Günter Dröse of ECIROA and Laurent Nihoul of FERMA discuss the current landscape of the European captive insurance market and potential challenges
The current high interest surrounding alternative risk financing in Europe is a product of reduced capacity and increased premiums in the traditional reinsurance market, as well as the overarching landscape of the hardening insurance market. Many European companies are looking to leverage their captives further, through reassessment of their business models and by facilitating new lines of business in promising market areas.
Günter Dröse, executive director of the European Captive Insurance and Reinsurance Owners Association (ECIROA), explains that “the use of captives as a risk management tool is driven by the realisation that the parent company itself can bear part of the risks, which is mainly reinforced by market cycles. Therefore, we must examine both claims development and the changing underwriting behaviour of insurers over the last few years”.
Dröse notes that as well as an increase in several new captive formations, the European captive market has also seen a rise in the insurance volumes insured or reinsured through captive structures and protected cell companies.
This distinct interest in the region around alternative risk financing tools is affirmed by Laurent Nihoul, group head of insurance at ArcelorMittal and board member of the Federation of European Risk Management Associations (FERMA) responsible for captives.
Nihoul says: “One trend we have observed is a move by some large European countries — most notably France, but there are others — to explore the opportunity to create a captive-friendly environment. They are more aware of the risk management case for captives by companies and the value of having the captives within their oversight.”
In particular, cell captives are emerging as a popular structure. These captive solutions allow small- to mid-sized companies to experience the advantages of alternative risk management strategies without imposing unattainable capital requirements, instead segregating a company’s risk from that of other organisations in the same pool.
However, Nihoul notes that new captive formations are not wholly indicative of the extent to which the captive market has grown. As a mature industry, he points out that most large companies with the resources to form a captive have already done so.
These organisations are in the process of putting more business into their captives in a threefold approach: increasing retention of frequency exposures; retaining medium-level severity exposures; and exploring new lines of business not currently in their captive structure.
Nihoul elaborates: “I make a distinction between pricing corrections and a global line of business shift. Where an individual client’s premium has to be adjusted to the new market reality, a discussion with carriers might still happen. However, a shift of a global line of business into a strongly disrupted pricing environment that is unrelated to the risk profile of organisations is different.”
Lines of business such as directors’ and officers’ liability insurance and cyber risk were underpriced from the global market perspective, as price changes and capacity shortage are not linked to the individual insured’s profile.
Nihoul identifies cyber risk and natural catastrophes as two peak exposures likely to see higher reinsurance pricing in the future, which will be passed on by insurers to commercial buyers and therefore continue the trend already demonstrated in large companies.
He also considers that, in the future, the captive industry may see the creation or re-domiciliation of captives from other European countries into the leading European captive domiciles.
The increased interest in alternative risk financing has created competition in domicile selection. Dröse notes that Luxembourg “seems to remain the dominant European captive market”, boasting a particularly strong reinsurance market that hosts captives from predominantly French and Italian parent companies. Elsewhere, Malta is noted for its protected cell and segregated portfolio companies, while Guernsey and the Isle of Man stand out as established domiciles, and there is also growing interest in Ireland. The success of a domicile is largely dependent on local regulators’ implementation of the regulatory framework, as well as the presence of complimentary captive service industries, such as banking, legal, secretarial, audit and insurance management.
Domicile selection in Europe may also depend on commitment to environmental, social and governance (ESG) principles. Dröse identifies that ESG and sustainable development goals “are of growing consideration for all stakeholders”. However, he notes that it is important to distinguish what insurers will consider and what changes or adjustments will need to be made.
He continues: “The investment strategy of insurers is increasingly under the observation of regulators. Captives generally act in line with the parent organisation’s investment strategy, as well as in accordance with the group treasury or chief financial officer.”
Nihoul agrees: “When it comes to ESG, non-financial risk disclosure will be at corporate level and is unlikely to be an issue for captives whose business is completely or very largely that of the parent company.”
Potential challenges
Looking at the impact of the COVID-19 pandemic on the European captive market, Dröse affirms that insured companies, as well as insurers and reinsurers, must consider the extent to which their exposure has changed.
Increased interest in captives precedes the pandemic and was predominantly a result of the hardening market; although that is not to say it has not been exacerbated by COVID-19. Nihoul notes that although “COVID-19 has had an impact on many captive-owning companies, it is not feeding through to captives in a material way”.
Dröse agrees that pandemic risk did not influence the risks underwritten by captives or other alternative risk transfer vehicles, although some healthcare insurance contracts may have been affected and subsequently triggered a premium increase which may require adjustment over time.
Lockdown across European countries generated growth in some sectors, such as online retail and technology. Post COVID-19, there is expected to be increased coverage in non-physical damage business interruption and contingent business interruption.
As well as the impact of the pandemic, in terms of the challenges currently facing captives in the European market, Nihoul acknowledges emerging cyber risks: “The cyber insurance market is evolving, and it is not clear how much capacity it will offer in future.”
“It is increasingly clear that cyber risks can be systemic, affecting many organisations at the same time,” he explains. “FERMA supports the creation of a pan-European catastrophe risk sustainability framework for systemic risks that are beyond the capacity of the private insurance market, including major cyber attacks, widespread natural disasters resulting from climate change and future pandemics.”
The Solvency II review is not expected to pose a heavier burden to the activity and reporting of European captives compared to how it stands today, according to Dröse. ECIROA contributed its opinions during the review’s consultation period.
The review of the directive, which came into force on 1 January 2016 under the European Insurance and Occupational Pensions Authority (EIOPA), will address balance updating of the regulatory framework, recognition and reflection of the economic situation, and regulatory toolbox completion.
“The Solvency II development has always been described by EIOPA as a flowing process of learning and adjustment, bearing in mind that the proportionality principle needs to be respected more carefully than it is currently,” Dröse adds.
Nihoul continues: “In terms of the revision to Solvency II, FERMA has continued to press for consistency in the application of the principle of proportionality in the insurance regulation of all member states.”
Looking ahead, Dröse holds an optimistic view for the future landscape of the European captive insurance market, predicting that “over the next two years, we expect to see a growing number of captive formations”.
“Due to some capacity limitations in the market, some insurance mutuals may be created; such an evolution will be influenced by the behaviour of the insurance market.”
“Although there is sufficient expertise in the market, we also see a lot of challenging questions in this area, not only regulatory- or tax-based but also in how to satisfy the mutual partners in a fair structure,” he concludes.
