Capital G
The mechanics of an informed decision
Choosing a domicile, captive manager and investment manager are crucial decisions for a captive owner. Here, Dr. Eugene Durenard and Andrew Marsh of Capital G focus on approaching your investment strategy, picking your investment manager and why Bermuda is the top domicile choice a captive manager can make.
and your reinsurance programme wisely are keys to a successful optimisation of your liability coverage at reduced costs.
L
Liability and asset risk Liability risk is not the only risk a captive should focus on. The
asset side is as important as the liability side—after all, they are part of the same balance sheet. When the assets of a captive are invested they are subject to market risk, credit risk and liquidity risk.
This is why many captive owners take what they think is an ultra-
conservative route and invest in money market funds. The problems with money market funds, however, are threefold. First, they are still heavily tilted towards credit instruments, despite the fact that in 2007 and 2008 some money market funds had to close down because they ‘broke the buck’ and had to be bailed out by their sponsors in the credit meltdown. Second, even if they are invested in credit, their yields are still very low and they barely cover their fees. Third, the most important problem is that money market funds do not provide the correct hedging instrument for captives—they do not put them into a risk-neutral state.
et us start with the basics. For a parent, setting up a captive is an exercise in improved risk mitigation at better cost. Your captive is supposed to be the optimal insurer for the dominant risks in your business. Hence choosing your captive manager
Engineering a risk-neutral state
So what is the risk-neutral state for a captive, and how does one achieve it? The correct approach comes from research into optimal asset-liability management (ALM) strategies. Essentially the concept is: hedge your declared liabilities with static fixed income portfolios, and hedge your expected unrealised liabilities with dynamic fixed income strategies; only after this can you use some excess return strategies with care.
This sounds complicated so we’ll explain the three parts. Take, for example, a medical malpractice captive. It has a few claims outstanding and they are already estimated with a high degree of certainty. They will take eight years to be completely paid off and their value is estimated at $2 million. Other claims have not occurred yet, but actuaries have already projected that for this particular business one should expect a series of claims that will have an average duration of six years and a severity of $10 million.
If we then assume the captive is capitalised to the tune of $15 million,
the ALM research we conducted suggests that the optimal strategy is the following:
• Hedge your $2 million of declared future losses with a high-quality bond ladder;
• Invest the $10 million of expected but unrealised claims in a managed duration strategy with an average duration of six years. Managed duration strategies are dynamic fixed income strategies that act as interest rate
bermuda captive 2012 39
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60 |
Page 61 |
Page 62 |
Page 63 |
Page 64 |
Page 65 |
Page 66 |
Page 67 |
Page 68