Pooling enables for-profit captives of U.S. parents to share their risks in a controlled environment. These captives benefit from greater stability of losses and potentially qualify as a “true” insurance company by means of the third party (unrelated or non-parental) business they reinsure from the pool.
Nexus Reinsurance Company (Nexus Re) was established in 1998 as a wholly-owned subsidiary of United Insurance Company to act as a dedicated risk pooling entity.
Nexus Re is domiciled and regulated in Cayman, but has taken a Section 953(d) tax election under the U.S. IRS code. For tax purposes, therefore, Nexus Re is a U.S. tax payer, which eliminates the Federal Excise Tax that would otherwise be payable when captives cede and retrocede risks with a non-U.S. reinsurer.
Why Pool Risks?
Pooling builds upon the fundamental insurance principle of risk sharing. By partnering with a recognized lead reinsurance company with unrivalled experience and established contracts and mechanisms, captives can transfer their own exposures to third parties and, in return, receive a share of a much larger pool of similar risks. The pooling of risks facilitates a smoothing effect, created by the “law of large numbers.”
How Does Risk Pooling Work?
Captives reinsure their primary casualty risks up to pre-agreed limits per occurrence and in aggregate to Nexus Re. The premium is based on expected loss projections only, with no increases for expenses or profit margins, as would apply in a typical commercial reinsurance scenario. Nexus Re receives the premium and reimburses claims (as paid by the captive). Aggregate losses are limited in each year to 135% of premiums, which protects the experience of the pool overall.
Should a Captive Pool Risk?
Generally, the writing of third party business by captives and their qualification as an insurance company with tax treatment benefits offers a significant advantage for participants. Captives and their parents should take a medium- to long-term view when entering a pool, which should have a history of stable loss experience at the selected loss limit. This ensures a reasonable chance of projecting ultimate losses as accurately as possible.
Captives need to accept that pooling is a risk-taking endeavor, premiums are determined in advance and actual losses incurred will invariably be higher or lower than the premium charged by Nexus Re. Equally, as a retrocessionaire, the actual losses reimbursed to Nexus Re may be higher or lower than the retrocession premium received.
What Risks Can the Captive Pool?
Pooling is suitable for high-frequency, stable primary casualty risks. Typically Workers’ Compensation is the main class ceded; however, Nexus Re will also accept Federal Employer’s Liability Act (FELA) liability, Auto liability, General liability and Products’ liability, either in addition to Workers’ Compensation or separately. The per occurrence loss limit varies by participant depending upon the historical loss experience and the level at which losses are predictable. While the majority of participants cede the first $250,000 to $500,000 to Nexus Re, there is capacity for limits up to $1.5 million if such losses are sufficiently stable and predictable.
Setting the Premium
Nexus Re has independent actuaries who undertake reserve analysis for each participant and for the pool overall. The premium setting is a function of the underwriter and based on actuarial principles. At least five (5) years of historical loss experience is required, and the underwriter will work closely with the captive and its parent to understand the underlying risks and review their information. The captive or parent will often be willing to share their own actuarial projections with Nexus Re, and these will also form part of the decision process. Ultimately, the premium will be negotiated and agreed upon between Nexus Re and the reinsured captive on an annual basis.
Handling the Cash
There is quarterly settlement of premiums and claims between the captives and Nexus Re. All transactions are directly made between captives and Nexus Re’s bank account. Captives will retain the retrocession premiums to reimburse retrocession losses and, therefore, the funds can be invested long term by the captives until pool losses are settled.
Costs of Nexus Re
Nexus Re charges a fee based on premium income and claims paid, which is entirely separate from the risk-based reinsurance premium. Generally, the overall fee for participation is equivalent to 2% or less of premiums.
How Can a Captive Join?
Nexus Re will ensure a full understanding of the agreements and mechanics with any potential participant prior to joining the pool. Loss and exposure data will be collected and analyzed, and a number of discussions will take place between Nexus Re underwriters and the captive and parent, usually involving risk management, accounting and tax personnel from the parent. Nexus Re does not interfere with any of the existing captive arrangements and provides reinsurance to the captive based on existing renewal dates and programs. There is no impact on any fronting insurers, third party administrators or direct issued captive policies. The captive will enter into a reinsurance agreement to cede risks to Nexus Re, and a separate retrocession treaty agreement will handle the business reinsured back from Nexus Re to its pooling retrocessionaires.
What Security Does Nexus Re Provide?
Each captive retrocessionaire of Nexus Re is required to provide collateral to secure its obligation to the Nexus pool. Therefore, in the event of the failure of a captive or its parent, the outstanding losses of the pool are protected, minimizing the credit risk of participation.
How Can Participation be Terminated?
Nexus Re always recommends that captives and their parents take a long-term view. There is an appreciation that circumstances, risk management approach and the financial position of the parent company can change, resulting in a decision to cease participation. The Nexus Re contracts are annual and therefore need not be renewed if they no longer meet the client’s needs. As all obligations have already been secured, there is no concern for Nexus Re or other participants of a captive leaving and being unable to meet future claim payments.
How Has Nexus Re Performed?
Compared to the break-even goal, the Nexus Re pool has achieved a loss ratio of 98% since inception for all years combined. There are fluctuations by year and between captives; however, the long-term objective is being achieved and those captives that have participated and continue to do so, benefit from this long-term result.