SECURITIES AND EXCHANGE COMMISSION

(Release No. 35-27824; 70-10188)

Cinergy Corp.

Order Authorizing Establishment of a Captive Insurance Company Subsidiary; Reservation of Jurisdiction

March 29, 2004

Cinergy Corp. ("Cinergy" or "Applicant"), Cincinnati, Ohio, a registered public-utility holding company under the Public Utility Holding Company Act of 1935, as amended ("Act"), filed with the Securities and Exchange Commission ("Commission") an application-declaration, as amended ("Application"), under sections 6(a), 7, 9(a), 10, 12(b) and 13(b) of the Act and rules 45, 54, 90 and 91. The Commission issued a notice of the filing of the Application on Feb. 6, 2004 (Holding Co. Act Release No. 27798).

Cinergy requests authorization to establish a subsidiary captive insurance company ("Cinergy Captive") to engage in the business of insuring or reinsuring certain levels of risk for Cinergy and its associate companies (collectively, "Cinergy System" or "System" and, any constituent company, a "System Company").¹ Cinergy states that it considers risk management a key corporate function, providing for protection of physical and financial assets. As such, risk management is one of the primary responsibilities of Cinergy Services, Inc. ("Service Company"), a wholly owned subsidiary of Cinergy, which coordinates, and will continue to coordinate, risk management through the Insurance and Claims Department of its Global Risk Management Department.²

Cinergy intends Cinergy Captive to underwrite a significant portion of the Cinergy System deductible or self-insured retained risks for workers' compensation, general liability, auto liability and property insurance coverage. In addition to this primary role of underwriting System retained risks, Cinergy Captive may be used to replace, or reduce, insurance coverage purchased on behalf of System Companies from traditional insurance providers for workers' compensation, general liability, auto liability and property risks. In this context, Cinergy Captive would seek to obtain equal levels of loss protection and coverage in the reinsurance market. Cinergy, at some future time, also may propose to underwrite certain additional coverage, but not without a further Commission order.³ Consequently, Cinergy requests that the Commission reserve jurisdiction over these potential additional activities, pending completion of the record. Cinergy does not intend to increase the risk of loss to the Cinergy System with its use of Cinergy Captive, but to enhance the System's risk management processes, while attempting to save costs.

Cinergy states that, in today's insurance market, traditional insurance programs are relatively expensive to maintain, largely due to the costs of doing business with a "full service" traditional insurer. Underlying the traditional insurance programs is a robust reinsurance market that is available, generally speaking, only to insurance companies. By eliminating the traditional insurance company "middleman" for selected transactions and coverage, Cinergy seeks to take advantage of opportunities for savings that it believes exist for those companies that are able to deal directly in the reinsurance market. Cinergy further notes that many Fortune 500 companies presently utilize a captive insurance company ("captive") to control and manage their insurance costs more effectively.

Cinergy believes that its proposed comprehensive insurance program - blending traditional commercial insurance, management of retained risks through the Cinergy Captive and direct access to the wholesale reinsurance markets - is the best way for it to maximize cost effectiveness, minimize risk exposure and provide each System Company with the flexibility to meet its strategic goals and objectives. Cinergy proposes to establish Cinergy Captive as a wholly owned, direct subsidiary organized under Vermont law and licensed to operate as an insurance company in the State of Vermont.⁴

Cinergy intends to establish Cinergy Captive with an aggregate initial capitalization of approximately $12.5 million, comprised of (i) $2.5 million to be supplied by Cinergy as an equity contribution and (ii) approximately $10 million in 2004 premiums from participating System Companies (representing the value of the total loss expected by all System Companies for 2004 expected events).⁵ Funding of the approximately $10 million in 2004 premiums will be paid in cash by the participating System Companies based on their allocated shares.⁶

Cinergy Captive will initially focus on providing four major coverages to System Companies: (1) workers' compensation, (2) general liability, (3) automobile liability and (4) property (including terrorism, as defined under the Terrorism Risk Insurance Act of 2002). Cinergy Captive will not provide these coverages to any company or person other than System Companies.⁷

