How should captive insurers navigate economic headwinds, seize investment openings, streamline operations, and address heightened regulatory oversight? Scott Kurland of SS&C Insurance Solutions, Jason Flaxbeard of Brown & Brown and Mikhail Raybshteyn of EY give advice for the year ahead
As we look ahead into 2024, what are some of the biggest economic and market-related trends that you believe pose the biggest risk to captive insurers, particularly as it pertains to their investment activities and portfolios?
Jason Flaxbeard: This year will be another growth year for captives, although it may be less dynamic than the past couple of years due to some market softening.
Once a captive assumes a particular risk — and the captive parent has agreed that that particular risk fits within the corporate appetite — it seems unlikely that the particular risk will ever make its way back into the risk transfer market.
Captives will increase in size, becoming more complex and diverse. They will form a central part of the risk strategy for their owners as they expand.
Therefore, the biggest risk to captive insurers is the speed at which the risk transfer market changes and the response time needed for the captives to respond.
Scott Kurland: Both inflation and interest rate trends will be the significant drivers for allocation decisions by captive managers on invested premiums. Additionally, reinsurance markets are expected not to soften much this year.
Combined with traditional commercial insurance premiums continuing their upward trend, we expect to see additional funds flowing into both new and existing captive structures – particularly in the group and rental captive space.
Unlike pure captives, since group captives may have less exposure to ‘single-event’ liabilities, they may also have more flexibility to invest premiums in broader asset types.
These could include alternatives, RMBS or CMBS securities and select credit instruments with the potential to offer higher short- to mid-term yields.
Mikhail Raybshteyn: Economic and market trends are generally helping the captive insurance and alternative risk finance market. Coverage gaps, reduced capacity, inflexibility of some commercial policies, lowered risk tolerance in commercial space and overall continuing hard market all appear to be providing fertile ground for alternative risk finance. With that said, the investment side is a bit different.
The fluctuations in the market that seem to be driven by social issues more than economics — nuclear verdicts, heightened litigation risks — all require captives to better manage investments, seek higher returns and pay closer attention to their portfolios.
There is a heightened need for specialised captive insurance and alternative risk finance focused investment advisors and managers.
On the investment side, where do you see remaining opportunities and red flags?
Flaxbeard: Investment returns are important to captives. For single-parent captives, the investment portfolio is usually managed through parental relationships, so I don’t see material discussions on investments inside captives. However, what I do see is a discussion where a captive parent can make around five per cent risk-free on its funds without taking risk, leading to broader discussions on the return required from the captive.
Kurland: In terms of investment opportunities, with higher short-term interest rates, we have seen continued interest in investment grade bonds, government bonds and even mortgage backed securities that are now offering 300-500 basis points more yield than they were two years ago.
There have also been pockets of opportunities in the private credit space, where banks have tightened their lending activities. This trend has provided an opportunity for insurers and captives to step in and provide short-term fixed or floating rate loans with more attractive yields.
Raybshteyn: The red flags are still in the grade of investments. Some captive owners may want riskier investments in their captive or less liquid investments, which may not work well in case of a large loss.
For captive insurance regulators, the dilemma is where to draw the line. Some investments, while not basic “cash and cash equivalents”, may be prudent, but not all investments may make sense.
Regulators will need to sharpen their investments IQ as well to keep up with market and available options. As previously highlighted, opportunities should exist with better matching of investments to longevity of risks taken on, history of payouts and risk factors around various investment pools. Higher return investments can be a good income option but this will most certainly come with loss risk that needs an evaluation.
Operationally speaking, what advice might you give to new or emerging captives and captive managers as it pertains to positioning themselves for the best success?
Flaxbeard: Every captive, every owner, every risk, is discrete. There is no universal captive playbook. Talk to the owner, understand the risks and motivations and answer the key question honestly — “do I have an appetite to assume this risk?”.
Kurland: Operationally, it’s critical for today’s captives to have the right technology, systems and service providers in place to allow them to pivot quickly and efficiently on the investment side. They need to be able to capture incremental yield on invested premiums through investments that are closely aligned with their expected liabilities, durations and cash flow needs. Captives should be working with systems and providers capable of accounting for all investment types — public and private, equity and credit instruments — in a streamlined and automated manner. They should also provide clear financial reporting and visibility into things such as expected cash flows and current valuations.
Raybshteyn: Consult, inquire, network — three items that encompass a great ability to learn best practices, new market ideas and provide an insight into industry trends. Invite your market partners and industry colleagues to your clients where or as needed. This is a collaborative industry and everyone works together. At the fear of bringing others into the mix on a project, there is a risk of missing a critical point that will be harder to resolve after the fact. For captive owners and captives specifically — seek professional advice and do so from firms that have a brand name and reputation in this market. This industry has plenty. Captive insurance associations and even regulators can always suggest reputable consulting firms for each type of service.
There has been an increased focus and potential scrutiny on captives by local regulators in each of the major markets, as both the number and size of captives have continued to grow over the past two to three years. What do you think are the biggest things they will be looking out for, that captives and managers should be aware of?
Flaxbeard: Compliance is key for managers. Financial statements should be delivered accurately, efficiently and on-time. This means compliance with domicile regulations, generally accepted accounting principles (GAAP) and the captive parent’s internal compliance. Captive managers will need to demonstrate that they understand their control environment, their ability to scale and deliver reports to all parties that meet the ever-changing regulations. The biggest risk in developing this is our ability as an industry to attract talent.
Kurland: Similar to traditional insurers and reinsurers, captives will be required to provide timely and accurate reporting on both their investment activities, holdings and capital or surplus balances. The regulators are most concerned with an insurer’s ability to meet liability obligations from their policyholders. As captives and captive managers embark on broader and more diversified investment activities with the premiums they hold, the regulators will want to understand the true risk and exposure within the investment portfolios.
Raybshteyn: Taking into account new developments, I see regulators paying more attention to: appropriate capitalisation and financial institutions issuing guarantees, grade of investments and contractual obligations around them, and well executed and supported actuarial work, especially at the feasibility study and for captives writing more unique programmes. Outside of those, each regulator should always assess their own comfort level with each captive, its owners and business written. That comfort level does not have to be identical across all regulators but there should be commonalities in the approach, which I am sure are being discussed between captive regulators already.
