For captives, investing takes centre stage

Saad Hafiz discusses the role of the investment manager in an age of increasing awareness of the available choices.

April 2007

Globally, captive business continues to increase, and as it does, more
net premium dollars are being accumulated and becoming available for
investment. As such, we are now seeing the captive investment industry growing and maturing, and an increasing number of investment managers are coming to the fold to offer advice and investment programmes.

Investment management is no longer an afterthought for risk managers, who now actively seek to enhance investment yield as if it were a front-line product. Risk managers are increasingly better-prepared and well-informed about investment opportunities, and as a result, captives’ investment profiles and expectations are growing ever more sophisticated.

As the alternative risk industry continues to develop, there is increased
demand for higher returns and lower costs. We are now seeing captives’ investment strategies branching out into the use of hedge funds, which was not happening as recently as six or seven years ago. In keeping up-to-date with their clients’ needs, institutions are offering hedge fund products tailored for captives, with a typical asset allocation of up to 20 percent of a captive’s assets invested in these products.

Captives have also started setting up mutual fund investment vehicles
as collective pools. This reduces their running costs through economies of scale, and they can take advantage of a bank such as the Royal Bank of Canada (RBC), which understands alternative investments and the use of mutual fund shares as collateral for letters of credit. It is a very interesting concept that has been increasingly gathering momentum, and we expect to see further activity along these lines.

Meanwhile, we have been witnessing a greater desire from captive
insurers to vary the mould of the traditional fixed-income investments and move towards an increased participation in the equity markets. Equities is an area where excellence can be achieved and differentiation is possible between investment managers, because they are able to carve out their own distinct programmes and expertise. This is in contrast to fixed-income products, which do not vary a great deal due to captives’ requirements for quality paper and the relatively narrow choices therefore available to the captive investor.

Captives are also now more interested in setting up global investment
arrangements. Most of the paper we have traditionally seen was from the US, but now a much more international approach is spreading through the captive sector.

This move towards more creative and ambitious investment represents
an increased understanding by clients of the operations of their own
captives. They know about their captives’ cash flows, what is being put
aside to pay losses and what the net premiums will be after losses have been accrued in the financial statements.

As a general rule, a captive’s investment programme should essentially match its insurance programme. If the owners anticipate surplus pools of money coming in for long periods of time, they should set up their investment programme accordingly to take advantage of the medium and longer term. Matching assets and liabilities, of course, has a special place in the operation of an insurance company.

Getting the right help In the past, risk managers and captive owners were simply reluctant to move out of cash. They preferred to sit on their funds, because they thought it was the safest strategy. Their mistake was not treating investment management as something they did on a regular basis, and because of that, they missed out on longer-term yield and other benefits. But, as in the law, ignorance is no defence.

Now captives are willing to spend money getting their investment
strategies right. If you look at the various methodologies available, it is increasingly desirable to hire an investment manager to do a professional job. Just as no one would try to carry out their company’s legal work without the advice of a trained professional, so the understanding is gaining ground that to invest without professional advice could be just as short-sighted, and potentially dangerous. The right investment programme manager should achieve great results for the owner’s captive and will help its long-term future.

Often captives pay consultants to review their investment managers,
both when they hire them and on an ongoing basis. This is an additional cost for captives but shows they are interested in making sure that the people they hire perform.

Hopefully, captives can embrace the idea of bringing professional
investment managers on board at any stage of their development to help them select a range of investments. This would allow them to participate, through a single point of entry, in all the investment styles that they may require. Captives can start off in money markets and move all the way up to a balanced portfolio if they so desire, maximising yield at all stages of their life.

RBC sees relationships with its captive clients as long-term engagements, not one-off revenue propositions, and offers hands-on financial solutions with a high-quality service. The company possesses the in-house research and expertise to develop suitable products for the captive community and is currently focusing on a fund specifically for captive investors, which will offer a range of investment styles