An unaffiliated Vermont management company will be retained to provide management and administrative services, as is the case with most captives.⁸ Cinergy Captive will allocate premiums and nominal operating costs to System Companies using the same methods currently used for allocation of the costs of commercial insurance premiums.⁹ The allocation methods are designed to result in a fair and equitable apportionment of insurance costs to System Companies congruent with the relevant cost drivers.¹⁰ In addition, the Service Company's Insurance and Claims Department will continue to give each System Company a choice of deductibles.¹¹ Cinergy notes that, under the current program, a commercial insurance premium increase caused by a significant loss or a higher frequency of losses may have been allocated on a basis that did not take the cause of the loss or frequency of loss into account. Under the new program, the source of the loss or the subsidiary's loss history will also be used as a basis for allocation.

To the extent Cinergy Captive obtains insurance at a lower cost than could be obtained through traditional insurers, the savings in the premiums could flow through ratably to System Companies, using the allocation method for premiums. Good loss prevention would be encouraged, and with lower administrative costs and the expected efficiency of the new program, overall premiums are expected to be lower.

Cinergy Captive will analyze the commercial insurance bought by System Companies and coordinate coverage to minimize the risk of loss to the System. An actuarial analysis will be performed to determine the proper premiums, consistent with methods used to determine the retained risk premium. Cinergy Captive will apply stringent credit standards to all reinsurance counterparties, as Cinergy currently does with its insurance providers.

Cinergy states that its captive will not be operated to generate profits beyond those necessary to maintain adequate reserves. To the extent that premiums and interest earned exceed current claims and expenses, an appropriate reserve will be accumulated to respond in years when claims and expenses exceed premiums. Furthermore, to the extent losses over the long term are lower than projected, Cinergy Captive could correspondingly lower premiums, reducing the System Companies' premium expenses. In addition, if losses are lower than predicted, the captive may be able to reduce the amount of its reserves and return excess capital to the System Companies.

Cinergy states that, based on actuarial models with a high confidence factor, it is expected that the captive would not experience losses in excess of approximately $10 million in the first year of operation. In the unlikely event of losses exceeding this amount, not covered by outside insurance and accumulated claim reserves, additional capital from Cinergy would be needed. Commercial insurance will continue to respond to any claims in excess of the retained risks to ensure coverage will be available to the Cinergy System. Finally, to assure its financial strength and integrity (it must comply with strict Vermont capital-to-premium requirements of approximately $1 of capital for every $5 of net premium), Cinergy Captive will attempt to purchase aggregate "stop loss" protection from a commercial insurer. In sum, Applicant states that the benefits to be obtained from the use of a captive insurance subsidiary are: (1) reduced System exposure to retained risks and enhanced risk management control; (2) reduced overhead charges for commercial insurance underwriting; (3) direct access to global reinsurers; (4) continued choice of deductibles; (5) greater control and input over the claims management process; and (6) less reliance on the commercial insurance market resulting in less volatility of future premiums.

Rule 54 provides that in determining whether to approve certain transactions, other than those involving exempt wholesale generators ("EWGs") or foreign utility companies ("FUCOs"), if rule 53(a), (b) and (c) are satisfied, the Commission will not consider the effect of the capitalization or earnings of any subsidiary which is an EWG or a FUCO upon the registered holding company. Cinergy states that, except for rule 53(a)(1), it satisfies all of the conditions of rule 53.

