CITI
MAKING THE RIGHT COLLATERAL CHOICE
Douglas Tienken, director, insurance trust sales, and Vivek Thakur, director, insurance trust product management, at Citi’s Global Transaction Services, explain the key factors captives must examine when making the choice between letters of credit and trusts.
reinsurance agreement. While LoCs have long-standing and numerous merits, trusts offer signifi cant attractions too.
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For years, since their introduction in the US in the 1960s as a substitute for escrow facilities, LoCs have been the most popular solution used by captive insurers. Since then, captive insurance has undergone a revolution: there are now thousands of captives writing business worldwide using fronting companies.
Although each jurisdiction has unique requirements, the principle that captives are thinly capitalised (and therefore require security for both regulatory and credit reasons) is universal, and LoCs have, consequently, remained the dominant product.
According to Marsh’s 2010 Global Captive Benchmarking Report, which analysed 750 single-parent captives in its client group, LoCs represent 59 percent of all collateral instruments used, compared with 19 percent employing insurance trusts, 19 percent escrow facilities and 3 percent parental guarantees.
ndustry discussions on the most appropriate form of insurance collateral ebb and fl ow as we move through the cycle, but in reality both letters of credit (LoCs) and trusts are important instruments
for securing a captive’s obligations under
Citi’s own experience shows that in the US, up to 80 percent of collateralisation uses LoCs and around 20 percent insurance trusts, but does this always represent the best choice of structure?
a
How LoCs and trusts differ While LoCs are the most signifi cant instrument used by captive insurers for collateralisation, trusts are of growing importance. Trusts perform the same role in securing a captive insurer’s reinsurance obligations, but work in a somewhat different way. Instead of an applicant for a LoC, the captive is called the grantor of the trust. The fronting company is the benefi ciary of both products, and a bank sits in the middle. However, there are further differences between the products that need to be considered.
One of the most important differences between a LoC and a trust is the role of the bank. Under a LoC, the bank issues LoCs in favour of the benefi ciary and acts as a guarantor. With a trust, the bank is a trustee rather than a guarantor.
One of the reasons for the growth in the use of trusts by captive insurers is that LoCs are a credit product and therefore carry regulatory capital costs—a 100 percent capital charge—for banks. This has prompted
CICA | Forty years of captive leadership 83
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