Captives are playing an increasing role in ESG risk strategies, providing ways to align C-suite concerns, risk management demands and HR priorities. David Benyon reports
Environment, Social, Governance (ESG) has risen to prominence in recent years. The concept groups together several strands of corporate risks and responsibilities – from responding to the climate emergency, to launching diversity and inclusion (D&I) drives, while demonstrating a culture of transparency and sustainability.
ESG investment has become mainstream in the past decade. ESG investors have fuelled board-level engagement, human resources (HR) departments now think in ESG terms to appeal to the Millennial and Gen Z workforces, and risk professionals are grappling with ESG in risk mitigation and risk transfer terms. As the perception of ESG issues has grown from many sides, so has interest in captive solutions.
“We are living in a decade of cascading global risks, which can greatly impact coverage capacity and increase insurance rates in the traditional risk transfer market,” says Adriana Scherzinger, head of captives, sales and execution at Zurich North America. “Given those cascading risks and the harder market for many types of risks, we are seeing more risk managers adding or expanding the use of captives.”
Capital E
“Across the three pillars of ESG, environmental, social, and governance, the biggest risk transfer area and the deepest concern globally is environmental risk and, more specifically, climate risk,” says Lorraine Stack, managing director at Marsh Captive Solutions, International.
In part, this has been driven by a rise in the volatility of extreme weather events, with severe floods, droughts and wildfires growing more frequent, and companies not being successfully insured against all of these risks through traditional markets.
Captives can be used to provide coverage for these environmental risks or to supplement the coverage provided by traditional insurers,” says Scherzinger. “While many companies turned to captives simply for efficiency in years past, now it is increasingly for foundational business resilience.”
The transition to a low-carbon future is also impacting the appetite of commercial insurers to underwrite the dirtier, carbon-emitting environmental risks. Most of the biggest insurers are committed to net-zero underwriting and investment by 2050 and to significant reductions by 2030.
“This has an impact on insurers’ capacity and appetite for carbon intensive risks, and insurers will reward good behaviour,” says Stack.
“Captives have always been the go-to mechanism for firms whose risk financing needs are not being met by commercial insurance markets and, in the past few years, we have been in challenging insurance markets.”
Captives can provide an alternative to traditional insurance and reinsurance when capacity in the market is limited or exclusions are insisted upon, thereby creating coverage gaps — as evidenced with recent renewals.
“In the past two years we created 200 new captives, which is roughly double what we would have done in a normal year, prior to challenging market conditions on property and casualty insurance (P&C) side,” says Stack.
“Globally, the premium within the 1500 captives that we manage has increased from US$60 billion to US$68 billion in the past year.”
Captives can provide more control over premiums by smoothing market volatility caused by the poor loss experience of others, notes Emma Sansom, group head of captives at Zurich Insurance.
They can also provide cover for emerging risks with limited loss experience, where there is limited or no appetite either in P&C markets.
“Initially, loss experiences can be poor for new technologies — for example with fire risks for solar panels and lithium batteries — but as understanding of those technologies evolves over time, leading for example to improved manufacturing methods and risk management approaches, then in theory claims experience will also improve,” says Sansom.
“In addition, the captive can collect data on these risks, which can then be taken to the traditional markets to supplement the captive’s capacity,” she adds.
Smaller companies are now looking to enter into captives than historically, Stack observes, citing Marsh data. Currently, 77 per cent of new formations are captives with under US$5m of gross premium under management against a historical average of 50 per cent. More than a third of the parent companies setting them up have revenues below US$500m, she observes.
“There’s a general shift in the size of company, which makes sense because of the challenging market and pricing increases,” she says.
“Smaller companies face insurance pricing that has risen dramatically. Even if the size of price increases is reducing, the bar is set so much higher than it was four years ago. These smaller companies are being forced to retain more risk and so they are going to turn to captives.”
The types of risk going into captives is also expanding, with ESG risks in the forefront.
“Traditionally, captives were utilised for high-frequency, low-severity risks. But that is evolving. A captive can be used to insure almost any of its parent’s insurable exposures, from traditional property and casualty coverages to employee benefit programmes,” says Scherzinger.
