Captives urged to invest more aggressively to achieve better returns

Captive owners should be more aggressive in their investment strategies and target higher returns from their portfolios than many are currently achieving, according to Andrew Barile, founder and CEO of Andrew Barile Consulting Corporation, a consultant for the insurance industry.

Barile said many captive managers have relatively conservative investment appetites and are reluctant to step outside what their captives have traditionally invested in, or what their peers are doing. This means many are achieving returns of between 2 and 3 percent investing in traditional bonds, while traditional insurance companies, hedge funds and others invest in more exotic structures achieving higher returns.

For example, DVB Capital Asset II is raising $350 million via fully collateralised senior secured notes paying a coupon of 6 percent, Captive International can exclusively reveal. The note is being put together by Boustead Securities and has not yet received regulatory approval, but is expected to be formally announced within the next month. When it is, captives should take the opportunity to invest in it, and other products with similar returns expectations, said Barile - who is expected to join the board of the bond issuer.

If approved, the notes will generate returns via DVB Capital Asset II, a special purpose vehicle that will acquire and manage senior life settlement policies with a face value of $420 million.

This is combined with a government guaranteed mortgage REIT worth $220 million. The REIT takes advantage of the difference between short term borrowings and the investment yield offered by the agency mortgage back securities on a leveraged basis, generating positive spreads, even in a flat yield curve environment.

The pool has a life expectancy of 6.2 years, and the notes will use hedging to protect investors from interest rate risk, according to the bond’s executive summary document.

Data analytics will ensure the variability of the mortality curve and a steady cash flow. DVB's model has been designed to create complete non-correlation with other asset classes in investor portfolios, the executive summary said.

The managers claim the strategy will produce higher fixed income returns than are commonly available from other fixed income asset classes, with the REIT reducing the risk of uneven cash flows over the term of the bond. Back-testing has generated an average dividend yield of over 9 percent over a 20 year period.

But captives should be thinking bigger not only in their investment strategies, said Barile. “Risk managers should become presidents of their captives and be personally involved in their investments and their operations, rather than delegating those decisions to more junior people,” said Barile.

Captives need to start thinking of themselves more like traditional insurance companies, because that’s what they are - insurance companies,” he added. “When appointing a board of directors they shouldn’t be thinking about how much it costs to appoint the best people. When modelling loss development factors they should not just use the models that insurance companies use, they should be developing their own models.”