Paul Corver, group head of legacy M&A at R&Q, talks through how captives and their parents can navigate the market following Covid-19.
Captive Review (CR): How is the captive industry performing at the moment amid Covid-19 and the economic downturn?
Paul Corver (PC): It ‘s very interesting because you’ve almost got two ends of a scale. So on the one hand, you’ve got companies that may be very financially stretched needing to access capital in the captive, at the other end you’ve got companies that possibly aren’t financially stretched but are looking to avoid the penalties of a hardening market and inability to get products by then using the captive for that but recycle captive capital already in the captive in order to support those new lines.
CR: Why are parent companies accessing capital in their captive?
PC: You’ve got parent companies that are probably facing some serious financial difficulty because of the disruption in the market. They may not even be in business at the moment, we’re seeing companies here such as Rolls-Royce and others laying off thousands of people, it’s having a real impact on their actual business. And if it’s if it’s impacted them financially, they may then look to see where they can be more efficient with managing their capital, what fundability that they got with the capital. If they’ve got large captives there may be significant wealth in the captive that they would like to get hold of and use as a group to help support the overall corporate balance sheet.
CR: How can an organisation use their captive if the parent is in financial difficulty?
PC: At the end of the day having a captive is all very well and good, but if you are a manufacturing company, your main job is manufacturing. The captive was a nice to have to an extent, is it important to keep that going if the overall health of your group is suffering financially. So if they’re able to dispose of the captive to release the capital that is used to support the captive, then that will be passed up and distributed to the parent. Or they could look at rationalising what’s in the captive and dispose of perhaps the older years of business, or certain lines of business, to free up capital in that regard.
A lot of captives would potentially be able to lend money to the parent depending on the territory and the regulatory oversight. And so that may be one route around that. But again, those sorts of captives which are perhaps in the lighter touch regulatory environments or have low capital regimes, possibly sit behind front companies and therefore have significant collateral obligations to front companies. If they were to pass on those liabilities to a third party, such as R&Q, then we take over the obligation for the collateral. And that would then release capital itself to the captive to perhaps then pay off a loan to the parent.
CR: What about organisations building up their captive currently?
PC: At the other end of the scale, what we’re likely to see with the impact of Covid-19, is significant rate hardening across the market and certain lines of business, potential inability to even acquire certain lines, such as business interruption. Companies may want to put more in a captive to avoid the hardening rate and perhaps difficulty of getting cover in the commercial market. So you’ve got the position of needing to perhaps reinforce capital in the captive in order to write more business into it. And again, a way of doing that is to dispose of legacy liabilities in the captive, to release the capital that’s held against those, recycle it, to then write the new business. Why continue to carry a book of workers compensation claims that are going to run off over 10 or 20 years when you could extract capital that’s being used to support those claims to support the new business lines that you need to then be a better structured risk business going forward. Use the capital to put that into those closed lines into the captive that then become a much harder to place or more expensive place.