Captive insurance solutions – size shouldn’t matter

24
CAPTIVE GUERNSEY REPORT 2014
GUERNSEY | LONDON & CAPITAL
Cell captives have historically not
been able to fully capitalise on
investment markets because
they lack scale. William Dalziel
explains how London & Capital’s
new cell captive investment solution, Cell
Portfolios, provides smaller captive clients
with the same investment expertise as larger
entities.
Captive Review (CR): How has London &
Capital’s specialist captive investment
management division evolved since its
inception?
William Dalziel (WD): London & Capital was
established in 1986. The company has always
focused on capital preservation and risk management
in relation to portfolio construction,
aspects which are particularly important for
the investment needs of captive insurers. Our
captive investment management division,
established in 2006, now has around $850m in
assets under management (AUM), representing
roughly one third of the company’s total
AUM.
Over the past seven years this division has
become a very important and strategic part
of London & Capital’s offering. We place signifi
cant emphasis on providing high levels
of client service, a testament to our wealth
management heritage, which differentiates us
from competitors.
Many clients have previously avoided the
investment market. There was a perception
that risk had to be taken on an ‘all or nothing’
basis which understandably made them
uncomfortable. London & Capital controls the
risk content of its client portfolios accordingly,
ensuring a client isn’t exposed to the market’s
full downside.
CR: The current environment is characterised
by low returns. What is London &
Capital’s market outlook and how should
captives navigate this kind of market?
WD: Although our captive clients are concerned
about the lower returns on the horizon,
it is important for them to remember
that investments in high quality bonds (which
are common captive investments) have seen
assets appreciate signifi cantly as yields have
compressed.
Interest rates will stay where they are for
a little while longer, and in light of that, captives
need to think about the real risks their
portfolios are running. Highly rated bonds
can still hide substantial liquidity problems.
Clients should also be aware of the sub-asset
classes they may be exposed to, such as mortgage-
backed securities, asset-backed securities
and municipal bonds.
It’s important to have a disciplined methodology
for assessing the risks and rewards of
each asset (and sub-asset) class. Even in the
current market there are investment opportunities
to be had – with the right asset mix
it’s possible to match or outperform infl ation,
but there’s no doubt that bond investments
are running with a much higher level
of volatility than investors are traditionally
used to and clients that don’t recognise that
are in for some unpleasant surprises. We
think that globally diversifi ed bond portfolios
can generate good returns, particularly
with some equity allocations to provide for
risk diversifi cation.
CR: How do active and passive investment
SIZE SHOULDN’T
MATTER
London & Capital’s William Dalziel tells Captive Review how their solution can help cell
captives take advantage of capital market investment opportunities
Written by
William Dalziel
William Dalziel is a partner at London & Capital with
more than 30 years’ insurance industry experience.
Dalziel set up the fi rm’s captive’s investment management
division in 2006 and has led its growth to
$850m assets under management. He is a faculty
member of the International Centre for Captive
Insurance Education (ICCIE) and was recommended
in Citywealth’s Leaders List 2013.
“It is important for them to remember that
investments in high quality bonds have seen assets
appreciate signifi cantly as yields have compressed”
25
CAPTIVE GUERNSEY REPORT 2014
LONDON & CAPITAL | GUERNSEY
strategies compare in the current market
context?
WD: Passive investing is being recognised by
clients as having value. It has its place in a
portfolio, although the current environment
does tend to favour active management. Clients
need to use the approach that best suits
them at any given time, but currently active
managers are likely to outperform. Selectivity
within asset classes is required to ensure that
they add value to a portfolio. A passive strategy
has full exposure to an entire asset class,
which can present problems when it comes to
controlling risk. Passive portfolios really find
it difficult to anticipate and react to market
changes, such as a decrease in yields. Clients
need to understand the nuances between the
two investment approaches to take advantage
of each of them where appropriate.
CR: What investment options are available
for cell captives?
WD: For most cell captives, the only investment
option is to adopt a passive strategy,
either through exchange-traded, mutual or
money market funds or cash deposits, and
this has been very limiting. In our view, the
needs of cell captives have been ignored,
largely because they have been seen as too
small to generate a profit for investment
managers. Very few managers will deal with
portfolios of less than $10m. Few cell captives
have assets in excess of that and the vast
majority have assets that fall well below the
$10m mark.
Many cell captives haven’t been able to take
full advantage of investment markets for this
reason. We don’t feel that mutual funds can
meet the needs of most captives – they can
lack transparency and in many instances have
hidden costs. We know of some funds that
are being offered to cell captives with total
expense ratios in excess of 2.5%, which is just
not feasible in an environment with such low
interest rates. That is why London & Capital
established Cell Portfolios, our cell captive
investment solution.
CR: Can you tell us more about this solution?
WD: The cell captive investment solution was
developed in response to a client request – we
were approached by an organisation managing
180 cells and were asked to find a solution
to address their investment needs.
Cell Portfolios allow captive cells to
invest in a segregated portfolio and benefit
from full cost and asset transparency. We,
as investment managers, actively adjust the
portfolio to ensure it only takes the level of
risk that is appropriate for that particular
client. Effectively, our solution treats small
cells in the same way as large, standalone or
group captives.
The establishment of the segregated
portfolio follows the same process that we
would undertake with any other client such
as asset allocation as a risk diversifier, then
portfolio construction discipline to mitigate
unrewarded risk and finally appropriate
stock selection to give clients a good balance
between capital preservation, liquidity and
reasonable rates of return.
With this solution, cell captives also benefit
from the management discipline applied to all
portfolios. We provide monthly performance
reviews and link every investment decision to
our prospective macro-economic outlook for
each asset class. Cell portfolios provide clients
with economies of scale, reducing the aggregate
costs of trading and ensuring this is viable
for captives of all sizes, but particularly those
cells with relatively small portfolios.
Our solution is flexible and simple, key
requirements for cell captives. Our clients
can access and download all the material they
need in a full, auditable format at their convenience,
ensuring smooth communication
between all parties regardless of time zone or
geography.
CR: What do the next 12 months hold for the
cell captive industry?
WD: We see the future for cell captives as
being extremely strong – this is one of the key
growth drivers in the overall captive market.
We expect to see the formation of a greater
number of cell captives where traditionally
standalone captives have been used, simply
because the regulatory burdens being placed
on captives are increasing.
We are the first investment manager to
offer such a targeted approach to the investment
needs of cell captives, but we would
welcome the entry of additional managers to
this space, to ensure that the diverse needs of
clients are met.
“The needs of cell captives have been ignored, largely
because they have been seen as too small to generate
a profit for investment managers. Very few managers
will deal with portfolios of less than $10m”