Although this year has been difficult for many, it seems 2020 has been favourable for the captive insurance market. Industry participants reflect on this year’s trends and challenges
It’s 00:01 on 1 January 2020, you can hear the sound of champagne glasses clinking as people hug and kiss each other while the dark midnight sky is lit up in artificial colours from the hundreds of fireworks being launched into the cold air.
As laughs and intoxicated singing echoes through the streets and music rings out from nightclubs, nobody could have imagined what was in store for the world throughout 2020.
COVID-19, a deadly virus that shut the world down in March as government officials across the globe were forced to implement national lockdowns in order to contain the spread of the virus and to not overrun its healthcare services.
Due to the actions taken in order to protect people, the unemployment rate continues to surge as millions of people around the world continue to lose their jobs and businesses, with hospitality and travel being the most affected.
Even though 2020 has been a difficult year overall for most everyone, for the captive insurance industry it seems 2020 has been favourable.
Belinda Fortman, director of captive programmes for the Tennessee Department of Commerce and Insurance (TDCI), says that 2020 has been “a banner year for the captive industry”.
The hardening of the insurance market has driven companies to seek alternative methods for financing their risk.
Fortman explains that the COVID-19 pandemic has also made companies more aware of additional risk exposures that their traditional insurance programme has not provided coverage.
A captive insurance company offers a solution for both of these problems, resulting in an increase in interest in forming a captive.
In agreement with Fortman, Ben Whitehouse, senior counsel at Butler Snow, suggests that “we may very well look back on 2020 in a decade or two and mark this as the watershed year for our industry”.
He comments: “The insurance world is being turned upside down. It may take a few years for some business owners to truly appreciate that, but I suspect we will all be looking on 2020 as the year everything changed.”
This year has been one in which more business owners have determined that the use of a captive insurer is a useful tool for their risk management needs.
Debbie Walker senior deputy commissioner of North Carolina Department of Insurance, explains: “In a year when many businesses experienced losses due to COVID-19, some business owners received benefits to address those losses from coverages provided by their captive insurer.”
She highlights that those coverages included, but were not limited, to business interruption, loss of key suppliers, loss of key customers, and others that helped businesses during these difficult times.
“The impact of COVID-19 and the hardening commercial market this year has caused business owners to further consider the use of captive insurance, either in their current captive or through the formation of a new one, to help them address risks faced by their businesses,” she adds.
In September, Marsh published its 2020 Captive Landscape Report, which highlighted the trend of increased captive use continuing in H1 2020 amid a rise in challenging insurance market conditions and the impact of the global COVID-19 pandemic.
The report showed that Marsh-managed captives saw steep growth in gross premiums in various lines of coverage in the past year due to the tightening global insurance market conditions.
Supply chain, business interruption and contingent business interruption premiums written saw an increase of 283 percent on average in 2019.
The results also showed a 64 percent rise in all-risk property premiums, led by the energy and financial institutions sector, which saw all-risk property premiums increase 151 percent and 104 percent, respectively.
Going virtual
There were only two in-person events to take place this year, which included the World Captive Forum (WCF) in January and the Alabama Captive Insurance Association in September.
With the world on lockdown, venue restrictions and travel bans in place, multiple captive conferences were reorganised in a virtual format such as the Vermont Captive Insurance Association (VCIA) and the Bermuda Captive Conference.
As uncertainty surrounds 2021, the WCF has already announced its 2021 conference will be virtual as well as VCIA.
Commenting on the 2021 conference decision, Richard Smith, president of the VCIA, said: “We will build on the success of the 2020 event, keep the quality of the education as high as ever, and increase opportunities for people to connect in small group-video settings during the event. We are listening to the needs of the entire membership, and are acting in ways that meet their needs.”
The next big captive gathering after WCF will be the Captive Insurance Companies Association (CICA) conference, which as it stands plans are moving forward for an in-person event.
Challenges
Although the year has predominantly focused on the impacts of the pandemic, the industry has been faced with ongoing challenges, such as the increased scrutiny from the Internal Revenue Service (IRS).
Walker explains that the IRS’ activity including letters and announcements on the expansion of its enforcement efforts on 831(b) captives has created “concerns in the minds of some business owners that may have utilised a small captive insurer to manage their risks, but out of fear or concern about the IRS, have decided not to pursue that”.
“These efforts of the IRS have led to the closure of some small captive insurers where the business owners’ concerns about the possibility of an IRS audit are high,” Walker adds.
Fortman also noted that the IRS scrutiny of captives utilising the 831(b) election has been a challenge for captives for several years now.
The IRS has targeted micro captives for years, but in more recent times they have ramped up their efforts to do so, including them on its ‘Dirty Dozen’ list of tax scams since 2014, along with other actions.
The most recent communication from the IRS was a second time-limited settlement offer for certain taxpayers under audit who participated in ‘abusive’ micro captive insurance transactions.
During 2020, it also deployed 12 newly formed micro captive examination teams to “substantially increase” the examinations of ‘abusive’ micro captive transactions.
Commenting on the IRS’ activity, Fortman states: “We are seeing fewer captive insurance applications being submitted with programmes solely composed of low frequency/high severity lines of business, which the IRS has had a particular interest in.”
“Instead, we are seeing captive applications with more traditional captive coverages, such as high deductible reimbursement programmes, or a mix of the two,” Fortman adds.
Positivity in negative times
The captive industry has seen a large increase in interest around the formation of new captives and the expansion of existing ones during a year of difficult times. But the pandemic has reminded the world that business owners must be prepared for such adverse situations, even those risks where losses are likely to be infrequent and unusual.
Walker says: “More than ever, captive insurance is an important tool that allows the insured to obtain the exact coverage needed with the terms and conditions that are relevant to each insured’s situation.”
