Inflation could cause captive funding rethink

Higher levels of inflation globally and the fight to get it under control could force some captive owners to rethink how their captives are funded.

That could be a key discussion point at this year’s Cayman Captive Forum, Charles Baker, senior vice president, corporate debt and specialised services, at Computershare Trust Company, told Captive International.

“In the effort to fight and put the brakes on rampant inflation, the Fed and other world banks as a whole have been increasing interest rates,” said Baker. “Those are two key things that play into the form of collateral that a captive insurer chooses to provide to their fronting carrier.”

Captives typically use a cash collateral trust or letters of credit to satisfy collateral requirements. But higher interest rates will increase the cost of credit. As a result, many captives that have historically used letters of credit at a low cost of credit may now re-evaluate the cost of collateral.

A second thing consideration will be around the consequences of higher interest rates. When they were at historic lows, the return or yield that funds held in trust would generate were also low. As interest rates increase, the trust has the ability to provide a higher return via interest bearing deposits.

“Captive insurance companies will evaluate the cost of the collateral that they're posting,” Baker said. “Is the cost of a letter of credit now more than the cost of posting cash or securities into a trust? I think there's going to be some conversations around doing a cost analysis of whatever collateral they may need or be currently posting.”

Baker said that both captives and their managers will be considering this. Letters of credit typically renew on an annual basis. This could prompt new trusts will be established. Baker said he would expect more demand more trusts replacing letters of credit because of the economics of each.

He does not necessarily believe this dynamic will impact the formation of new captives. But the nature of collateral will become a conversation point with the fronting carrier. New captives will seek a clear understanding of the costs associated with a trust versus a letter of credit.

He said that Computershare is focused on the collateral component and meeting the needs of its clients.

Computershare works with captive insurance companies and their fronting carriers to establish and administer trust accounts that hold collateral in support of their captive programs. It’s also able to support captive insurance companies as it relates to any custody or securities custody needs that they may have related the captive that may not involve a fronting carrier or a tri-party agreement.

Finally, looking at if this make some captives redomicile, Baker pointed out that there are so many domicile options nowadays.

“Cayman is more healthcare heavy in the captive space than others including Bermuda and the US domestically, but I’m not sure how the events of the last year will drive demand for one domicile choice over another,” he concluded.