As a new year begins, the captive industry anticipates another year of growth
Last year was difficult for many industries due to the outbreak of the COVID-19 pandemic, but for the captive insurance industry, it was favourable.
As captive figures from 2020 start to emerge from domiciles globally, the sector is positive at what this new year has in store.
The financial pressures companies face as a result of the COVID-19 pandemic and a hard insurance market gives the industry an opportunity to demonstrate the value of captives as a risk management tool.
Laurent Nihoul, Federation of European Risk Management Associations (FERMA) board member, describes 2021 as “a fantastic opportunity for risk and insurance managers to show how they can contribute to the value of their organisation’s business by developing”.
“For instance, a more dynamic insurance management and strategy design, essentially through their captive: carving out some ‘sub-exposures’ within their programmes, moving from ‘self-insuring frequency’ to ‘self-insuring over-priced layers’,” Nihoul says.
The current environment has created an opportunity for the captive industry to educate clients and effectively rebrand itself as a longer-term fix, finally moving away from its reputation as a short-term solution.
John Mina, CEO of Risk Strategies, says this moment in time calls for captive practitioners everywhere to up their game and improve the image of the industry.
Mina explains: “Given the pandemic, higher retention and the hard market, there will be ample opportunity to educate around this and therein lies the opportunity.” Current market conditions are making prospective captive users more receptive to alternative risk financing, especially for enterprise risks like pandemics, and the industry should capitalise on the opportunity.
This year also provides a good opportunity to implement and get buy-in from our management to implement a more sophisticated approach to the total cost of risk (TCR).
Nihoul comments: “By this, we mean how to design, define and communicate the distribution of the expected increase in TCR between retention (increasingly in higher layers) and the cash-out costs. As risk and insurance management professionals, we will certainly have tougher discussions with our chief financial officer.”
“We will need to translate the challenges we face and the techniques we use into the right language and the right metrics for our response to be understood and valued by our company,” he adds.
Reflecting on the trends he sees for the sector this year, Steve Kinion, director of the State of Delaware captive bureau, expects to see the continuation of the hardening commercial insurance market.
In a recent report by A.M. Best, they noted that the price increases in the (re)insurance market started to appear as early as 2018 in some segments. The market continued to harden in 2019, and increases have gained significant momentum in 2020, as the industry has reacted to losses resulting from the COVID-19 pandemic.
Nihoul agrees stating the insurance market will continue to harden while exposures will keep on rising this year.
He explains: “Risk and insurance managers are facing what I call a ‘triple crunch’: price increase, underwriting restrictions and shortage of capacity.”
Courtney Claflin, executive director of captive programmes for the University of California, Office of the President, believes the market will continue hardening this year, which he notes will result in an increase of captive insurance company formations and utilisation of existing captive structures.
Mina explains that he expects to see an increased exploration in the use of captives to help solve a variety of risk management challenges.
He says: “Clients seem ready to accept additional retention of risk and many will decide to retain that risk by opting for higher deductibles or self-insured retention and then financing that retained risk in a captive.”
Property, auto and liability insurance markets are extremely hard right now, especially for excess layer pricing.
Mina explains: “This is due primarily to the exponential increase in ‘nuclear verdicts’ that are frequently exceeding insurance limit towers. Excess carriers are having to address premium adequacy by sharply increasing rates. At the same time, policy language and coverage terms are becoming less favourable and are either restricting or outright excluding coverage for certain exposures.”
“A challenging excess market will also see an increased use of captives to insure buffer layers,” he adds.
Mina anticipates that the use of captives as profit centres, transforming customer risk into underwriting profit, will grow substantially this year.
Growth
Reflecting on growth within the captive market this year, Claflin reveals that nearly every captive management and consulting firm is reporting an increased interest in captive formations.
Also weighing in, Nihoul says that he has been observing this trend for the last few years. In FERMA’s European Risk Management Survey in 2020, it confirmed that the use of a captive strategy had increased the most over others in the last two years.
In 2018, only 15 percent of respondents said they would consider a captive, however, in FERMA’s 2020 report, which was before COVID-19 pandemic, 43 percent of survey participants said they would look at a captive as a solution to deal with risks that are difficult to place on the insurance market.
Nihoul adds that the European Commission Solvency II Review will lead to an improved and attractive regulatory framework for captives in Europe.
He says one of the improvements in the pipeline is a “more harmonised implementation of the proportionality principle by the EU member states”.
The European Insurance and Occupational Pensions Authority (EIOPA) has submitted its advice to the Commission in December 2020 and the European Commission will issue a proposal by June.
Nihoul comments: “FERMA has contributed to this work, in particular by proposing a concrete method to harmonise the way national supervisors evaluate the need for proportionality measures for their supervised insurance entities.”
Challenges
Beyond the obvious challenges from the hardening insurance market and the skillset required for optimising self-financing techniques, Nihoul highlights two main others.
The first he explains is the way risk and insurance managers communicate internally has to be adapted.
He says: “With such significant changes in the insurance products we buy, the ‘premium only story’ is not enough anymore. We need to focus on explaining, of course, the hard market but even more the value of insurance for our management to make an informed decision.”
“More and more tricky questions are coming from the c-suite about exposure, reduced capacity, and the financial impact of increased retention. Risk and insurance managers’ communication needs to be more impactful, going into insurance technical details that our management is not always familiar with.”
The second challenge is about optimising the connection between insurance and enterprise risk management (ERM), according to Nihoul.
He explains in a hardening insurance market, risk managers may have to make sensitive decisions about retaining more risk because of underwriting restrictions or overpricing.
“In order to efficiently address such decisions, insurance managers must have a clear understanding of their risks and their potential impact on their company to answer questions such as: How much retention can we accept? How do we differentiate a must-have-cover from a nice-to-have one? How much insurance should we purchase and where?”
Nihoul notes that it is about having a better, clearer and deeper understanding of our risk exposure and its financial consequences.
He adds: “Skills and knowledge to answer these questions are usually available within the ERM function.”
“For risk managers not having ERM within their scope, it is time to think about how they can efficiently liaise with their ERM colleagues.”
“What value can be created from a strong partnership between ERM and insurance? How do we optimise the value of ERM inputs into the insurance management process?”
Going virtual
As a result of the COVID-19 pandemic, the majority of captive conferences were changed from in-person to virtual due to safety and travel restrictions.
Mina suggests that virtual events will continue to be the norm for the better part of this year.
He explains: “We’re also predicting a lasting structural shift in the way people receive their information.”
“If attendees can learn from the same industry experts by committing a couple of hours to a virtual event versus the time, travel and expense of a three-day conference, that will continue to hold a certain appeal.”
“As vaccines become available and utilised, live events will re-emerge though probably not to the same level as prior to the pandemic,” he adds.
The future
When the pandemic is behind us, the captive industry will be in a new landscape. Nihoul suggests the industry will have a transitional period with the first half of 2021 continuing to rely on virtual events and if the situation improves thanks to vaccines, he expects to see hybrid events taking off in the second half of the year.
Nihoul adds: “We’ve experienced the limits of virtual events. People are looking forward to meeting and networking again. Physical events will return, but often with a virtual aspect to reach a larger audience and to acknowledge that budgets for travelling and attending events are likely to be reduced. For sure, the new landscape will be very different.”
Mina also believes virtual events will continue to be the norm for the better part of 2021 and predicts “a lasting structural shift in the way people receive their information”.
He says: “If attendees can learn from the same industry experts by committing a couple of hours to a virtual event versus the time, travel and expense of a three-day conference, that will continue to hold a certain
