Anne Marie Towle, Adrien Collovray and Courtney Claflin provide an overview of the current captive market, challenges that have carried over into 2022, and what’s on the horizon
As captive domiciles around the world begin to release their 2021 statistics, indications point to continued growth and good fortune for the captive industry as a whole. This growth is manifested not only in an increase in the number of new captive and risk retention group (RRG) formations, but also in the expansion of existing captives to finance risk across a wider range of coverages. This includes coverage for excess, medical stop-loss, trade craft, environmental, cyber, medical professional liability, employment practices liability, and directors and officers liability, notes Anne Marie Towle, global captive solutions leader at Hylant.
In addition, the COVID-19 pandemic has encouraged the utilisation of captives for supply chain risk, which affects an enormous number of organisations indiscriminately across industries, operations, products and services. These companies seek alternative risk options to protect interruption to their business model, including captives.
“We are seeing more interest in establishing a captive or RRG for those organisations which either have not explored captives in the past or are reopening a captive or RRG previously shut down during the soft market,” Towle explains.
She adds that low losses means that captives are able to function as reinsurance companies, which is particularly attractive as companies seek in multi-year and multi-line reinsurance options.
“One of the best uses of a captive is the access to the reinsurance market; this can provide both capacity and a cost-effective solution for organisations,” notes Towle.
This is affirmed by Courtney Claflin, executive director of captive programmes at University of California, Office of the President. He observes “significant interest” in captive formations as a way to manage the lack of reinsurance capacity, reduction in terms and conditions, and the loss of coverages that the reinsurance market no longer provides. It is undeniable that the rising attractiveness of captives has been borne from the prolonged hardening market, lingering since the late 2010s and bringing with it high commercial pricing and capacity restrictions that, for lack of a less dramatic word, force organisations to turn to alternative risk financing and management.
Adrien Collovray, head of captive advisory, Europe and international, WTW, identifies that a significant factor contributing to the continuation of these hard conditions is the large losses impacting a market that is struggling to generate premium volume, as well as insurers refocusing their business plans and a protected low interest rate environment.
Claflin adds that these large losses include significant catastrophe losses which, combined with low interest rates, result in insurer and reinsurer financial losses that must be replaced — “thus increased pricing, decreased capacity, and reduced terms and conditions,” he explains.
Towle names another significant factor to be traditional insurance carriers writing business at a significant loss, which is supported by their robust balance sheets.
She explains: “The past few years have shown significant losses have occurred in a variety of lines impacting those balance sheets. As a result, many carriers are imposing increases or stopping writing coverages in certain industry segments or lines all together. This impacts the continually hardening market and organisations are seeking viable alternative solutions.”
This translates into an impact on the landscape of the captive market as it allows captive owners to continue to challenge the traditional insurance market through cost-effective and broader coverage options that retain and manage the risk they are most comfortable with, Towle continues.
Collovray anticipates that these current market conditions will persist for the foreseeable future. He observes that while some areas are seeing a plateauing of rates, there appears to be few expectations that rates will return to anywhere close to soft market levels.
He continues: “Combined with market-driven increases in retentions, which once increased are very difficult to push back down, this means that captives have and will continue to demonstrate their role as essential enablement vehicles.”
“Captives are participating in their own risks at a higher level than before. We simply have to step up and provide cover, absorb rate increases, provide capacity and return profits to our parents to help offset the effects of the COVID-19 pandemic and the hard market,” adds Claflin.
The captive landscape
WTW’s Adrien Collovray describes the current landscape of the captive industry to be an “exciting development phase”, with trends that include, among others:
Significant increases in premiums written by captives as they retain greater risk
Retained risk assessed as a portfolio of risk rather than a series or unrelated lines of business resulting in pricing and capital efficiencies
Captive solutions increasingly benefiting from alternative risk transfer capacity
Increasing popularity of cells
Cyber and other financial lines are a high priority for captive solutions
Increased focus on ESG in respect of a captive’s risk management framework and supporting the parent’s physical and transition risk
Don’t be held captive by challenges
Although there exists this heightened interest among companies looking to establish captives in home domiciles, Collovray warns that there remains a “deficit in suitable captive regulatory frameworks or administrative access” in these jurisdictions.
“We have seen some discussions and groups established to assess and make recommendations, however, experience has shown us that it could take 20 years to develop this into a strategy which makes captive establishment practical and competitive relative to established captive domiciles,” he explains.
