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U.S. Securities and Exchange Commission


(Release No. 35-27669; 70-9957)

KeySpan Corporation

Order Authorizing the Acquisition of a Captive Insurance Company as a Subsidiary of KeySpan

April 24, 2003

KeySpan Corporation ("KeySpan"), Brooklyn, New York, a registered holding company under the Public Utility Holding Company Act of 1935, as amended, ("Act"), has filed with the Securities and Exchange Commission ("Commission") an application-declaration ("Application") under sections 6(a), 7, 9(a), 10, and 13(b) of the Act and rules 43, 54, 90 and 91 under the Act. The Commission issued a notice of the filing on November 28, 2001 (HCAR No. 27469).

KeySpan requests authority to establish a subsidiary captive insurance company ("Captive") to engage in the business of reinsuring certain levels of predictable risk for KeySpan and its associate companies (collectively, "System"). By using the Captive to underwrite some risks and maintaining traditional insurance with respect to other risks, KeySpan says the System can minimize its costs of obtaining insurance and managing claims while maintaining adequate coverage of the risks it encounters in its businesses. At the time the Captive is created, KeySpan will acquire all of its issued common stock for $100. The Captive will be essentially an administrative mechanism that permits the System to access the reinsurance markets that are only available to insurance companies or brokers.

KeySpan proposes to establish Captive as a new direct wholly-owned subsidiary which would be authorized to operate as an insurance company in the state of Vermont and would reinsure certain commercial insurance bought by the System companies from commercial insurance companies. The Captive will initially focus on providing three major types of coverage to the System companies: automobile liability, workers' compensation and general liability. In addition, the Captive will provide general liability and workers' compensation insurance to its principal contractor under an Owner's Controlled Insurance Program ("OCIP"). The contractor provides scheduled gas main construction and maintenance to System companies. KeySpan's system service company, KeySpan Corporate Services LLC, currently provides this OCIP coverage. KeySpan says that by providing this insurance to the unaffiliated contractor under OCIP, the contractor's costs are reduced and it passes these savings on to the System companies by charging lower prices for the work performed. Except for the general liability and worker's compensation insurance provided to the principal contractor under OCIP, the Captive will not extend or provide to any non-affiliated company any insurance services without obtaining Commission approval. The proposed coverage for the principal contractor will only be for the duration of the projects undertaken by the contractor for the KeySpan System companies and only for the gas main and maintenance services provided by the contractor to System companies.

No additional staff would be required for the operation of the Captive. An unaffiliated Vermont management company will be retained to provide administrative services.1 System service company employees will be directors and principal officers of the Captive and will oversee all administrative functions performed by the Vermont management company. Administrative functions would be directed by the service company through the management company and would include: (1) accounting and reporting activities; (2) legal, actuarial, banking and audit services; (3) negotiating reinsurance contracts, policy terms and conditions; (4) invoicing and making payments; and (5) managing regulatory affairs. The existing service company claims staff would continue to perform the claims adjusting function. All goods and services provided by the service company to the Captive would be provided in accordance with section 13(b) of the Act and the rules under the Act, and the costs incurred by the Captive would be recovered in premiums charged by the Captive to the System.

The Captive will allocate premiums and nominal operating costs to System companies in accordance with the same allocation methods currently employed by the system service company. KeySpan says the allocation methods used are designed to result in a fair and equitable apportionment of insurance costs to System companies based on cost drivers. For example, automobile liability insurance costs would be allocated to System companies in proportion to the number of vehicles operated by each company (or similar approximation of risk exposure, such as vehicle miles driven). The allocation to the System companies for workers' compensation insurance rates will be based on payroll and job classifications. General liability rates will be allocated to the System Companies based on projected revenues to determine a base premium, which will be audited and adjusted at year end. To the extent the Captive procures insurance at a lower cost than that which could be obtained through traditional insurers, the savings in the premiums will flow through ratably to System companies through the operation of the allocation methodology used to establish premiums.

