Captives a key tool in hard market but need serious investment

Bart Smets, head of the insurance and risk department at Umicore

Captives are currently a good option for European risk managers as they grapple to contain costs and maximise coverage during the rapidly hardening corporate insurance market.

They offer the opportunity to more effectively identify, measure, manage and prevent risks, and provide critical leverage when negotiating terms and conditions with the insurance and reinsurance markets.

But a panel of experts gathered by Ferma to discuss alternative strategies during this hardening market, meeting on the opening day of its seminar today, agreed that risk managers need to appreciate that creating a captive takes time, effort and money, and needs to be taken seriously.

Key internal stakeholders such as legal, treasury and tax need to be involved in the discussions and also, of course, top management needs to buy into the concept. The risk manager needs a transparent and robust business plan for the captive and this needs to be clearly and well communicated to make it a success, agreed the experts.

Bart Smets, head of the insurance and risk department at Umicore, a global materials technology and recycling group based in Brussels, Belgium, has spent the last two years working on the creation of a captive for his group. The captive will go live in January.

“This was time consuming but a very positive experience. You need to convince top management and you need a good business plan. You need to debate and discuss the drivers and why you are setting it up – show the pros and cons,” he stressed.

“This is not a one-man show. You need a good internal network and need to communicate clearly to senior management. Above all, you really should be using this as a risk management tool above all else – there is nothing else than that,” continued Mr Smets.

The Belgian risk manager said he has identified six core factors that fellow risk managers need to take into account if they are considering setting up a captive in response to the challenging commercial insurance market. These are:

  • It is a time-consuming process
  • You need a good business plan
  • You have to involve other departments and have a good internal network
  • Clear communication is essential
  • The risk manager must be very knowledgable about the details and reasons for creating the captive
  • The captive must be a risk management tool above all.

One delegate at this year’s virtual seminar asked whether captives offer a possible solution for the seemingly fast-rising range of risks that the commercial insurance market is unwilling or unable to cover currently, as underlined by the Covid-19 crisis.

Matthew Latham, head of global programmes and captives at AXA XL, said captives definitely help corporations better identify their risks, assess appetite for the risks and determine the level of risk they wish to retain and transfer.

But he also warned risk managers not to see the captive as a panacea for dealing with emerging risks such as the pandemic, because generally they will not be adequately capitalised to provide the full answer. The key is to choose the right partner in the insurance and reinsurance market, he added.

“There is definitely more interest shown in captives currently for transferring typically uninsurable risk… the challenge with systemic risks such as Covid-19 is how to get the captive to provide significant limits and make a difference,” pointed out Mr Latham.

“You want to start with a partner, with an insurer that has some level of appetite that may be more on an excess basis… this may be done on a multi-year basis, which enables enough premium to be built within the captive over time, enabling it to pay significant losses over time. Undoubtedly, a captive provides better data on risks and this is key to determining the price and management of the risk. It is really good for the overall risk management of the company but there are undoubtedly challenges,” he added.

Stéphane Yvon, Paris-based insurance and personal insurance policy director at energy group EDF, hosted the discussion and took a question on how to ensure that the premiums charged by the captive are more efficient than those offered by the open market, and what the transfer pricing implications are.

Mr Yvon advised fellow risk and insurance managers to tread carefully in this sometimes delicate area but did stress that the captive can provide significant leverage with the open market.

“A captive does have significant advantages because it has lower setup and working costs – an economic advantage that can be transferred. But we have to be careful about the transfer pricing rules. When the market hardens, the captive can certainly help restrain the insurers because, while they may be looking for higher premiums, at the same time they want to keep the business. So, you can use the captive to leverage with the insurers,” he explained.

Mr Smets added that this question is not as simple to answer because captives are created to achieve different goals. Above all, however, good documentation about how the pricing was worked out needs to be retained, he said.

“It is not necessarily that the premium paid to the captive is much lower than in the commercial insurance market; it depends on what you are trying to achieve… and the quality of the risk. You really need to ensure that you have good documentation on why and how you carried out the calculations. It can be a good idea to ask your fronting insurers or co-insurer on the panel to also make a calculation of the cost of the layer if it were to be transferred to the open market,” said Mr Smets.