With respect to rule 53(a)(1), the Commission issued an order on May 18, 2001 authorizing Cinergy to increase its aggregate investment to an amount equal to the sum of (1) 100% of consolidated retained earnings plus (2) $2,000,000,000, excluding certain restructuring investments. Holding Co. Act Release No. 27400 (the "May 2001 Order"). Although Cinergy's aggregate investment as of Dec. 31, 2003, exceeded the 50% "safe harbor" limitation of rule 53, it is within the higher investment level permitted by the May 2001 Order.¹²

Cinergy estimates that the total fees, commissions and expenses paid or incurred, or to be paid or incurred, directly or indirectly, to persons not affiliated with Cinergy in connection with the preparation, filing and processing of this Application will not exceed approximately $15,000, consisting chiefly of fees and expenses of outside counsel and of the Vermont management company for Cinergy Captive.

No state or federal commission, other than this Commission, has jurisdiction over the proposed transactions. As noted above, Cinergy Captive will apply to be a licensed insurer in the State of Vermont, licensed by the Vermont Department of Banking, Insurance, Securities and Health Care Administration and subject to that department's ongoing regulation.

Due notice of the filing of the Application 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 that, except as to those matters over which jurisdiction is reserved, the Application is granted and permitted to become effective immediately, subject to the terms and conditions prescribed in rule 24 and provided that Applicant file reports on a semi-annual basis, for the periods ended June 30 and December 31 of each year (such reports to be submitted within 60 days after the end of the preceding semi-annual period, commencing with the first full semi-annual period following the issuance of the Commission's order):

1. A summary for the reporting period of each System Company's premium payments to Cinergy Captive, as compared to loss experience, organized by line of insurance coverage provided by Cinergy Captive (for the first year, compared to the commercial insurance premiums paid (if any) and, thereafter, showing the comparison period over period, on a rolling basis, for three years successively);
    
2. An analysis by System Company of claims paid by Cinergy Captive during the period on behalf of an associate company, to include lead-in and end-of-period insurance reserve balances (for the first year, compared to any insurance reserve balances maintained (if any) and, thereafter, showing the comparison period over period, on a rolling basis, for three years successively); and
    
3. Cinergy Captive's income statement and balance sheet (including any accompanying notes).

IT IS FURTHER ORDERED that jurisdiction is reserved over the underwriting of additional insurance activities, pending completion of the record.

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

Endnotes

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¹ Cinergy directly or indirectly owns all the outstanding common stock of five public-utility companies, the most significant of which are PSI Energy, Inc. ("PSI"), an Indiana electric utility, and The Cincinnati Gas & Electric Company ("CG&E"), a combination Ohio electric and gas utility and holding company. PSI and CG&E (including the utility subsidiaries of CG&E, the most significant of which is The Union Light, Heat and Power Company, a Kentucky combination electric and gas utility) collectively provide electric and gas service to approximately 1.6 million retail and wholesale customers in parts of Indiana, Ohio and Kentucky. The Cinergy System also includes numerous nonutility subsidiaries engaged in energy-related businesses and other nonutility businesses.

² On an annual basis, Cinergy's System Companies spend approximately $15 million for commercial insurance and related services. Currently, System Companies maintain insurance policies with underlying deductibles of $1 million per event for automobile and general liability coverage and $2.5 million for property coverage. For the excess of these deductibles, System Companies currently purchase commercial insurance. System Companies currently self-insure for workers' compensation in the States of Ohio, Indiana and Kentucky (i.e., carry no or only minimal commercial insurance for those risks). System Companies, nevertheless, from time to time, may choose to purchase commercial insurance in place of, or to reduce, the deductible or self-insurance to meet their strategic goals and objectives. Commercial premiums and the deductibles and self-insured retained risks are then allocated by the Service Company to subsidiaries owning a given risk, based on such factors as number of automobiles, payroll, revenues, total property values, product throughput, as well as loss history. The allocation methods used are designed to result in a fair and equitable apportionment of insurance costs to System Companies consistent with the relevant cost drivers.

³ Cinergy Captive may propose to underwrite the following additional coverage: transmission and distribution line coverage; construction-related insurance for contractors working on projects for System Companies; performance and construction bonds; employee benefits; legal malpractice for employee attorneys; directors and officers fiduciary liability; weather risk; and credit risk or reinsurance of certain customer warranty programs.

