13 June 2019Analysis

Many captives pay over the odds for collateral arrangements

Many captives are still paying over the odds for their collateral arrangements due to an inertia when it comes to exploring the use of captive collateral trusts instead of letters of credit (LoC). While more captives are starting to use the option, many captive owners and captive managers neglect the idea, often due to myths that do not stand up to scrutiny.

That is according to Robert Quinn, vice president, global capital markets institutional client services, Wilmington Trust, speaking at the Bermuda Captive Conference taking place this week.

Quinn has now worked in this sector for some 20 years, helping captives and other risk vehicles. He estimates that 20 years’ ago, only around 5 percent of captives used trusts; now he estimates the figure is closer to 35 percent.

But it has been a long road and that still leaves 65 percent of captives paying too much, he claimed.

Quinn said: “When I started in this business in 1999, not many people knew what a trust was. I was at one of two banks that spoke specifically to collateral. There were many myths around their costs and how long it took to establish a trust account. A lot has changed since then and there a lot more providers now. But the myths remain and the inertia is still in place in the market when it comes to changing things.”

Quinn states that for a captive with a $10m collateral requirement, a letter of credit will cost between 50 and 75 basis points, equating to around $50,000 to $75,000. It then needs to cash collateralize the LoC. By contrast, a trust can simply be used as a vehicle for the same cash and only an arrangement fee will be required of around $5,000.

Whereas most LoCs need to be renewed every one to three years, trusts will continue until both parties agree to unwind them, he added.

“The perception has also been that trusts are much more difficult to establish, but that is also not true,” he said. “Most fronting carriers are now very familiar with their legal requirements and it is far easier than a letter of credit to form. Once we have all the necessary documents from a client, it generally takes no more than two days.”

He said that in the aftermath of the financial crisis there was a spike in the use of trusts as credit was harder to get and the cost of LoCs soared. But now take-up rates have normalised again.

He also commented on the idea that LoCs have more flexible investment criterion, allowing users to make a more substantial investment return. While this is true in some cases, most captives are relatively conservative in their investment tolerance and this difference is nil for the average captive as a result, he said.