NEWS & EVENTS

The End of a Captive’s Lifecycle

How do you handle your captive when it reaches the end of its lifecycle? Larry Yumkas, Sean Logan and Lawrence Dixon explain the options.

Alternative market vehicles have been around long enough now that we can all identify and appreciate their benefits. For instance, we know that by forming a captive, risk retention group or risk purchasing group (collectively known as 'captives'), the owner and/or insured can: reduce its costs of insurance; help control cash flow; focus on risk management; help to stabilise pricing; gain access to reinsurance markets; provide coverages that are otherwise unavailable in the traditional insurance marketplace; help control the claims management process; provide an ability to control the investment options; and enjoy any number of other industry or captive-specific benefits as well.

Captive owners have come to realise the importance of paying careful attention to detail when forming a captive. A party who is interested in finding out about the benefits of captive ownership should retain experienced professionals to advise them on: the expected benefits of forming and operating a captive; the costs of formation, maintenance and compliance; the best choice of domicile; the need for and methods of regulatory compliance; the tax implications; the balance sheet implications; the costs; the level of distraction from one's core business; staffing needs; director & officer liability coverage; and numerous other issues.

Given that the alternative risk market is relatively mature, ACG, LLC has recognised that captives have a limited lifecycle and require professional guidance in planning and implementing solutions for the end of their useful life. The sophisticated marketplace has come to understand that market conditions and business variables do change during the life of a captive, sometimes making owning it less desirable than at the time it was first formed.

What business circumstances might lead to considering whether to plan the end of a captive's natural life?

There are a number of causes that can trigger a decision to close a captive. A non-exhaustive list includes:

Change in governmental policy towards sovereign risk assumption
An M&A deal that results in the acquired captive being redundant to the acquiring business's needs
Changes in market conditions that make direct purchase of insurance a better alternative to continuing the captive
A need to free up collateral tied up with a captive's front
The desire to eliminate reserves-based liability on the captive owner's balance sheet
The loss of a key captive component (for example, a front, reinsurance, an insured base, etc.)
Adverse changes in tax laws that make continuing the captive or staying in the group untenable or undesirable
D&O liability fears and difficulty finding competent directors willing and committed to serve
Compliance fatigue
Insolvency and other compliance violations.

What advantages can a captive owner derive from planning end-of-lifecycle solutions?

If, after consulting with its advisers, circumstances warrant considering whether to plan the ending of a captive, a captive or its owner has the potential to:

Realise potentially significant cost savings from traditional run-off approaches by restructuring and curtailing current and foreseeable annual captive expenses
Recoup surplus capital and reserves
Eliminate balance sheet liabilities
Maximise tax advantages, and
Obtain 'effective finality' to its captive involvement.

How can a captive owner determine the right solution?

Companies such as ACG specialise in designing and implementing captive end-of-lifecycle solutions. As is the case with ACG, some of the companies in this space have the ability to assume risk and acquire risk portfolios. Others merely provide fee-based services and cannot assume risk. Both types of companies can advise captive insurance companies about the broad range of solutions available in the marketplace. Any solution should be tailored to the individual needs of the captive and its parent, with an eye to protecting the rights of insureds and satisfying the requirements of the overseeing regulators.

What types of end-of-lifecycle solutions are available?

In UK law-dominated offshore jurisdictions, the most frequently utilised captive end-of-lifecycle options available to the captive owner are:

Members voluntary liquidation
Scheme of arrangement
Program run-off

These options can take a long time to execute, be expensive and sometimes result in a 'forced solution' that wasn't initially contemplated or desired by the captive's owner. Moreover, they may have little use in the US run-off market.

As more efficient alternatives and, in the US market, as more appropriate alternatives, ACG believes captive owners should also consider:

Outright sale of the captive, and/or
Run-off business transfers.

Captive sale

After conducting suitable due diligence on a prospective client's profile, finances and goals, an end-of-lifecycle solutions company with the ability to assume risk can negotiate a price to acquire a captive in order to run off the portfolio in an efficient and orderly manner.

The acquisition price will depend on the nature of the risk being assumed, the assets and liabilities acquired, and the expected manner of the run-off.

A sale can reward the captive owner with direct benefits. For instance, a sale of a captive can cut off the direct and indirect costs of a run-off for a price that can be significantly less than the captive would incur by running off its portfolios on its own over the life of the captive.

Another benefit is that the post-acquisition run-off can best be handled by experienced professional run-off management, using a flexible run-off methodology suited to the captive owner's requirements.

The captive parent could also benefit from its newly restored freedom to choose from all options available for its prospective insurance needs. Of course, if structured properly, the seller will benefit from obtaining finality to its captive involvement.

