Sara Hakim, Callan
20 January 2020Analysis

Let’s make the Year of the Rat the year of the captive investment portfolio

There have been some important steps to improve industry practices around captive insurance investment portfolios over the years. Beginning in the early 1980s, premiums written started being tracked as a financial metric. At that time, one-third of the Forbes 500 companies owned a captive. By 1993, almost half of the Fortune Global 1,000 owned captive insurance entities.

In 2008 Marsh, the largest captive manager globally, released its first captive insurance benchmarking report. In later years it added information on captive investment portfolios. In 2014, asset manager London & Capital launched its first set of portfolio indices for offshore captives, which allow captives owners to benchmark their investment performance.

“During the feasibility study of a new captive’s formation, the assets and investment policy statement are often not addressed.”

The year 2020 marks the Year of the Rat. This animal is seen as a sign of wealth in the Chinese zodiac, which seems like an auspicious sign for captives to make 2020 the year they prioritise their investment portfolios.

What questions need to be addressed?

While the efforts detailed above are a good start, there is still a tremendous amount that can be done to apply institutional investment best practices to the portfolios of captive insurance companies.

There are still many unanswered questions about data and information for these asset pools

  • Who are the top asset managers used for short-term fixed income products?
  • What is the typical asset mix for a captive of multiple sizes?
  • What benchmark studies were conducted on investment and custodian fees?
  • How are banks or asset managers selected and reviewed?
  • Who is conducting the due diligence on the investment portfolio?

These are commonly asked questions with documented answers for other institutional investors. The good news for the captives industry is that the investment programmes for non-profits and for retirement plans had roots similar to those of the captive insurance industry—they operated within an “investment cottage industry”.

This included investing in retail funds, using personal or family contacts to manage money, participating in opaque decision-making, being unaware of multiple hidden fees and having limited information to share.

Non-profits and retirement plans have seen a large uptake in standardisation across investment reporting and fiduciary standards over the past 40 years. They implemented greater transparency, closer investment performance monitoring, better understanding of investment fees and improved overall governance.

As a result, these investors matured and continued to grow in assets. They operate within a professional milieu that not only follows regulations but, in many cases, influences them.

While the captive insurance industry has many professional associations in multiple domiciles helping to educate their members and influence regulations, these groups are not always advocates of bringing institutional investment and governance best practices to the forefront. There are few educational sessions and white papers on these topics at their conferences.

Why the slow adoption?

As we enter 2020, many captive investments are still being managed under an older model. The institutional investment framework has not taken hold as it has in other industries. Why? There may be a few reasons.

  • Lack of attention: The investment portfolio is often seen as an afterthought. For example, during the feasibility study of a new captive’s formation, the assets and investment policy statement are often not addressed. In many cases they are still viewed as an afterthought as the assets grow.
  • Small single parent captives: In many cases, the parent organisation does not have time to support the smaller assets in the captive, despite following institutional best practices for its pension plan and other assets. As such, the captive board turns to a retail or high-net-worth model to manage the captive portfolio. In these scenarios, we see model portfolios and separate accounts typically implemented using proprietary or affiliated funds with higher fees and commissions.
  • Large single parent captives: For those captive assets that do grow, the parent company may want to manage those assets and treat them similarly to its other assets. While the investment managers may be institutional, the investment guidelines and investment policy statement governance documents are not specific to the captive.
  • Board membership: Boards typically have strong risk management representation, along with strong operational expertise, but not always investment acumen. As a result, the agenda tends to have limited time allocated to the captive investment portfolio.

What to do?

Since the captive is, in legal terms, a separate insurance entity, an independent, third party consultant should review the portfolio and all it entails. For a single parent captive, this does not take away from the in-house expertise but treats the captive insurance company as an independent, alternative risk management transfer solution.

An overall assessment checklist of a captive’s investment portfolio to consider for 2020 includes:

  • Examining the asset mix to see whether it meets the needs of the captive’s reserve/liabilities and surplus;
  • Reviewing the investment structure to determine the right number and mix of managers;
  • Performing due diligence to confirm managers are meeting risk and return expectations;
  • Conducting investment management and custodial fee benchmarking; and
  • Documenting key findings.

Final thoughts

There are some very large captives (whether single parent or risk retention groups) that are following good fiduciary and governance practices (see earlier article). This helps the captives industry.

Having these large captive owners share their journey toward an institutional investment environment at conference sessions would be beneficial. They should share their experiences of how these best practices can be used and transferred to a majority of captive investment portfolios.

The captive insurance industry has much to gain from moving towards other institutional asset pools. It will not only improve the overall governance of these captive investment programmes but will potentially produce higher returns at lower cost and mitigate risk within the portfolio. But it can also act as a tool to attract and retain much-needed talent in the captives industry who may wish to pursue an investment career.

May the Year of the Rat also be the year that captive investment portfolios deliver prosperity to their captives owners!

Sara Hakim is a senior vice president and consultant in Callan’s New Jersey office. She can be contacted at: hakim@callan.com