Collateral trusts: trust me, time flies


Robert Quinn

Collateral trusts: trust me, time flies

It has been 10 years since Robert Quinn first visited Cayman to promote the merits of trusts. Here he talks about his experiences.

Grand Cayman…Seven Mile Beach…The Ritz Carlton…the perfect setting for one of the best conferences of the year. Honestly, though…with all of the natural beauty and fun on this Island, it shows a remarkable level of dedication for those that work here each day.

On this, the 10th anniversary of my first visit to the Island and my discussions of collateral alternatives to letters of credit (LOCs), I take a moment to reminisce…

John Pitcairn…the first Cayman-based deal I ever did. There is no mistaking when you are talking to John on the phone, is there?

I remember my first meeting in the domicile…Dan MacLean of Aon. Boy, has Dan ascended through the ranks or what? Dan was not only my first meeting; he was also the first person on the Island to realise the consequences of ‘giving Robert Quinn the slightest indication that he might have a deal for Robert!’ I guess I can be like a dog with a bone, right Dan?

Peter Mackay…the first time I ever saw him on the Island was not in his office, but in his home away from home…Fidel Murphy’s. Seriously.

Stephen Gray and Jim Owen, the two that first made me realise how small an island Grand Cayman really is!

I also remember standing near the post office. It was sometime in July, about 95 degrees and very humid out, and I was wearing a suit. It might as well have been a suit of armour for as hot as it was. I remember the tourists in their shorts and flip-flops. I remember how embarrassed I was during my subsequent meeting. My neatly pressed suit looked like I had just taken it out of the washing machine. But all the while, I remember how nice everyone was. Me in my navy blue suit, losing three pounds an hour.

A number of people come immediately to mind when I think of my 10 years on the Island: Seamus Tivnan, Nick Leighton, Michael Gibbs, Monique Jackson, Fiona Moseley, Conor Jennings, Peter Jones, Clayton Price, David Self, Paul Macy…wow, the list is longer than I thought.

Seriously, to those who have made our time in the Cayman Islands so productive and so much fun, I thank you sincerely.

My grand efforts in Grand Cayman

I have been trying to explain to my friends and family back home that business is going well. Of course, I try to take more credit than I really deserve. If I was being honest, I would say that, simply stated, this is a perfect time to be offering alternatives to letters of credit (LOCs). Why? Well, let’s see…the economy is in the tank, credit is hard to find and, when it is obtained, it is often two or three times more expensive, and the credit review process is a total drag.

Indeed, I stand by my previous statements over the years: use of an insurance trust in lieu of a LOC will likely save you or yourclients well over 80 percent of their LOC fees. But now, with the credit markets the way they are, the savings are even higher. Here is what I mean.

The gist of it…

The concept of the insurance trust is fairly straightforward. So is the LOC. For an LOC, the captive (generally) puts cash or cash equivalents into an account at an LOC-issuing bank. That cash acts as collateral that the LOC-issuing bank requires. In addition to posting collateral with the bank, the captive must pay a fee to the bank for issuing the LOC. Lately, LOC fees seem more like a king’s ransom.

The trust concept is one where, rather than putting your money into an LOC collateral account and paying the bank the fee for the LOC, the captive simply puts its money directly into a trust account that pledges the money directly to the insurance company to whom they would otherwise post the LOC. Like the LOC, income generated from the trust belongs to the captive. To be clear, the captive still owns the trust assets. They are only ‘pledged’ to the carrier in the event of a problem.

Credit has never really been the best option…

We don’t have to go back very long to the days when LOCs were considered ‘inexpensive’. I put that in quotation marks because even when LOCs were in the 25 to 45 basis point range, they were still far more expensive than the trust. Of course, there are more things to consider than just cost, but we will get to those in a bit.

If you consider a 2007 LOC that might have cost 40 BPS, then a $10 million collateral requirement would cost, if a LOC wasemployed, $40,000 per year. Compared to a trust that might cost $5,000, that is an 87.5 percent saving. Or stated another way, the LOC is eight times more expensive.

…but now it is a nightmare

It is no secret that LOCs are far more expensive now than in 2007. And in case anyone is holding their breath hoping that LOC fees will come down soon, I say that LOC fees are about where they will be for the foreseeable future.

Those LOCs that were 25 to 45 BPS in 2007 are now often 75 to 100 BPS. And to be clear, these are fully collateralised LOCs. So the $10 million LOC that cost $40,000 in 2007 now likely costs $75,000 to $100,000.

Interesting point: While LOCs are doubling and tripling in price, the price for an insurance trust, at least with Wells Fargo, has gone down.

Stay sharp #1

There are those who will tell you that there will be an ‘opportunity cost’ associated with using a trust versus using an LOC. This is what they are trying to say:

“The LOC has to be fully collateralised with cash or cash equivalents. Of course, the trust must also be funded. But the investment guidelines for a LOC collateral account might be more ‘liberal’ than that of a trust, thus allowing the captive to earn more investment return. The guidelines for a trust might be more ‘restrictive’ than those of a LOC collateral account. Therefore, any benefit to using a trust is eroded by a lack of investment return.”

This position is correct so few times that it is difficult for me to give it credence by putting it in writing. But once in a while, it is true, so there you have it. But for most, there is zero merit to this position.

Think of it this way: The single most important responsibility of a captive is to be sure that said captive is always able to pay its claims. Having stated that, I will assert that most captive insurance companies have fairly conservative ‘internal investment guidelines’. Could a captive invest its money in low-rated (and higher-yielding) investments? Of course they could. But do they? Most of the time, no. Higher-yielding investments create additional risk to the captive (as if insurance risk isn’t bad enough, investing in lower-rated securities creates principal risk). Given that, I assert that most captives’ investment policies are right in line with the trust’s investment guidelines. And for this reason, most captives can use a trust in lieu of a LOC without realising ‘foregone investment income’.

Stay sharp #2

There is a huge misconception out there that the trust is difficult to establish. Further, I have heard people assert that since a LOC is only two pages long and the trust agreement is often 15 pages long, the LOC must be easier to establish. This could not be further from the truth.

Of course, the trust is a comprehensive legal document. However, Wells Fargo has pre-established the required language of the trust agreement for both fronted captive programmes and traditional deductible programmes. So to the extent that Wells Fargo is the trustee on your captive trust, the work is already 98 percent finished.

When considering the LOC, one must consider that an LOC is, in fact, a request for credit from a bank. The fact that the actual LOC document is only two pages is not representative of the amount of time and effort required to actually obtain that two-page document. The credit review process involved in obtaining approval for a LOC for a captive is a longer and more involved process than that of establishing a trust for a captive.

To support this position: my group has established multiple trusts in fewer than 24 hours. While that is not the norm, it is not out of the question. Having worked for banks for 10 years and understanding the credit approval process, I am confident that LOCs are not generally approved and issued in fewer than 24 hours.

I should also point out that the trust does not need to be renewed each year. This will save the captive a lot of time and effort on an ongoing basis. No more stacking LOCs and no more LOC renewal processes.

Wrapping up my first 10 years

As the Cayman Captive Forum and the year 2010 come to a close, so will my first 10 years working in this domicile selling insurance trusts. Thank you all for your help and faith in me and my team at Wells Fargo.

Robert Quinn is vice president of the collateral trust division, Wells Fargo Insurance Trust. He can be contacted at:

Captive International