Nick Smith, a relationship director with Barclays’ captive insurance team in London, talks EMEA Captive through the advantages of trusts as an alternative to Letters of Credit.
In the European market most captives have traditionally posted their collateral requirements to fronters by way of a Letter of Credit (LoC) but captives are increasingly keen to explore alternative ways to post collateral. Security Trust Agreements (STAs) have become available in the European market in the last couple of years.
They were built principally in response to client demand and as a solution to address the lack of options available to captives and the limited flexibility afforded by the LoC, the only traditional captive insurance collateral structure. In the past, captives have used LoCs in Europe and Reg 114 Trusts in the US for asset holding but it became evident that a new product was needed to meet the needs of the European captive industry.
STAs are a tripartite agreement between a captive insurance company (the settlor), a fronting insurance company (the beneficiary) and a security trustee (normally a trust provider).
In simple terms, the assets are transferred by the settlor to the security trustee which will hold these in a bank account (cash) or a custodian account (investments) in its own name and under its control to secure the captive company’s obligation to the beneficiary. This arrangement is governed by a trust deed to which the beneficiary and the settler both have input and agree on.
Prior to the launch of the STA the captive market outlined concerns with LoCs, with the principal issues focusing on the lack of flexibility and cost. The inception of the STA has definitely addressed and allayed many of these concerns. Even though the STA has removed the concerns with the LoC offering there have been new barriers to overcome before wide-reaching acceptance is found within the captives industry.
Unfamiliarity with the trust structure was seen as the primary stumbling block for captive insurance companies and also for fronting insurers. Initial wariness of a new structure is now becoming less of an issue, with many fronters now prepared to accept them. The simplicity offered by trusts provided by companies such as Barclays, as well as close cooperation with banking partners, is helping fronting insurers see the benefits of a trust. There is also a truly collective approach when drawing up the trust deed and all parties can gain comfort in its construction, which is also helping with the market penetration of this product.
"THERE IS ALSO A TRULY COLLECTIVE APPROACH WHEN DRAWING UP THE TRUST DEED AND ALL PARTIES CAN GAIN COMFORT IN ITS CONSTRUCTION."
As with any sector, the captive market is also subject to a certain degree of inertia—the status quo is often seen as the safer, easier option. There are perceived costs associated with changing a business model and it can seem a risky strategy if you are electing to be a pioneer with a new product class. Moving to a new type of arrangement can be seen as a ‘risk’, with the responsibility for the success of the move resting with the decision-makers in any business.
Taking the plunge
Staying with the familiar is a powerful draw and incentives must be right for businesses to take the plunge. The initial apprehension now seems to be dwindling with a number of trust structures already established, and many enquiries being explored.
Flexibility has indeed been a factor for captive insurers when choosing to establish a trust but it has perhaps been the efficiency and cost elements that have helped cement the decision. Captive companies can see that the STA is easy to set up with its taking as few as seven to 14 working days to establish once all parties agree. There is an ease of administration for the captive company and once established an STA is cost-effective to maintain as it does not have the same burdensome annual renewal process as an LoC.
The flexibility of the product is enhanced by the fact that assets held with an STA may be invested in different ways. From a fronting insurer’s perspective they have access, via the trustee, to a pool of assets held within the STA and for the captive company they can access asset classes that may provide higher yields, such as equities. The fronting insurer and the captive company both build into the trust deed an agreed investment schedule which the trustee (using the banking partner) manages the structure against. This gives clarity to the fronting insurer on the ‘type’ of asset class they rely on and gives the captive company, and its parent, considerable flexibility to work constructively with assets in the structure with known controls in place.
One of the captive managers we have recently worked with said: “Our captive client placed a fronting arrangement which required the provision of large amounts of collateral to the fronting insurer. The STA facilitated by Barclays provided our client with the amount of collateral required at a much cheaper cost than a traditional LoC as well as providing flexibility in the future for easily adjusting the amount of collateral provided as the client’s insurance programme develops.
“This was the first STA we had ever placed and the various teams at Barclays were exceptional in hand-holding us all the way through the formation process and enabled the STA to be operational within a fairly tight timescale.”
STAs have proved popular and the early adopters are reporting a positive reception among fronting insurers with several now looking at their suitability for a wider market outside of captive insurance.
Alternative products are increasingly being pursued by fronting insurers and captive companies. In the current low interest rate environment there is a greater desire for innovation and new thinking in order to break the shackles of low returns. The STA provides a good alternative to traditional security vehicles and gives captive companies the flexibility to enhance rates of return if they wish while maintaining strong security for fronting insurers.
Nick Smith is a relationship director with Barclays’ captive insurance team in London. He can be contacted at: firstname.lastname@example.org
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