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Low interest rates prompt captives to be less conservative about investing


While captives tend to be conservative investors, low interest rates have some looking at loans to their corporate parents or alternative investment structures to better use their capital while staying in line with solvency requirements.

Typically, captives invest heavily in fixed-income instruments, which for most captive parents has meant limited returns because of low bond yields.

“They'd all love to enhance their investment returns,” said Les Boughner, executive vice president and managing director of Willis Group Holdings P.L.C.'s North American captive and consulting practice in Burlington, Vt. “Companies are either using a dividend or a loan-back” arrangement in the face of low interest rates, he said.

As captives consider their investment alternatives, there have been “a few inquiries by companies who are just making sure they know the rules,” said David F. Provost, deputy commissioner of the Captive Insurance Division in the Vermont Department of Financial Regulation.

“With pure captives, there are no rules,” Mr. Provost said of single-parent captives. “The only rules are I can restrict things if they appear too crazy and look like they'll threaten the solvency of the company.”

In this low-interest-rate environment, making a loan to the parent “does make sense for the company, and it does make sense for the captive,” the Vermont regulator said.

In Vermont, the parent must have at least $100 million in equity and an investment-grade credit rating. In the event the parent has no debt and consequently is unrated, the captive division will work with the company to account for that, he said.

“Every company's different,” Mr. Provost said of such proposals, which are evaluated individually.


Many captive owners were shocked last year by their investment returns because of low bond yields, said Carl E. Terzer, principal and founder of CapVisor Associates L.L.C. in Chatham, N.J.

For example, the 10-year Treasury rate was about 1.9% on Jan. 2, 2013, and about 3% on Dec. 31, 2013, both well below the long-term average of 6.5%.

“I think they're concerned with a disproportionate amount of the portfolio in bonds they're not going to get the return that they forecast,” Mr. Terzer said, leading them to ask, “Can we move out of bonds and, if so, to what?”

With bonds projected to post returns well below historic norms, “they're asking where can we get a return and is it prudent to reduce our bond holdings,” Mr. Terzer said.

The answer depends on where a captive is in its life cycle, he said. “There's no one-size-fits-all investment plan, obviously.”

“There are all these different investment classes that lie between the two ends of the spectrum,” with investment-grade bonds at one end and stocks at the other, Mr. Terzer said.

For larger, more mature captives with strong solvency, possible investment vehicles could include master limited partnerships, Mr. Terzer said.

With the current U.S. energy boom, the energy-oriented investment vehicles are “a pretty solid play, I think, for at least the next three years,” he said. “I would say the average return was somewhere between 28% and 42%.”


The master limited partnerships offer a current-income component and an appreciation component, and add diversity in a portfolio, Mr. Terzer said.

Other potential investments include real estate investment trusts and hedge funds.

“That would be for the companies that already have a reserve portfolio that is serving as a sound foundation for their claims-paying ability,” Mr. Terzer said.

While forming a captive requires a significant commitment of capital, there's no sign that captive domiciles are trying to reduce their capital requirements to drive growth.

“The minimums (on states' capital requirements) are pretty much the same and, in most cases, the minimums don't come into play,” said Brady Young, president and CEO of captive manager Strategic Risk Solutions Inc. in Concord, Mass.

Mr. Boughner offered a similar view. “I think it's pretty standard across the board,” he said. “I think there's an accepted way of doing things.”

One benefit of low interest rates has been a greater focus by many captives on their assets, Mr. Terzer said.

“It appears there is an increased interest in the asset side of the balance sheet for a change,” he said. “Not only that, both sides need to be correlated.”

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