Strategic Risk Solutions
There is no real limit to the types of risk that can be insured in enterprise risk captives, according to Patrick Theriault of Strategic Risk Solutions
How does an enterprise risk captive work and how have they evolved in recent years?
There are different forms of enterprise risk captives, but the one most often seen historically has provided a wrap programme that complements the commercial insurance programme, with an emphasis on low-frequency and high-severity risk. As such, the enterprise risk captive will often provide difference in condition (DIC) and difference in limits (DIL) coverage for self-insured retention or deductibles, excess limits, along with standalone policies covering risks unavailable or overpriced in the commercial market.
Captives have been addressing the changing needs of their insureds with more enterprise risk captives starting to provide coverage for various business interruption risks that often keep middle-market business owners up at night as well as ‘newer’ captive risks such as cyber and medical stop-loss.
There is an increased level of education and understanding of enterprise risk captives by potential captive owners and their insurance brokers or consultants. We often now spend less time on education and more on structure planning, which is nice to see.
How would a company incorporate cyber risk within an enterprise risk captive? What are the challenges specific to cyber?
While the interest in insuring cyber risk in enterprise risk captives has been on the rise, and is likely to continue to rise, it is a risk that the market in general still knows very little about and it is therefore difficult to price or to compare pricing when commercial coverage is available. Also, there are limited claims or premium information available to actuaries to price the risk, and often the data is old.
Considering how quickly technology evolves, are rate filings from three to four years ago appropriate?
It is also interesting to see that situations that have arisen at larger organisations that appeared to be significant in nature also appear to have resulted in generally only small losses. Did they get lucky or are some of the costs still hidden? How will all of this translate to mid-size organisations that primarily use enterprise risk captives? Is their cyber risk exposure smaller or greater? These are many questions that will be answered over time. Meanwhile, if an organisation chooses to self-insure its cyber risk exposure, an enterprise risk captive could be a good vehicle to formalise this process.
We see cyber risk being insured in enterprise risk captives as part of standalone policies or DIC/DIL policies complementing commercial coverage in place. Some enterprise risk captive owners also may elect to participate in risk pools to obtain a level of risk transfer in the event of large claims.
What advantages are there to an enterprise risk captive? Are there any drawbacks?
An enterprise risk captive can provide all the same risk management and other benefits that a ‘traditional’ captive can provide including: the ability to provide proof of insurance; pre-funding of self-insured risks for strengthening the balance sheet; better tracking of claims data; and access to the reinsurance market.
In addition, an enterprise risk captive, if meeting all the requirements to be considered an insurance company for tax purposes, can provide certain tax benefits. Under Section 831(b) of the tax code, property and casualty insurance companies that meet certain requirements are only taxed on their investment income, for example, underwriting profits are tax exempt. This election allows enterprise risk captives to pre-fund self-insured risks on a financially efficient basis, allowing them to grow their surplus more quickly and to be in a position to take on more risk over time.
It is, however, important to remember that this special tax election is not best for everyone and is irrevocable once made. Under 831(b), insurance companies that have made this election are no longer able to deduct claims paid and also cannot carry back or forward any net operating losses.
As such, in the event of bad claims experience, the captive, and its owners, are in effect forgiving large tax deductions that would have otherwise been available to them.
Also under the election, most general operating expenses are also not tax deductible, only investment expenses can be used to offset investment income for tax purposes. A detailed analysis should therefore be made before the election is made to avoid unexpected surprises.
What other risks can companies use an enterprise risk captive for?
There is no real limitation in the type of risk that can be insured in enterprise risk captives. We are starting to see entities looking at more traditional coverages for their enterprise risk captives, and with the premium limitations increasing to $2.2 million from $1.2 million in 2017, we expect this trend to continue.
Also, while the structure has been mainly seen with single parent captives and cells to date, with the premium limitation increase we also expect to start seeing more group programmes considering making the election.
However, before expanding the risks insured by their captives, owners should make sure they fully understand the potential impact on their programme. For example, including long tail lines such as workers’ compensation in an enterprise risk captive that has historically only insured short-tail risk would materially affect the risk profile of the captive as well as its operations. A detailed analysis of the pros and cons should be performed before a decision is made to expand coverage, or for ‘traditional’ or group captives to make the election.
What does the future of enterprise risk captives look like?
The industry is currently going through a ‘pause and analysis’ phase, still trying to digest the changes passed in 2015 that will come into effect in 2017. The industry is also hoping for further clarification on the new wording so that we can best serve our clients. So, while many existing enterprise risk captives may restructure or cease operation in light of upcoming changes, especially those that included an estate-planning component, we feel the environment remains favourable overall.
The changes that will come from the new rules should benefit the environment by bringing the focus back to what it should have been all along. The enterprise risk captive provides an efficient way for an organisation to improve its risk management programme through the pre-funding of certain self-insured risks.
