Industry experts examine how businesses can harness captives and reinsurance solutions to mitigate unprecedented climate risks
Severe wildfires raging through the Los Angeles area have marked the start of 2025, raising alarms across global insurance and reinsurance markets. Initial estimates suggest insured losses could range between US$20 billion and US$45 billion, while the true economic toll is expected to be far higher.
These projections put into perspective the growing frequency of extreme weather events and the mounting costs of adapting to a changing climate.
According to Aon’s Climate and Catastrophe Insight report, natural catastrophe insured losses amounted to US$145 billion worldwide in 2024 — making it the sixth-costliest year on record. Only around 40 percent of global economic losses were covered by insurance, exposing a substantial shortfall in protection.
Experts observe that traditional insurance alone may no longer suffice for these large-scale risks, prompting many to explore reinsurance and captive insurance solutions as alternative risk-transfer methods. These options allow organisations to spread or retain risks more strategically, providing a measure of resilience in the face of accelerating climate impacts.
Anchoring risks with captives
Captives have traditionally insured predictable risks such as employee benefits, workers’ compensation, and commercial fleets. Over time, as commercial insurance markets have become more selective and expensive, captives have evolved to handle less predictable exposures.
With climate risks escalating, many large companies are integrating significant natural catastrophe (Nat Cat) risks into their captives.
Vittorio Pozzo, director of the Europe and Great Britain captive advisory team at WTW, explains: “Captive owners aim for dynamic risk management and proactive risk mitigation. To tackle the challenges posed by rising natural catastrophes, they need a clear view of their exposures, policies, losses, and risks that can be easily assessed, analysed, and modelled.”
“The evolution of captives over recent years has enabled them to help with Nat Cat risks more effectively. Traditionally, they were used for straightforward risk retention, but today they provide tailored solutions and even incorporate innovative triggers like parametric insurance,” he adds.
A key driver of this shift is cost control. For large multinationals, commercial insurance for wildfire, flood, or hurricane risks is often prohibitively expensive or laden with exclusions. Retaining some risk in-house allows captives to smooth out the peaks and troughs of the insurance cycle, while excess layers can be transferred to reinsurers to shield against catastrophic losses.
Allan Smith, client service leader at Marsh Captive Solutions, further elaborates: “Captives play a crucial role in managing Nat Cat risks in a couple of key ways. First, they are particularly effective in the lower layers of an insurance tower, where risks are more predictable and companies have the capacity to retain them.
“This allows businesses to take on and manage those risks directly. On the other hand, when it comes to the higher, more volatile layers of the tower, captives serve as an access point to the reinsurance market, helping companies expand their capacity and secure coverage for those larger exposures.”
Yann Krattiger, head of Alternative Risk Transfer EMEA at Swiss Re Corporate Solutions, highlights the strategic role captives play in assessing climate risk: “Captives can specifically analyse the effects of climate change in relation to their own insurance programmes, helping corporates better understand and protect their assets.”
He adds: “With access to strategic and confidential risk information, captives gain deep insights into their parent companies and affiliates. This knowledge is instrumental in effectively participating in and managing these risks.”
However, managing extreme events through captives is not feasible for every organisation. Hurricanes, earthquakes, and wildfires can result in sudden, massive losses that may overwhelm less capitalised captives. Pozzo warns: “Captives may have limited capacity to absorb the financial impact of extreme or high-severity Nat Cat events. While captives can effectively manage predictable and moderate risks, their ability to retain high-severity losses could be constrained by their capital base.”
When considering whether to include Nat Cat risks in a captive, Krattiger notes that businesses must evaluate key factors such as the capacity of subsidiaries to absorb risks, the economic efficiency of self-insurance, and the capital costs of the captive.
He stresses: “In any case, captive owners are recommended at least to check the solvency as well as creditworthiness of their captive in accordance with an extended underwriting policy.”
Smith echoes this, emphasising the importance of a strategic approach: “When structuring a captive for Nat Cat exposure, businesses need to carefully consider their risk appetite and how their coverages are modelled in relation to their financial strength. It is crucial to assess their ability to absorb risk and manage the associated volatility at different levels. There are several key factors that need to be carefully evaluated to ensure a well-thought-out approach.”