Looking at European regulation as a whole, Collovray contends that this has failed to progress sufficiently to accommodate the needs and risks of corporates. In particular, he describes the Solvency II regime as “a barrier to entry for many”, as well as disproportionate for the majority of captive risk. The rising costs associated with more stringent — and often disproportionate — reporting and regulation requirements poses a significant restriction on the opportunities available for captive participation.
Cost is a concern echoed by Claflin. He says: “A big challenge is how to navigate the hard market, and provide financial rigor and resources to our parents. We are participating in our own risk at unprecedented levels — at least my captive platform is — and providing funds and resources to our parents as a result of the COVID-19 pandemic and hard market.”
In addition, Claflin notes that ongoing regulatory disputes between the Internal Revenue Service (IRS) and micro captives over the 831(b) tax election means that the captive industry still faces the reputational risk associated with captive formation and operation for malicious purposes.
Towle agrees: “Regulation, whether it is the IRS, Solvency II or domicile regulators, will continue to challenge and uphold a high standard for captive utilisation. In 2022, captive owners and service providers will continue to define and describe the benefits and use of a captive to regulators around the world to enhance and further the understanding of good governance and captive use.”
The significant strides in digitalisation and social changes encountered over the past two years in the context of the COVID-19 pandemic have fundamentally altered the way in which the captive industry — and indeed, most industries around the world — interacts and conducts business. Towle adds: “Seeking ways to connect virtually, growing the business and keeping relevant in captive owners’ interaction with their service providers and regulators will continue to be challenging.”
Although many companies rose to the occasion to quickly and seamlessly make the transition to a virtual work environment, Collovray comments that many domicile managers have little to no exposure to other domiciles. This contradicts the fact that, as he points out, “captive strategy is increasingly one of globalisation”.
“While single-domicile expertise is great for undertaking focused domicile and regulatory consulting, it does not provide sufficient breadth of knowledge or experience for feasibility or optimisation strategy compared to that which may be provided through globally experienced advisers,” Collovray warns.
He adds: “It will therefore be necessary, with the new abundance of consulting options, for captive and potential captive owners to undertake increased due diligence of their consultants to ensure suitability and independence of advice.”
As well as regulation and globalisation, the captive industry may be hindered in achieving its fullest optimisation as it is widely recognised that talent acquisition and retention has historically posed a challenge in the industry owing to a lack of sufficient education surrounding the sector. This dubbed ‘talent crisis’ becomes even more pressing when combined with the almost simultaneous retirement of many influential and experienced professionals in the captive industry.
Citing this to be the most significant challenge currently facing the captive industry, Towle explains that this creates a knowledge gap between senior thought leaders and the next generation of captive professionals.
“The industry as a whole needs to recruit, educate and train actively in order to successfully grow our next generation of leaders and lessen this gap.”
Referred to by Collovray as a complication in the ‘continuity of expertise’, he agrees that this presents an alarming predicament for the captive industry. He warns: “In many geographies, our industry has not done well in developing and retaining new talent. It is already difficult to find captive technical expertise and I fear that there is a risk of a skills gap within years.”
On the horizon
Turning to the future of the market conditions, emerging risks and business priorities that will inform the landscape of the captive industry, Collovray expects a continuation of growth in new formations, as well as in utilisation and premium volumes for existing captives.
Claflin agrees: “I believe we will see significant growth in captive formations, and significant increase of captive utilisation to counter the effects of the hard market, COVID-19 pandemic, and new emerging risks.”
“Captives must look to the future and either start to prepare or continue to prepare for increasing the financial resources we provide to our parents. This increased financial planning can come from many sources, but the key is to highlight how increased captive utilisation can accumulate surpluses that can be deployed the next time we hit a market cycle like that we are experiencing today.”
Collovray adds that it is likely the captive industry will see ESG themes and principles integrated further into captive strategy, especially concerning the assessment of retained risk and investment strategy.
Also anticipating further emphasis on proper governance to ensure regulatory compliance, Towle adds a growing popularity in structured programmes, multi-year programmes in captives and expanded non-traditional uses of captives is likely to emerge in the next 12 months.
She says: “Innovation will continue to be a large part of what the captive industry delivers to many organisations and having markets, including reinsurance partners, who want to innovate will be important in the next 12 months.”
“2022 will see continued formation of new captives and owners being extremely creative and innovative on how they finance and manage their risk profiles,” Towle concludes.