The aggregate amount of the initial funding of the Captive will be approximately $50.5 million, which is comprised of approximately $21.5 million for the 2003 premiums and the transfer of approximately $29 million of existing reserves for prior losses. The $50.5 million represents the value of the total loss expected by all KeySpan System companies for prior years and 2003 expected events (including reserves for all prior years for injuries and damages as well as 2003 predicted losses). Funding of the approximately $21.5 million to the Captive will be paid in cash from the participating System companies based on their allocated share. All funds will be deposited with the Captive's bank and will be invested in securities that are exempt under rule 40 under the Act. KeySpan would also provide any subsequently required capital contributions through additional equity and or debt purchases exempt under rule 52 or 45 of the Act, or guarantees, letters of credit or other forms of credit support authorized by Commission order. If payment is required under a letter of credit, KeySpan would reimburse the bank providing the letter of credit, and the amount paid would be treated as a capital contribution to the Captive.

Premiums for the first year were actuarially determined to equal the aggregate predictable loss, plus administrative expenses. The Captive would assume the risk of the more predictable loss layer from the commercial insurers for losses between zero and $3,000,000 for automobile and general liability losses and between zero and $500,000 for workers' compensation. Commercial insurance would continue to be purchased for "unpredictable" losses above $3,000,000 from various commercial insurance companies as is done under the current program.

Each subsidiary would be given a choice of deductibles, and premiums would be based on that choice and the subsidiary's own prior loss experience so that a subsidiary with a historical lower loss experience would be rewarded with lower premiums. With this exception, premium allocations would continue to be made using the bases of allocation previously filed with the Commission for the current insurance program. Under the current program, a premium increase caused by a significant loss or a higher frequency of losses was allocated on a basis that did not take the loss or frequency of loss into account. Under the new program, the source of the loss would be a basis of allocation. However, due to the lower administrative costs and efficiency of the program, premiums will be lower, KeySpan states.

The Captive will not be operated to generate profits beyond what is necessary to maintain adequate reserves. To the extent that premiums and interest earned exceed current claims and expenses, an appropriate reserve would be accumulated to respond in years when claims and expenses exceed premiums. To the extent that losses over the long term are lower than projected, the Captive will correspondingly lower premiums and thus return excess capital to the System companies.

In addition, to assure the financial strength and integrity of the Captive, which must comply with strict Vermont capital-to-premium requirements of $1 of capital for every $5 of net premium, aggregate "stop loss" protection will be arranged from a commercial insurer. Using actuarial models with a high confidence factor, it is expected that the Captive would not experience losses in excess of approximately $10,800,000 in the first year of operation. As noted above, the Captive's available funding is designed to meet this level of loss. In the unlikely event of losses exceeding this amount, however, commercial insurance will respond to any claims in excess of the aggregate and retention amounts. This ensures coverage will be available to the KeySpan subsidiaries, the applicant states.

KeySpan sees the following benefits from establishing the Captive: (i) significant reduction in the 20% to 30% overhead charge for commercial insurers underwriting "predictable" risk (approximately $1,500,000 savings in premiums for the first year); (ii) direct access to global reinsurers to ensure the most competitive and cost-effective pricing for KeySpan's "unpredictable" commercial insurance exposures (this could result in savings in premiums above the $1,500,000 level); (iii) flexibility for subsidiaries to select deductibles consistent with their business needs and objectives; (iv) greater control and input over the claim management process for system companies; and (v) less reliance on the commercial insurance market for insuring predictable risk, resulting in less volatility of future premiums.

Fees and expenses incurred in connection with this request are estimated to be $10,000.

No state or federal commission, other than this Commission, has jurisdiction over the proposed transactions to establish Captive.

