Captives weather financial storm: event coverage of the Vermont Captive Insurance Association 24th Annual Conference: Sheraton Hotel & Conference Center, Burlington, Vt., Aug. 11-13.

The financial crisis was a hot topic at the Vermont Captive Insurance Association conference--although most agreed captives had fared better than many traditional insurers.

"Captives have weathered the storm," said John Lochner, principal of Towers Perrin, during a seminar at the conference.

Steven M. Chirico, assistant vice president at A.M. Best Co., said captives were more profitable than traditional commercial insurers, according to an Aug. 3 Best's Special Report, Captives Buck Investment Losses With Strong Underwriting Results. The study examined the performance of 186 captives.

"Using combined ratio as a measure, the captive community significantly beat the commercial insurance market from a profitability perspective. The combined ratio for captives was approximately 5 points below the ratio for the commercial insurance market," Chirico said during a break at the conference.

Vermont regulators said they hadn't seen a single captive impaired due to the recession.

"Our risk retention group's surplus actually went up year over year," said David F. Provost, deputy commissioner of captive insurance, in an interview at the conference. "Most of our captives are very conservatively run and very conservatively invested. So they really were not particularly impacted too hard by the recession."

Captives have been fairly insulated from the financial turmoil because of their conservative nature, said Greg Lang, head of business development for Munich Reinsurance America Inc.

"A captive allows you to control your own destiny," Lang said. "They are smarter consumers, more incentivized to provide prudent risk management solutions."

While captives performed well overall, counterparty security was on the minds of many: captives, fronting companies, reinsurers and brokers and consultants.

"The biggest challenge is the security issue," said Steven R. Bauman, senior vice president and head of captive services for Zurich. Bauman said: "Not only the security of us as a company as we front--people want to make sure they are working with a financially secure company--but security is a requirement on them as a captive."

In fact, "Collateral is the first thing we talk about today," said James Riley, business manager of Zurich's captive solutions.

Captives are often required to post cash, a letter of credit or a trust as collateral for a fronting company, Riley explained.

Letters of credit used to be the most common vehicle, but as banks have gotten tighter with their loans, captives have been turning more often to trusts. Trusts work a lot like a savings account, except the money is earmarked to pay whatever obligation is expected from the fronting company.

"Trusts have become more popular in the last two years. We see more trust accounts than we ever have before. It's good. We are flexible and can work either way," Bauman said during an interview at the conference.

Stephen Cross, chief executive officer of Aon Global Risk Consulting, said the company is fielding many calls from captives concerned with their collateral obligations.

"An awful lot of front companies make collateral demands, and collateral just gets put up. Our approach is different," Cross said.

He said Aon's actuarial team will ask the fronting company how they arrived at that required dollar amount, and perhaps suggest a different, often lower, number.

"We always end up somewhere in the middle, hopefully somewhere were we need to be," Cross said.

Cross said another issue captives are facing is whether their assets have been impaired.

"The same question applies when you loan back money to the parent. If you had a major loss, how easy would it be to call the loan? Have those assets been impaired? Are they liquid, or as liquid as you thought?" Cross said. "The answer to the question, we would say, is it is probably not as liquid as you think."

By the Numbers: Vermont Captives

18 The number of new captives formed in Vermont so far in 2009

5 of the new captives are risk retention groups

3 relocated from other domiciles

33% of new captives are medical professional liability writers

$16 billion amount of premium Vermont captives generated in 2008

Source: Vermont Captive Insurance Association

Cover for Higher Wind Deductibles

Commercial insurance buyers have seen windstorm-related deductibles increase dramatically since the 2004-2005 hurricane seasons, but captives and stop-loss insurance can be used to help cover that additional expense, said Ace USA.

Windstorm deductibles have increased from a typical flat fee of $100,000 or 1% to 2% of insured property value to up to 5% of insured property value, according to Managing Catastrophe Risk Retentions Using a Captive Insurance Company, a white paper that Ace released in August.

Windstorm deductibles are often based on a per-occurrence deductible. So companies such as a hotel chain with multiple locations along the coast would not only have to meet that deductible for every property that was damaged in a year, but would have to cover the deductible for every windstorm event that happened in a year, said Ravi V. Nathan, senior vice president at Ace Global Weather.

If that per-occurrence deductible were $25 million, it would be hard for many companies to face multiple hits in a same year, Nathan said during an interview at the VCIA.

It's like a bee sting, Nathan said. A body might be able to handle the first bee sting, but the second bee sting might cause multiple complications if the body's resistance is down because of the first sting.

"I'm saying after one bee sting, I'm stopping it," Nathan said.

Ace is now offering to buy down the windstorm deductible for captives (or companies buying direct) with an aggregate stop-loss policy. If offered to a captive, it's a reinsurance program. If offered to a company buying direct, it's offered as a type of primary coverage.

According to Nathan, the captive that purchased the aggregate stop-loss windstorm deductible coverage might only be on the hook for the first $25 million deductible, and-Ace would cover any additional windstorm events over that.

"The advantage to a CFO is now they can plan it. They know, regardless of how many storms they have, how many buildings they have, they know that they can't take a hit of more than $25 million," Nathan said.

Also, sometimes captives and insurance buyers want to buy down the deductible to a lower level--say from $25 million to $10 million.

Ace's policy can accommodate that as well, Nathan said.

Both the minimum deductible and minimum premium for the Ace windstorm deductible buy down is $100,000.

The policy also covers business income loss (often called business interruption coverage).