⁴ Vermont is the largest, most established domestic domicile for captives and has had stable and consistent growth of licensed captives over the past 20 years. Applicant states that the Vermont Department of Banking, Insurance, Securities and Health Care Administration has a strong, experienced regulatory staff focused on maintaining captive solvency.

⁵ Premiums for the first year were actuarially determined to equal the aggregate losses for System Companies plus administrative expenses. Ultimate first year losses are estimated to be approximately $9.5 million, an amount Applicant expects will be paid over a seven-year period. Applicant states that this $10 million estimate (the 2004 premiums for the System Companies) was determined based on the following analysis. Initially, the captive will assume the risk from System Companies for losses between zero and $1 million for workers' compensation, general liability and automobile liability. In addition, the captive will assume the property risks in excess of a $1 million deductible up to $2.5 million. The captive will attempt to purchase reinsurance in excess of $1 million for workers' compensation and aggregate "stop loss" coverage, to limit the overall risks assumed by the captive for all liability coverages.

⁶ All funds will be deposited with Cinergy Captive's bank and invested in securities exempt under rule 40. Beyond its initial capitalization and funding of the captive, Cinergy will provide any subsequently required capital contributions through additional equity and or debt purchases exempt under rule 52 or 45, letters of credit or other forms of credit support. Cinergy has authority to issue a variety of debt and equity securities and guarantees, subject to various conditions, through June 25, 2005. See Cinergy Corp., et al., Holding Co. Act Release No. 27190 (June 23, 2000) ("June 2000 Cinergy Financing Order"). If payment is required under a letter of credit, Cinergy will reimburse the bank providing such letter of credit and the amount paid will be treated as a capital contribution to the captive.

⁷ Specifically, as described previously, Cinergy Captive is expected to underwrite, or assume the risk of, a significant portion of the deductible or self-insured retained risk currently maintained by System Companies for these coverages. Cinergy Captive will attempt to reinsure a portion of these risks in the reinsurance market. Cinergy Captive may also seek to replace, or reduce, insurance coverages of System Companies obtained from traditional commercial insurers in the areas of general liability, automobile liability, property and possibly workers' compensation. In this event, the captive will seek to obtain equal levels of loss protection and coverage in the reinsurance market.

⁸ Administrative functions will be directed by the Service Company through the Vermont management company and will 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. All goods and services provided by the Service Company to the captive will be provided in accordance with the Commission-approved service agreement for nonutility associate companies and the captive's costs will be recovered in the premiums paid by the respective System Companies.

⁹ See note 2 above.

¹⁰ For example, automobile liability insurance costs will be allocated to System Companies in proportion to the number of vehicles operated by each company (or a similar approximation of risk exposure). 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, audited and adjusted at year-end. Property insurance rates will be allocated by the total property values of the System Companies.

¹¹ Premiums payable to Cinergy Captive will be based on the level of deductibles chosen, as well as the allocation methods (number of vehicles, payroll, revenues, etc.). Consideration will also be given to the subsidiary's own prior loss experience, so that a subsidiary with a historically lower loss experience would be rewarded with lower premiums.

¹² As of Dec. 31, 2003, Cinergy had all requisite authority for an aggregate investment totaling $3,516 million. With respect to capitalization, Applicant states that there has been no material adverse impact on its consolidated capitalization due to investments in EWGs and FUCOs. As of Dec. 31, 2000, its consolidated capitalization was 40.4% equity and 59.6% debt. See May 2001 Order. As of Dec. 31, 2003, its consolidated capitalization was 41.4% equity and 58.6% debt and its senior unsecured debt was rated "investment grade" by all the major rating agencies. Applicant also states that it is committed to maintaining a 30% consolidated common equity ratio (subject to certain qualifications) (June 2000 Cinergy Financing Order) and the proposed transactions will have no adverse impact on its ability to meet that commitment. As of Dec. 31, 2003, Cinergy's consolidated common equity ratio was 40.7%.