KeySpan currently meets all of the conditions of rule 53(a) except for clause (1). At December 31, 2002, KeySpan's "aggregate investment," as defined in rule 53(a)(1), in exempt wholesale generators ("EWGs"), as defined in the Act, and foreign utility companies ("FUCOs"), as defined in the Act, was approximately $974,979,000. By Commission order dated December 6, 2002 (HCAR No. 27612), KeySpan was authorized to make investments in EWGs and FUCOs in an aggregate amount up to $2.2 billion. KeySpan has complied and will continue to comply with the record-keeping requirements of rule 53(a)(2), the limitation under rule 53(a)(3) of affiliate utility company personnel rendering services to KeySpan's EWGs or FUCOs and the requirements of rule 53(a)(4) concerning the submission of copies of certain filings under the Act to retail rate regulatory commissions. None of the circumstances described in rule 53(b) has occurred.

KeySpan states that there has been no material adverse impact on KeySpan's consolidated capitalization resulting from KeySpan's investments in EWGs and FUCOs. KeySpan says the formation of Captive would not, by itself, or even considered in conjunction with the effect of the capitalization and earnings of KeySpan's EWGs and FUCOs, have a material adverse effect on the financial integrity of the KeySpan system or an adverse impact on KeySpan's public-utility subsidiaries, their customers, or the ability of state commissions to protect the public-utility customers. As of December 31, 2002, KeySpan's consolidated capitalization consisted of 32.08% equity and 67.92% debt. These ratios comply with the requirement in KeySpan's financing order that KeySpan's common equity will be at least 30% of its capitalization. KeySpan states that the proposed transaction will have no adverse impact on KeySpan's ability to satisfy that requirement. In addition, at December 31, 2002, KeySpan's senior unsecured debt was rated "investment grade" by all the major rating agencies. In addition, KeySpan's EWG and FUCO investments have been profitable for all quarterly periods from December 31, 2000, through December 31, 2002.

KeySpan points out that all of its direct or indirect investments in EWGs and FUCOs are segregated from the public-utility subsidiaries. None of the public-utility subsidiaries provide financing for, extend credit to, or sell or pledge its assets directly or indirectly to any EWG or FUCO in which KeySpan owns any interest. KeySpan does not, and will not, seek recovery in the retail rates of any public-utility subsidiaries for any failed investment in, or inadequate returns from, an EWG or FUCO investment.

KeySpan states that investments in EWGs and FUCOs will not have a negative impact on the ability of the public-utility subsidiaries to fund operations and growth. The public-utility subsidiaries currently have financial facilities in place that are adequate to support their operations. The expectation of continued strong credit ratings by the public-utility subsidiaries should allow them to continue to access the capital markets to finance their operations and growth, KeySpan states.

KeySpan's annual report to the Commision on Form U5S will include the financial statement of the Captive. In addition, KeySpan will file a certificate of notification on a semi-annual basis describing the following:

1. A summary for the reporting period of each associate company's premium payments to the Captive as compared to aggregate loss experience organized by line of insurance coverage provided by Captive;

2. An analysis by each associate company of claims paid by the Captive during the period on behalf of the associate company to include lead-in and end-of period insurance reserve balances;

3. A listing of increases and decreases to premiums paid by each associated company to the Captive during the period;

4. For the first three years of the Captive's operations, a statement of actual savings achieved by the System as a result of the Captive's operations during the period.

5. A copy of Captive's income statement and balance sheet, including any accompanying notes.

Due notice of the filing of the Application, as amended, has been given in the manner prescribed by rule 23 under the Act, and no hearing has been requested of, or ordered by, the commission. Based on the facts in the record, the Commission finds that the applicable standards of the Act are satisfied and that no adverse findings are necessary.

IT IS ORDERED, under the applicable provisions of the Act and the rules under the Act, that the Application, as amended, be granted and permitted to become effective immediately, subject to the terms and conditions prescribed in rule 24 under the Act.

For the Commission, by the Division of Investment Management, pursuant to delegated authority.

J. Lynn Taylor
Assistant Secretary


1 Captive would not be an admitted commercial insurer in the United States but would work through admitted commercial insurers.



Modified: 08/05/2003