Sandra Truman Swayne of Comerica Bank provides an insight into reinsurance trusts and how they
can be used
Understanding reinsurance trusts
The most common use of a reinsurance trust is for an offshore/onshore reinsurance company such as a captive (grantor) to secure its obligations under a reinsurance treaty to an onshore fronting company (beneficiary). This allows the beneficiary to use trust assets to meet statutory reserve requirements. The trustee is responsible for safeguarding the assets that are held in the reinsurance trust. The trustee is required to adhere to the terms and conditions that are outlined in the trust agreement.
Reinsurance trusts
Trusts can be useful in many insurance transactions. A reinsurance trust provides a flexible and cost-effective alternative to a letter of credit (LOC). The following is an overview of how such trusts operate and what to expect of the trustee.
The basics
A reinsurance trust is a tri-party agreement in which the grantor has deposited cash or other assets to be held by the trustee to secure certain obligations to the beneficiary. The trustee holds the assets under the terms of the reinsurance trust agreement. A Regulation 114 Trust is a type of reinsurance trust established to secure payment of future losses, in the format prescribed by the New York Insurance Administrative Code, which governs the form of reinsurance trust agreement approved for use by New York insurance companies. The New York code is viewed as a model, although each state may have its own requirements.
The assets in the trust remain the property of the grantor for all purposes, including accounting and taxation. However, the reinsurance trust agreement provides the beneficiary with the right to withdraw assets from the trust. The trust agreement must be established “for the sole use and benefit of the beneficiary” per Regulation 114.
Reasons for withdrawals are defined in the underlying reinsurance agreement and are a matter to be resolved between the grantor and the beneficiary. In a Reg 114 Trust, the trustee is obligated to comply with the beneficiary’s written request for withdrawal.
Uses of reinsurance trusts
A reinsurance trust allows the beneficiary to calculate the value of the trust assets toward statutory reserve requirements.
Other creative uses for these trusts are possible, such as securing a deductible buy-down programme, which is an insurance contract provision that allows an insured party to pay a lower premium to reduce or eliminate the deductible that the insured would have to pay if a claim is made. Another use of the trust is securing the insured’s deferred obligations under a loss sensitive agreement.
The investment policy of the trust must be acceptable to the beneficiary and comply with applicable regulations. While this may be more restrictive than a LOC collateral account, the total cost of the trust arrangement is usually lower than the cost of a LOC.
Typically, the minimum size for a trust to make economic sense is around $3 million.
Establishing a trust
A reinsurance trust can be established in a relatively short timeframe. The first step for the grantor is to select experienced legal counsel to assist with the trust agreement. The beneficiary (or fronting company) will usually have a preferred form of a trust agreement. The grantor should complete a legal review of the document and request any reasonable changes, if necessary, in compliance with applicable regulatory requirements.
Selection of the bank trustee is a critical second step since the trustee must also review the agreement for acceptability. A bank trustee experienced in handling such trusts will also be able to expedite this review process.
Role of the trustee
The trustee is invariably also the custodian of the trust assets. The related duties are described below. The trustee can also act as the investment advisor of the trust. Alternatively, the grantor may direct the investments or hire one or more independent investment advisors who are authorised to direct the investments of the trust on behalf of the grantor.
Trustee duties
In selecting a trustee, it is critical that the bank is experienced in performing the fiduciary duties required and capable of properly executing the myriad of related custodial duties.
