Captives on standby for hard market

Captive insurers are looking to restructure captives to mitigate future increases in insurance rates and underwrite new lines of business, including cyber and non-damage business interruption.

Captive insurers have had a tough time of late, as an increased regulatory burden has challenged the captive concept. Owners have been hit with a double whammy of rising solvency regulation and risk management requirements under Solvency II, and a renewed focus on corporate tax avoidance under the OECD’s Base Erosion and Profit Shifting (BEPS) framework.

Despite increased regulation, captives have proven to be a resilient and sophisticated tool valued by risk managers, according to Matthew Latham, head of captives programmes globally for XL Catlin.

“Some clients, a minority, have chosen to close their captives for a number of reasons, including change of business, increased governance and compliance and new regulations such as BEPS. But the majority are looking to expand their captives and see them as a valuable tool as we move into a period of uncertainty,” said Mr Latham.

“Clients value captives as a long-term vehicle. It helps them to drive the risk management message through the company, as well as offering a possible solution to cover emerging risks and to protect against changes in market conditions,” he added.

Uncertainty around the future cost of insurance has led some captive owners to explore increasing retention and aggregate levels to manage any changes in the price of traditional cover, according to Mr Latham.

Following near record hurricane and wildfire losses in 2017, market conditions have been changing. Insurers have been pushing to increase rates, with a particular focus on catastrophe risks, although excess capital has curtailed these efforts.

Clients continue to recognise captives as one of the best ways to prepare for the return of a hard market, according to Jean Rondard, head of corporate risk broking at Gras Savoye Willis Towers Watson. “A captive allows a company to structure its risk and go to the market to seek the best protection terms,” he said.

While there is little demand for new captives, they remain an attractive risk management tool for corporates, and can help companies offset potential future insurance market hardening, agreed Robert Leblanc, chairman and CEO of Aon France.

“Captives are a good tool, and most of our clients have one. Companies could consider putting more risk into their captives, and if the insurance market were to harden, I expect our clients will put more and more business into their captives as they look to retain more risk,” he said.

Risk managers are looking at how to utilise their captives in anticipation of future market conditions, said Bruno Mostermans, head of France at Swiss Re Corporate Solutions. “We have had conversations with risk managers about their captives looking two to three years ahead,” he said.

Swiss Re Corporate Solutions is keen to support the captive sector, looking to provide multi-line protection solutions, which should become more attractive if the insurance market hardens.

“The market has been soft in recent years, so it has been harder to propose solutions for captives. But risks managers are now looking at their options,” said Mr Mostermans.

More and more companies are looking to restructure their captives, according to Fabien Graeff, head of risk financing and captives solutions at Marsh France. “The cost of insurance is still low after some 13 years of a soft market, but there is pressure from clients to optimise risk transfer,” he said.

Changes in solvency and governance rules have led to an increase in minimum capital requirements and a higher administrative burden for captives. Higher insurance premium taxes, which have risen in the UK, can also make captives less attractive and have seen some corporates retain more risk on their balance sheets.

BEPS remains an important issue for the risk management community, but captive managers need to work at making captives an effective risk management tool, according to Johan Willaert, Ferma president and corporate risk manager at Agfa Corporate.

“We keep dialogue open with the OECD. A discussion paper on transfer pricing is expected in the spring and we will watch to see if it deals with captives,” said Mr Willaert. “It’s about watching and being ready to react,” he said.

BEPS and Solvency II are likely to result in fewer new pure captives being established in Europe, but overall premiums will grow as existing owners make greater use of their captives, according to XL Catlin’s Mr Latham. “Given the higher minimum capital requirements, governance requirements and increased management time needed to run a captive, the bar for establishing a new captive has increased in terms of premium spend,” he explained.

To create economies of scale and diversify risks, which should provide greater capital efficiency, captive owners are looking to add new lines of business.

This can be traditional insurance lines that are not currently underwritten by the captive and, increasingly, risks that are typically not covered by insurers, such as non-damage business interruption, cyber, reputation, patent infringement and other operational threats, according to Mr Latham. A number of captives have excess capital that could be used to develop innovative solutions for these risks, he suggested.

When it comes to cyber, captives can be used to write standalone policies, or buy back exclusions, explained Mr Latham. Only a small number of captives currently provide cyber insurance, but this is an area that will grow rapidly, he said.

According to Marsh, some captives are already writing cyber insurance on a difference in limits and difference in conditions basis, or on a “first line” basis as they look to build limit. “We see more requests and this year we have seen clients put more cyber risk into captives. I expect to see more cyber in captives in the future,” said Mr Graeff.

The benefit of using a captive for these types of emerging risks is organisations can dip their toe in the water, raise risk awareness and start to collect data, said Mr Latham. “Incubating risks in a captive gives companies options and insurers may be prepared to come in and take a share through excess layers as the data becomes available and they get more comfortable with the risk,” he said.

Captives have also diversified through the addition of employee benefits risks, according to Mr Rondard. Willis has helped a number of its captive clients to include benefits, which are typically more predictable and less volatile than property casualty risks, he said.

Marsh has also seen more interest in writing employee benefits in captives, as well as cyber and non-damage business interruption.

In recent years, captive owners have been pre-occupied by Solvency II, and the implications for capital and processes, according to Marsh. With Solvency II compliance now “under control”, many captives find themselves with a surplus of capital, it added.

“Most captives in Europe have a surplus of capital and a good solvency ratio. The challenge is what to do with that surplus, and if it is to stay in the captive that means writing more business,” said the broker.

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