Captive trust a viable alternative to letters of credit for collateral: Wells Fargo expert

Given the increasing cost of credit in today’s market, the cost of letters of credit (LOCs) has become prohibitive for captives relying on them for collateral, said Robert Quinn, a vice president at Wells Fargo.
Quinn, who sells capital trusts, spoke at the 7th Annual Captives & Corporate Insurance Strategies Summit in Toronto on June 2.
As of 2010, roughly 70% of captives use LOCs to fund their lines and programs, Quinn said. However, since the 2008-09 financial crisis, the cost of LOCs has increased dramatically. Captives would therefore do well to search out alternative sources of collateral – such as a captive trust, Quinn said.
Prior to the 2008 financial crisis, the cost of LOCs on a cash collateralized basis ranged between 15 basis points and 45 basis points. “I would say the norm you are going to see for a letter of credit today is between 45 to 100 basis points,” Quinn said, “with 75 basis points appearing to be the sweet spot for these collateralized LOCs for captives.”
The business implications for captive and corporate insurance programs are huge, he continued. “If you were paying 25 basis points for collateral on $10 million, and now you’re paying 75 basis points, your cost of collateral just tripled. Therefore, the cost of your whole program just went up considerably.”
Captive owners would do well to consider a captive trust, he said. In this arrangement, the captive, the insurance carrier and the lender enter into a tri-partite agreement in which the lender is named as the trustee, the captive is the grantor and the insurance fronting carrier is the beneficiary.
In a handout accompanying his presentation, Quinn explained the trust is usually funded with the assets in the collateral account for the letter of credit. The trust is then pledged to the fronting insurance carrier as the sole beneficiary.
Benefits of the approach include:
•much lower fees than a LOC;
•the income from the trust is the property of the depositor;
•the assets in the trust generally remain on the books of the corporation;
•the trust does not need to be renewed each year; and
•the trust can often replace multiple LOCs posted to the same carrier.