Think of it this way: The single most important responsibility
of a captive is to be sure that said captive is always able to pay its claims. Having stated that, I will assert that most captive insurance companies have fairly conservative ‘internal investment guidelines’. Could a captive invest
its money in low-rated (and
“ Use of an insurance trust in lieu of a LOC will likely save you or your clients well over 80 percent of their LOC fees.”
higher-yielding) investments? Of course they could. But do they? Most of the time, no. Higher-yielding investments create additional risk to the captive (as if insurance risk isn’t bad enough, investing in lower-rated securities creates principal risk). Given that, I assert that most captives’ investment policies are right in line with the trust’s investment guidelines. And for this reason, most captives can use a trust in lieu of a LOC without realising ‘foregone investment income’.
Stay sharp #2 There is a huge misconception out there that the trust is difficult
to establish. Further, I have heard people assert that since a LOC is only two pages long and the trust agreement is often 15 pages long, the LOC must be easier to establish. This could not be further from the truth.
Of course, the trust is a comprehensive legal document.
employed, $40,000 per year. Compared to a trust that might cost $5,000, that is an 87.5 percent saving. Or stated another way, the LOC is eight times more expensive.
…but now it is a nightmare It is no secret that LOCs are far more expensive now than in 2007.
And in case anyone is holding their breath hoping that LOC fees will come down soon, I say that LOC fees are about where they will be for the foreseeable future.
Those LOCs that were 25 to 45 BPS in 2007 are now often 75 to
100 BPS. And to be clear, these are fully collateralised LOCs. So the $10 million LOC that cost $40,000 in 2007 now likely costs $75,000 to $100,000.
Interesting point: While LOCs are doubling and tripling in price, the price for an insurance trust, at least with Wells Fargo, has gone down.
Stay sharp #1 There are those who will tell you that there will be an ‘opportunity
cost’ associated with using a trust versus using an LOC. This is what they are trying to say:
“The LOC has to be fully collateralised with cash or cash
equivalents. Of course, the trust must also be funded. But the investment guidelines for a LOC collateral account might be more ‘liberal’ than that of a trust, thus allowing the captive to earn more investment return. The guidelines for a trust might be more ‘restrictive’ than those of a LOC collateral account. Therefore, any benefit to using a trust is eroded by a lack of investment return.”
This position is correct so few times that it is difficult for me
to give it credence by putting it in writing. But once in a while, it is true, so there you have it. But for most, there is zero merit to this position.
Robert Quinn is vice president of the collateral trust
division, Wells Fargo Insurance Trust. He can be contacted at:
robert.g.quinn@wellsfargo.com
CAYMAN CAPTIVE 57
However, Wells Fargo has pre-established the required language of the trust agreement for both fronted captive programmes and traditional deductible programmes. So to the extent that Wells Fargo is the trustee on your captive trust, the work is already 98 percent finished.
When considering the LOC, one must consider that an LOC is, in
fact, a request for credit from a bank. The fact that the actual LOC document is only two pages is not representative of the amount of time and effort required to actually obtain that two-page document. The credit review process involved in obtaining approval for a LOC for a captive is a longer and more involved process than that of establishing a trust for a captive.
To support this position: my group has established multiple trusts
in fewer than 24 hours. While that is not the norm, it is not out of the question. Having worked for banks for 10 years and understanding the credit approval process, I am confident that LOCs are not generally approved and issued in fewer than 24 hours.
I should also point out that the trust does not need to be
renewed each year. This will save the captive a lot of time and effort on an ongoing basis. No more stacking LOCs and no more LOC renewal processes.
Wrapping up my first 10 years As the Cayman Captive Forum and the year 2010 come to a close,
so will my first 10 years working in this domicile selling insurance trusts. Thank you all for your help and faith in me and my team at Wells Fargo.
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