Financial guarantee insurance: the captive insurance possibilities

Can financial guarantee insurance be put into a captive? Greg Lang, founder of the Reinsurance and Insurance Network, provides a guide to this niche product.

Financial guarantee insurance (FGI) has hit the press again, after AM Best put the credit rating of Oxford Insurance Company under review with negative implications at the start of March 2024, when the company deviated from its original business plan and became an insurer of large FGI policies. 

I’m often asked: “can I put FGI into my captive?”. The quick answer is “yes”. The follow-up question I ask is: “will the entity requiring that guarantee, usually a bank, accept your captive’s balance sheet as adequate collateral for the transaction?”. The most common answer to that is “no”. The next question is: “how can I get fronted paper?”. That’s when it gets interesting.

The 2008 National Association of Insurance Commissioners (NAIC) Model Guidelines definition of FGI runs for over nine pages. It’s a complicated product. FGI is a guarantee against nonpayment of principal and interest on a debt obligation or other monetary obligation. This is different from guaranteeing performance obligations, which are a principal’s contractual obligation to perform some obligation beyond the payment of money. Still have questions? You’ll have more if you read the nine-page definition too. 

One thing the NAIC guidelines make clear is the requirements for licensing an FGI company. Separate collateral is required. The only other coverages a FGI insurer can write are residual value, surety, or credit insurance. Insurers that write or front traditional lines of coverage such as property, general liability, workers’ compensation, or auto are precluded from writing FGI.  

Many bonds written by sureties meet the definition of FGI. For example, utility payment bonds, appeal bonds, and certain lease bonds are all guarantees of an obligation to pay a monetary obligation. The reason sureties can write these bonds is that state statutes contain a number of specific exceptions that allow multiline insurers to write bonds that would otherwise be prohibited as FGI. The New York Statute, for example, contains a general exception that permits the writing of otherwise prohibited FGI as long as the aggregate amount owed by the principal does not exceed a dollar threshold of $10 million. This is known as the “$10-million-exception”.

Three other states besides New York have statutes prohibiting multiline insurers from writing FGI. While similar, these statutes have one important difference: none contains the $10 million exception. The result is that a bond that could be written in New York and 46 other states under the $10 million exception cannot be written in California, Connecticut, or Florida.  

I know what you’re thinking. Can I cover a California or Florida FGI exposure in my Vermont or Cayman captive? Does it need to be a direct policy or reinsurance? Before I answer, let’s make this a little more complicated than it already is. This is insurance, more specifically captive insurance. We make everything more difficult than it needs to be.

The Appleton Rule

The Appleton Rule is a New York insurance regulation created in the early 1900s requiring insurers in the state to abide by its insurance code, even when conducting business in other states. FGI governed by the New York insurance code thus falls within Appleton. The Appleton Rule requires that every insurer doing business in New York abides by New York state law, even when doing business in other states.

Regarding those earlier questions, I’m going to offer my best stock answer: “I don’t give tax and legal advice. Many of the readers of this fine publication do, and I’ll leave it to the experts.” 

Back to captives

Captives can write FGI. I have been involved in several deals. The transactions I’ve worked on so far have been reinsurance captives, all fronted by sureties subject to the $10 million threshold. Since NAIC rules apply only in the US, several foreign insurers and reinsurers are happy to provide coverage above a captive retention. I’m involved in one such transaction right now.  

I’ve recently begun some work with a large insured which wants to write FGI direct from its captive. The approach is creative enough that it just might work. It involves technology and some modification to a bond form. I love this business, and I’ll keep you posted.

Greg Lang is the founder of the Reinsurance and Insurance Network (RAIN). He can be contacted at: glang@rainllc.com 

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