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Traditional v innovation: which way will captives go?

Tony Dowding asks: As interest in captives grows and more risk is pushed through captives, will the focus be on traditional uses of captive, or will there still be innovation?

As the hard market bites for many companies and their captives, it will all be about rates and getting better value for money, improved terms and conditions, and exclusions reversed. But there may also, for some, be a case for expansion in the use of captives into other strategic areas and taking an innovative approach to risk financing.

Willis Towers Watson’s Peter Carter says there is no question that they will be deployed with greater intensity to solve issues such as getting better value for money and improved terms and conditions on a tactical basis. “However, we are also seeing a greater appetite to deploy the captives more strategically. Good examples of this would be the greater use of risk portfolio analytics and solutions such as multiline/multiyear stop-loss policies and convertible bonds. Such trends underscore the long-term and strategic value of deploying capital in these structures to further optimise the cost of risk financing while building greater financial resilience for the sponsoring enterprise,” he says.

For Carl Leeman, chief risk officer at Belgian logistics firm Katoen Natie and vice-president of Belrim, the argument for using a captive comes down to buying and selling. He told Commercial Risk’s ‘Captives 2021: Now is the time for action’ virtual conference in May: “If you have to buy insurance, you have to sell your risk and if you have a captive involved, it will make that sale much easier.”

He added that a captive can bring more stability to your insurance renewal. “It can take the fluctuations out of your insurance budget. It is not easy to ask your accountant to double your budget because of changes in the market… There is a greater need to have more tailor-made coverage that is adapted for the needs of your company,” said Mr Leeman. He suggested that companies should consider a minimum of €1m to €1.5m premium for setting up a captive and to cover the cost of paying claims and fixed administration costs, which are subject to rising compliance expenses.

Improved terms and conditions
AXA XL’s Marine Charbonnier says that in the current upward-pricing market environment, the increased demand for captives is mainly driven by clients seeking better terms and conditions and deductible buybacks for their traditional global programmes. “That being said, we are also receiving more requests to include cyber-related risks within existing captives, as well as exclusion buybacks, as capacity for that class of business is sparser than it was in previous years. In that case, captives are set up as a complement to a traditional programme when the client couldn’t source enough capacity on the direct market,” she says, adding that there is increased demand for programmes that could include a parametric trigger.

Existing captive owners are likely to expand the use of their captives during a hard insurance market, particularly for difficult-to-place coverages. But the benefits of self-insurance, including having greater control over risk financing and risk management, as well as customisation of loss control and claims mitigation strategies, remain relevant when prices soften again, according to AIG’s Stephen Morton.

He believes the most successful insurance programmes maintain a balance of traditional and alternative risk transfer, with a strategy that adapts to changing market cycles and risks.

“Global supply chains impacted by an accelerated move towards digital transformation are causing many organisations to re-evaluate their current insurance protections, with a view to expanded use of captives. Another factor is the changing risk landscape. Emerging and intangible risks, such as cyber, reputation, supply chain and non-damage business interruption underscore the need for new and innovative risk managed solutions,” he says.

He points out that traditional lines are still driving most captive participation but there is also interest in evolving lines, particularly cyber, as well as warranty, tenants’ liability and other third-party coverages as companies look at their captives as a separate business unit and additional source of revenue.

Risk prevention and filling gaps
Zurich’s Paul Wöhrmann says: “Captives are very helpful to make risk prevention strategies happen, since captives generally keep a substantial net retention on their balance sheet (it is the captive owner’s money and the core business of the captive owner that will be protected). Given the market environment, we believe that captive owners are highly interested in risk prevention and are focusing much more on the aftermath of loss events.”

For risks that have become uninsurable or uneconomical in the commercial market, then a captive is likely to continue to play a role in filling gaps in the insurance tower until such time as the market adjusts. SRS Europe’s Derek Bridgeman says that in response to hard market conditions, “we are seeing the approach to risk management become more sophisticated, with an increased focus on not just insured P&C and employee benefits exposures, but also risks that were historically difficult to insure such as non-damage business interruption, cyber, reputational and other pandemic-related risks”.

He continues: “Here you have a continuation of trends in captive use during a soft market continuing into renewed interest in captives for traditional uses as the commercial market hardens. During the soft market we experienced a more strategic and entrepreneurial use of captives – third-party usage for risks such as warranty or customer-related coverages, as well as medical stop-loss. However, given the prolonged hardening market, traditional property, casualty and financial lines are of key importance currently and are likely to dominate throughout 2021 and 2022.”

“Captives and innovation have always been good bedfellows,” says Artex’s Mike Matthews. “The best use of a captive has been, and remains, the ability to better manage an owner’s total cost of risk by assisting in restructuring an existing insurance programme, addressing uninsured/uninsurable risk, designing new/bespoke coverages and/or providing additional capacity in both primary and excess layers. The hard market, fallout from Covid-19 and cyberattacks have all just heightened these benefits for large and mid-sized firms alike, leading to more innovative uses of various forms of captive, including greater use of distributed ledger technology.”

Whether taking a classic approach to risk financing and focusing on the traditional lines of business in response to the hard market conditions, or looking to be proactive and innovative, and looking at new areas of risk, captive use is set to ramp up for the next year or so at least, and probably well beyond. As Adri van der Waart, director, global insurance at Dutch engineering firm Arcadis and president of Narim, said at Commercial Risk’s ‘Captives 2021: Now is the time for action’ virtual conference in May, summing up the feeling of many risk and insurance managers about the hard market: “We don’t like it and we are taking our risk back in-house. The captive is the solution of the future.”

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