Run-off business transfers

To facilitate the closure of a captive, end-of-lifecycle companies can facilitate the transfer of risk by novation, loss portfolio transfer (LPT), and/ or cancel and rewrite to transfer run-off business to a replacement insurer and/or reinsurer.

One of the direct benefits that can accrue to captive owners, by consideration of these alternative strategies, is the liberation of excess collateral.

Liberation of excess collateral

End-of-lifecycle companies can design and implement programs that replace collateral held by the captive's fronting insurance company with some form of alternative collateral, enabling some portion of the excess collateral to be turned over to the captive.

For example, a company such as ACG can purchase the captive or novate the risks for a price and in a structure, with a financial partner, that permits the return to the captive owner of a significant portion of the excess collateral currently tied up in obligations and held by the front that the captive or its parent cannot free up on their own.

Proceeding this way can help a captive parent to cease or wind down the ongoing direct and indirect costs of captive run-off for a price that can be significantly less than the projected run-off costs over the expected life of the captive—in effect, enabling the captive to transition from an 'operating cost' to a 'run-off cost' structure. Further benefit can be derived if the captive is to be closed, which will also permit the return of unpledged statutory surplus funds to the captive's parent.

As is the case in a sale, the run-off will benefit from experienced professional run-off management, using a flexible run-off methodology suited to the captive owner's needs.

Run-off management

End-of-lifecycle specialists can often be hired as captive management, as captive directors, and can be retained for fee-based run-off services.

Putting a fine point on it

Successful planning for the end of a captive's useful life is something that CFOs, treasurers, risk managers, captive managers and brokers alike should actively consider. Consulting a specialist to determine how best to maximise value while assuring the quality of future claims-handling for the ultimate insureds and going through the exercise will help you to make sure that you control the outcome.

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Larry Yumkas is chief executive officer and a principal of ACG, LLC. Sean Logan is president and a principal in ACG, LLC. Lawrence Dixon is a director of ACG (Bermuda) Ltd. For additional information, contact Larry Yumkas at: lyumkas@acglimited.com.

Reprinted from U.S. Captive (May 2008) and Bermuda Captive (June 2008).