“I am seeing property, product liability and international employee benefits being put into single-parent captives. Lately, there is also increased interest in putting cyber, medical stop loss and directors’ and officers’ liability (D&O) into captives,” she adds.
The Social in ESG
The ‘social’ component has historically received the least focus of the three parts of ESG. However, there is a new focus on captives for the social component, for employee benefits, and issues such as employee wellbeing and D&I objectives.
“More companies recognise that ESG issues are a bottom-line issue and it is not just risk managers who recognise this,” Scherzinger says. “C-suite and HR leaders are increasingly asking about how captives can help companies address their ESG goals and responsibilities.”
Drivers for the expansion of employee benefits include fallout from the pandemic and changing employee expectations. The unforgiving economic outlook in 2023 also makes corporate employee benefits programmes of greater interest, as governments have less funds for state-run social security, she explains.
Employee benefits captives can be more challenging than those with a P&C focus, Laidler suggests, largely because of different stakeholders pertinent to ESG risks.
“The difference is that there are more stakeholders to align with,” he says.
“The HR side is focused on employee benefits. However, there is also risk management and the difficulty has been in getting those parties to align for employee benefits captives. However, a growing focus on the social part of ESG is helping them to come together.”
When captives are seen as a cold, financial tool — the domain of risk professionals — HR can be sceptical, Laidler emphasises. However, when captives can be used as a tool for employee benefits, HR sees value.
“When they view it through a lens of delivering value for employees and helping them, they take a more positive view of captives,” he says.
“In the past, captives have been risk management-led and focused on cost savings. Now we are seeing employee benefits captives that are much more sophisticated and geared to other objectives.”
There are three strands to using a captive for the social component, Laidler argues. The first of these is quality, he suggests, whereby a captive is used to ensure a baseline minimum access to employee benefits coverage around the world.
“A captive can be used to enhance and waive exclusions to employee benefits covers to ensure equal access to healthcare benefits, such as disability and life products. Where there are exclusions in local markets, you can achieve enhancements by moving employee benefits into captives that could not be achieved in a local market context,” he says.
Second, there are D&I opportunities, he suggests. “One component could be companies wanting to offer the same benefits for married couples and single sex relationships, for exclusion for death coverage due to HIV and AIDS. In certain less developed markets we still see exclusions. Captives allow you to extend eligibility wordings, providing extra levers to address shortfalls in coverage,” Laidler says.
A third consideration is wellbeing. Some of the more advanced employee benefits captives are using underwriting services to fund wellbeing initiatives. For example, an organisation might implement an employee assistance programme, such as access to mental health services, with the cost taken up by the captive. Use of captives leads to better data and management information, through which you can deliver more targeted wellbeing strategies,” he adds.
All of this means that using captives for the social part of ESG has a tendency to bring together the skillsets of HR and risk management — bringing their interests into closer alignment.
“It is when those parties do not understand each other that you have the friction,” Laidler says, noting the different cultures, taxonomies and language that exist between these different corporate roles and the world of P&C insurance in particular.
“Captives are not just a tool for cost saving or financial benefit, but of broader value for employees,” Laidler says. “That helps promote the collaboration between HR and risk management on captive financing strategies. Once you get HR and risk working hand in hand and understanding each other, it is a far more successful initiative. The more mature captives are recognising that and we are starting to see different objectives of captives.”
A virtuous circle
Surplus generated by captives can also be allocated to fund ESG activities.
You can leverage and use your surplus in the captive to fund different risk management strategies,” says Anne Marie Towle, CEO, Global Captive Solutions, Hylant. “This could contribute to your enterprise-wide strategy by supporting ESG initiatives. If you have underwriting profit, why not leverage and build your ESG philosophy?”
This is happening at group captive level, notes Scherzinger.
“This possibility was a consideration as our Group Captives team created a sustainability-focused group captive late last year,” she says. “This captive is intended to bring together companies from diverse industries that share a common interest in advancing sustainable business practices, as well as optimising their risk management programmes.
“We are working with Innovative Captive Strategies to vet companies for this group captive. Any surplus could be used to help fund ESG activities that the Sustainability Committee and the rest of the membership identify as priorities. This is just one example of the ways that captives can contribute to ESG progress for companies around the world,” she concludes.
