Captive health checks for captive owners

Making the most effective use of the captive retention to optimise risk financing costs is certainly a high risk management priority, and it is recommended that the retention be reviewed at regular intervals.

“We have experienced that around 40% of our European captive customers perform an annual basis ‘health check’ to explore whether the captive retention has been set in a proper manner compared to the current market environment,” said Dr Paul Wöhrmann, captive head of Zurich Commercial Insurance.

Furthermore, the higher the retention level a company takes, the more exposed the captive is to volatility. Since the company has to be able to finance the corresponding volatility, it consequently has to set aside enough capital to be able to survive a one-in-twenty-year event, which is the recommended risk capital base to finance a captive’s underwriting activities.

When a captive is first established, there are usually various analyses done to start with an optimised captive: which lines of business will be ceded, what limits will the captive retain, and what amount of premium is adequate? All these checks are important at the start of the life cycle of a captive. However, as the captive becomes established and has been running well for a couple of years, the conditions that held true in the beginning might have changed. New lines of business might potentially fit into the captive, and for the existing ones the limits of the previous years might not be adequate any longer.

“We at Zurich see it as inevitable to not only execute the corresponding analysis at the beginning of the life cycle of a captive, but also at frequent time intervals during this cycle. These so-called risk insight studies during the life cycle can be seen as ‘health checks’ for the captive: is the captive healthy in the sense that it is making full use of its potential in regards to the various captive key factors, such as per event and annual retention limits?” said Dr Wöhrmann.

Christoph Betz, captive pricing specialist of Zurich Commercial Insurance, has performed various health checks of existing captives via analysis of the risk over the years. “There are at least two distinct approaches to gain risk insights: you can either perform a fully customised analysis, where you look at the individual customer data. Or you can use a semi customised analysis, where you look into the data from a whole industry, to try to deduce insights for the individual customer,” said Mr Betz.

The fully customised analysis is an individual process that needs to be performed on a customer level, and therefore results in a tailor-made outcome that fits the single customer. The semi-customised analysis cannot match with that granularity, of course, but can help customers to gain first risk insights. For the first step of a captive, Christoph Betz sees the advantage of both methods: “The semi-customised analysis can be of use for a first indication for the customer if his industry shares a common risk pattern, but can never completely replace a fully-customised analysis. It can be a useful tool in the beginning of the decision phase, but the final decision regarding optimised retention levels for a captive should include a solid fully-customised analysis,” he said.

These fully-customised analyses are performed by Zurich Commercial Insurance in individual feasibility studies. In the later stages, Mr Betz sees a clear advantage for the fully-customised analysis: “When a captive is already running and you want to check if the retention is still optimal, you should not rely on industry benchmarks. If you want to release the full potential of your captive, you should check with your individual data. However, it can be useful to regularly check trends in the industry risk, as changes there can be a useful indication as to whether you should start looking into your own individual data,” he explained.

For the semi-customised risk insights, Zurich looked into various industries in their portfolio. For food and beverage, industrial metal and machinery, no common industry specific pattern could be deduced. This clearly underlines that for a health check in these industries, a regular fully-customised analysis should be performed. For the retailer segment, however, a pattern emerged for liability and property; therefore it can be used as a first indication for a new starting captive, and then captive health checks should be performed to check whether the captive is making use of its full potential.

“We have experienced that captive owners show interest in performing retention studies in a hard and in a soft market environment. Such studies can be performed for all business segments provided that enough loss history data is available. Our observation is that the majority of captive owner requests have been raised from the manufacturing industry,” said Dr Wöhrmann.

For captives covering life risks regular health checks are also recommended. Due to the nature of life business a fully-customised analysis is the preferred method. “Generally speaking, in employee benefit, risk insight studies based on pure experience is uncommon, because less claims occur to generate an actuarial simulation model. Instead a study based on pure exposure models (mortality, sums insured , etc) is possible,” said Santhosh Paracherry, captive pricing specialist for life and non-life exposure of Zurich Commercial Insurance.

Wendy Liu, head of Zurich Global Employee Benefits Solutions, added: “Large captive owners, especially those from the Solvency II regions, are showing increasing interest in exploring opportunities for captives to include employee benefits, in order to capture the advantage from a holistic risk management and central control approach.”

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