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U.S. 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.

Margaret H. McFarland
Deputy Secretary



Modified: 03/30/2004