non-issue for these placements.

• Captives – In all cases where it places terrorism reinsurance behind a captive program, Willis said the reinsurance arrangement this year has been organized to convert from quota share reinsurance of the captive—when a primary insurer and reinsurer establish a fixed percentage for sharing amounts of insurance, premiums and losses—to primary reinsurance of the captive (in anticipation of TRIA’s expiration). Reinsurance coverage agreements should be read carefully to determine the new limit. The new primary limits are likely to approximate their existing quota share capacity. Willis recommends that any capacity that does convert should remain as reinsurance of the captive. This would maintain captive involvement, should TRIA be reauthorized in early 2015, and avoid any direct self-procurement or frictional costs during the transition. A program may also include excess capacity which, in many cases, should drop down to provide excess over revised captive limits, Willis advised.

Captives under Scrutiny

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A mere decade ago, captive insurers were viewed by most regulators as a small, even exotic part of the insurance industry. Most were assumed to be offshore and aroused little attention. Now, captives have gone mainstream. A sizable, but undetermined, portion of the property casualty coverage is placed through, or issued by, captives. A good guess is 30% to 40%, but no one has been able to establish an accurate number. Thirty-nine states have some form of captive or self-insurance law. Captives are now part of everyday life for regulators and the result is more scrutiny.

The issues now on the agenda for captives are significant:

• XXX and AXXX Reinsurance Captives

According to Superintendent Joseph Torti (Rhode Island), 80% to 85% of life and annuity insurance is ceded to reinsurers. Much of the so-called “excess reserves” required by Rules XXX and AXXX are ceded to captive reinsurers or special purpose vehicles owned by the same licensed life and annuity companies which cede the risk. Because the amount of this risk is so large, any trouble collecting this reinsurance could have a major effect on the industry. Some regulators, even a few who approved these cessions, have criticized these arrangements. In some cases, the collateral for the reserves has been subject to parental guarantees, which tends to undermine the confidence which can be placed in the transaction. The NAIC is continuing its examination and has met some stiff resistance from the industry.

• Multistate Insurers 

The proposal to amend the preamble to the NAIC Accreditation Standards to treat captive reinsurers as “multistate insurers” (with some limited exceptions) was withdrawn at the last NAIC meeting in Louisville. A new proposal should be forthcoming (and may have already been issued by the date of publication of this Newsletter). The premise of this proposed change is that non-domiciliary regulators need to know how insurance issued in another state may affect the citizens of their state. The opposite point of view is that the regulators of the domicile have done their job and should be trusted by their regulator colleagues and that the transaction should not affect third parties, anyway. Some say the risk to the domestic captive industry is existential. If enacted and enforced, the proposed change could, ironically, drive much of the industry offshore and therefore beyond the authority of the regulators promoting it.

• Nonadmitted Risk and Reinsurance Act

Captives have been inadvertently drawn into the regulatory structure imposed by this federal legislation intended to streamline the reporting and payment of surplus lines taxes. It has shined a spotlight on the payment (or non-payment) of state self-procurement taxes, but, ironically, does not in any way alter either the application of them or their payment. While risk retention groups (RRGs) were able to get an exemption from the law during its formative phase, captives, because they are (generally) single state entities and therefore not doing business as a “non-admitted” insurer, did not even attempt to get an exemption. Now there is a group, the Coalition for Captive Insurance Clarity, which is seeking a legislative exemption on Capitol Hill.

• Insurance Company Income Taxation

The Internal Revenue Service is investigating several insurance pooling mechanisms and, in some cases, the captives that have utilized them to establish third party risk—which is essential for an insurer to get the benefit of insurance tax treatment. This investigation is presumably a response to the rapid growth of “micro-captives” as mechanisms to assist with avoidance of taxation in estate planning and wealth transfer. This process is in its early stages, but is likely to produce some dramatic results.

• Federal Home Loan Bank (FHLB)

Who would have thought that the FHLB would have anything to do with captives?  It appears that some captives, and at least one risk retention group, are members of the FHLB, which allows them to obtain federal funds at advantageous rates. The Federal Housing Finance Agency (FHFA), which regulates the twelve FHLBs, has proposed a rule that would exclude all captives from membership by defining “insurance company” to mean an entity which “has as its primary business the underwriting of risk for nonaffiliated persons.”

Why is this happening now? While there are numerous reasons for these kinds of actions, there are two primary motivators. First, regulation is always subject to the problem of “what’s worth doing is worth overdoing.” Reasonable minds can differ on the interpretation of statutes and regulations. Each of the above includes an element of “pushing the envelope,” which can be significant or insignificant issues depending on your point of view. Second, captives have been caught in the vortex of regulatory competition. As we have discussed before in this column, the National Association of Insurance Commissioners (NAIC), the Federal Insurance Office (FIO), and the International Association of Insurance Supervisors (IAIS) are jockeying for position and power. Add to the mix the position of the Organization for Economic Cooperation and Development (OECD) that captives may be used as a device to avoid taxation (“base erosion” in OECD parlance), and you have a tumult of regulatory action which at the same time can be challenging and conflicting in its goals and implementation.

What does this bode for the future of captives? Once you have been seen on the radar, it is hard to drop off. Captives can expect more of the same for the foreseeable future.

This blog was previously published on the Morris, Manning & Martin, LLP website.

The Rise and Fall of Captive Reinsurers in the Mortgage Market

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Before the collapse of the housing market in 2008, it was common for large, high-volume mortgage lenders to form captives to spread their exposures to property mortgage insurance (PMI). But once the market bottomed-out, these arrangements fell under greater legal scrutiny and many courts are now finding them lacking. According to attorneys David McMahon and Peter Felsenfeld of Barger & Wolen, in a new online article in Risk Management magazine, the way premiums are collected by the captives may be a violation of federal law.

Mortgage reinsurance captives…are not funded by premiums paid by the parent company. Just like a standard reinsurer, they operate by collecting premiums from the PMI provider and sharing in the payment of losses. They are “captives” by virtue of their relationship to the parent institutional lender. In that way, they appear to the outside world just like any other wholly owned subsidiary of the lender.

Once commonplace, this arrangement may create legal exposure to lenders that outweighs the benefits of reinsuring through a captive. Courts are increasingly frowning on the captive mortgage reinsurer model, allowing class actions to proceed against lenders that allege the premiums generated constitute improper referral fees or even “kickbacks.”

As the authors report, court decisions over the last few years are increasingly chipping away at the concept of mortgage reinsurance captives and putting lenders on the defensive. For more, you can read the entire article at RMmagazine.com.