	HOME FIRM CAPTIVE RISK TRANSFERS CONSULTING EXPERTISE INDUSTRY FOCUS RESOURCES CAREERS NEWS & EVENTS CONTACT SITE MAP 443.569.0788 Annapolis, Maryland Offices and Affiliations in: United States and Bermuda	NEWS & EVENTS The End of a Captive’s Lifecycle How do you handle your captive when it reaches the end of its lifecycle? Larry Yumkas, Sean Logan and Lawrence Dixon explain the options. Alternative market vehicles have been around long enough now that we can all identify and appreciate their benefits. For instance, we know that by forming a captive, risk retention group or risk purchasing group (collectively known as 'captives'), the owner and/or insured can: reduce its costs of insurance; help control cash flow; focus on risk management; help to stabilise pricing; gain access to reinsurance markets; provide coverages that are otherwise unavailable in the traditional insurance marketplace; help control the claims management process; provide an ability to control the investment options; and enjoy any number of other industry or captive-specific benefits as well. Captive owners have come to realise the importance of paying careful attention to detail when forming a captive. A party who is interested in finding out about the benefits of captive ownership should retain experienced professionals to advise them on: the expected benefits of forming and operating a captive; the costs of formation, maintenance and compliance; the best choice of domicile; the need for and methods of regulatory compliance; the tax implications; the balance sheet implications; the costs; the level of distraction from one's core business; staffing needs; director & officer liability coverage; and numerous other issues. Given that the alternative risk market is relatively mature, ACG, LLC has recognised that captives have a limited lifecycle and require professional guidance in planning and implementing solutions for the end of their useful life. The sophisticated marketplace has come to understand that market conditions and business variables do change during the life of a captive, sometimes making owning it less desirable than at the time it was first formed. What business circumstances might lead to considering whether to plan the end of a captive's natural life? There are a number of causes that can trigger a decision to close a captive. A non-exhaustive list includes: Change in governmental policy towards sovereign risk assumption An M&A deal that results in the acquired captive being redundant to the acquiring business's needs Changes in market conditions that make direct purchase of insurance a better alternative to continuing the captive A need to free up collateral tied up with a captive's front The desire to eliminate reserves-based liability on the captive owner's balance sheet The loss of a key captive component (for example, a front, reinsurance, an insured base, etc.) Adverse changes in tax laws that make continuing the captive or staying in the group untenable or undesirable D&O liability fears and difficulty finding competent directors willing and committed to serve Compliance fatigue Insolvency and other compliance violations. What advantages can a captive owner derive from planning end-of-lifecycle solutions? If, after consulting with its advisers, circumstances warrant considering whether to plan the ending of a captive, a captive or its owner has the potential to: Realise potentially significant cost savings from traditional run-off approaches by restructuring and curtailing current and foreseeable annual captive expenses Recoup surplus capital and reserves Eliminate balance sheet liabilities Maximise tax advantages, and Obtain 'effective finality' to its captive involvement. How can a captive owner determine the right solution? Companies such as ACG specialise in designing and implementing captive end-of-lifecycle solutions. As is the case with ACG, some of the companies in this space have the ability to assume risk and acquire risk portfolios. Others merely provide fee-based services and cannot assume risk. Both types of companies can advise captive insurance companies about the broad range of solutions available in the marketplace. Any solution should be tailored to the individual needs of the captive and its parent, with an eye to protecting the rights of insureds and satisfying the requirements of the overseeing regulators. What types of end-of-lifecycle solutions are available? In UK law-dominated offshore jurisdictions, the most frequently utilised captive end-of-lifecycle options available to the captive owner are: Members voluntary liquidation Scheme of arrangement Program run-off These options can take a long time to execute, be expensive and sometimes result in a 'forced solution' that wasn't initially contemplated or desired by the captive's owner. Moreover, they may have little use in the US run-off market. As more efficient alternatives and, in the US market, as more appropriate alternatives, ACG believes captive owners should also consider: Outright sale of the captive, and/or Run-off business transfers. Captive sale After conducting suitable due diligence on a prospective client's profile, finances and goals, an end-of-lifecycle solutions company with the ability to assume risk can negotiate a price to acquire a captive in order to run off the portfolio in an efficient and orderly manner. The acquisition price will depend on the nature of the risk being assumed, the assets and liabilities acquired, and the expected manner of the run-off. A sale can reward the captive owner with direct benefits. For instance, a sale of a captive can cut off the direct and indirect costs of a run-off for a price that can be significantly less than the captive would incur by running off its portfolios on its own over the life of the captive. Another benefit is that the post-acquisition run-off can best be handled by experienced professional run-off management, using a flexible run-off methodology suited to the captive owner's requirements. The captive parent could also benefit from its newly restored freedom to choose from all options available for its prospective insurance needs. Of course, if structured properly, the seller will benefit from obtaining finality to its captive involvement. Run-off business transfers To facilitate the closure of a captive, end-of-lifecycle companies can facilitate the transfer of risk by novation, loss portfolio transfer (LPT), and/ or cancel and rewrite to transfer run-off business to a replacement insurer and/or reinsurer. One of the direct benefits that can accrue to captive owners, by consideration of these alternative strategies, is the liberation of excess collateral. Liberation of excess collateral End-of-lifecycle companies can design and implement programs that replace collateral held by the captive's fronting insurance company with some form of alternative collateral, enabling some portion of the excess collateral to be turned over to the captive. For example, a company such as ACG can purchase the captive or novate the risks for a price and in a structure, with a financial partner, that permits the return to the captive owner of a significant portion of the excess collateral currently tied up in obligations and held by the front that the captive or its parent cannot free up on their own. Proceeding this way can help a captive parent to cease or wind down the ongoing direct and indirect costs of captive run-off for a price that can be significantly less than the projected run-off costs over the expected life of the captive—in effect, enabling the captive to transition from an 'operating cost' to a 'run-off cost' structure. Further benefit can be derived if the captive is to be closed, which will also permit the return of unpledged statutory surplus funds to the captive's parent. As is the case in a sale, the run-off will benefit from experienced professional run-off management, using a flexible run-off methodology suited to the captive owner's needs. Run-off management End-of-lifecycle specialists can often be hired as captive management, as captive directors, and can be retained for fee-based run-off services. Putting a fine point on it Successful planning for the end of a captive's useful life is something that CFOs, treasurers, risk managers, captive managers and brokers alike should actively consider. Consulting a specialist to determine how best to maximise value while assuring the quality of future claims-handling for the ultimate insureds and going through the exercise will help you to make sure that you control the outcome. ------------------------------------------------------------------------------------ Larry Yumkas is chief executive officer and a principal of ACG, LLC. Sean Logan is president and a principal in ACG, LLC. Lawrence Dixon is a director of ACG (Bermuda) Ltd. For additional information, contact Larry Yumkas at: lyumkas@acglimited.com. Reprinted from U.S. Captive (May 2008) and Bermuda Captive (June 2008). Back to Top Back to News & Events