In practice, many captives depend on fronters and reinsurers to strengthen capacity, safeguarding their reserves from being depleted by a single event. “Captive owners generally need an efficient fronter and reinsurer,” Krattiger explains. “The decision to transfer Nat Cat risks to the captive is likely to be the result of a capacity bottleneck in the traditional market.
“On the other hand, the effects of various entrepreneurial self-financing strategies were weighed up. However, an additional assumption of Nat Cat risks is likely to be promising for well-capitalised captives.”
For many, the solution lies in a combination of captive retention and reinsurance. A captive might take on the first layer of losses before passing the higher layers to reinsurers. This structure allows the parent company to maintain control over coverage terms and pricing while capping its financial exposure in worst-case scenarios, such as the recent wildfires in LA.
Reinsurance as a lifeline
“When disasters happen,” says Pozzo, “businesses often face immediate financial strain from claims or operational disruptions. Reinsurance agreements, in their various forms, ensure that funds are available quickly to cover these unexpected costs, enabling faster recovery and minimising disruptions to operations.”
In the wake of a massive event like the LA wildfires, quick access to funds can determine whether a business endures the crisis or collapses under financial pressure. Well-structured reinsurance programmes that provide timely payouts allow businesses to cover immediate expenses, such as repairing damaged property or relocating employees, helping to contain a crisis before it spirals into a deeper financial threat.
Smith points out that reinsurance capacity is constantly in flux, shaped by recent events and emerging risks. “Wildfires are a major focus right now, but last year, for example, convective wind was the big concern. As different types of catastrophes become more prominent, they start to reshape the allocation of funds.”
However, reinsurance has its limits. With catastrophic events becoming more frequent and severe, reinsurers’ payouts are mounting. In the case of the LA wildfires, Fitch Ratings warned that if final losses hit US$35 billion, it could wipe out more than 30 per cent of the natural catastrophe budgets for Europe’s four largest reinsurers — Swiss Re, Munich Re, Hannover Re, and SCOR.
In response to rising losses, the reinsurance market has adopted new structures. “Parametric covers, which pay out when a predefined trigger — like wind speed or fire perimeter — is reached, have gained traction. They reduce claims settlement times and offer greater certainty in payouts,” emphasises Pozzo.
Ming Li, partner, EVP, and global head of catastrophe modelling at Acrisure Re, notes that parametric reinsurance has gained popularity in recent years, largely due to the hard insurance market. “It certainly has its advantages and disadvantages,” he says.
“One of the key benefits of parametric reinsurance is that all parties have access to the same data, and payouts can be made almost immediately. Unlike traditional indemnity-based insurance, where claims must be assessed before payment, parametric triggers allow for a much faster process. However, the main challenge is basis risk — the potential disconnect between the payout and the actual financial loss experienced.”
Beyond structural innovations, the decision to retain or transfer risk through reinsurance remains complex. “In many ways, the decision about retaining versus transferring risk through reinsurance is subjective and depends on several factors — such as how much capital a company has, the strength of its balance sheet, its annual premium volume, current reinsurance market conditions, and regulatory requirements,” says Li. “All these elements influence whether to retain or transfer risk.”
A key part of this decision-making process is economic analysis, which boils down to understanding the cost of capital. “Reinsurance is just another form of capital, so the question is whether to use reinsurance to cover risk or rely on internal capital,” Li explains.
He continues: “The key is to compare the cost of both options. For reinsurance, it is possible to get a rough estimate of how much coverage would cost in the market and assess the capital relief it provides to the portfolio.”
Ultimately, comparing parametric solutions with traditional reinsurance is a balancing act. “Many insurers turn to parametric products because they can be more cost-effective and offer lower pricing,” Li says. “However, there is always a trade-off — you have to accept a certain level of basic risk. The challenge is to strike the right balance between cost and coverage, and that's where robust cat modelling becomes invaluable in decision-making.”
Catastrophe modelling
One of the biggest changes in how companies approach natural disasters over the past decade has been the growth of advanced catastrophe modelling. “The models, developed by leading firms like RMS and AIR, integrate sophisticated algorithms, historical data, and real-time analytics to estimate the potential impact of catastrophic events,” Pozzo says.
“This data-driven approach allows companies to make more informed decisions about risk transfer and retention. One significant advantage of cat modeling is its ability to identify high-risk geographies and vulnerabilities.”
Smith agrees: “Advancements in cat modelling tools have significantly changed the way captives approach Nat Cat risks. These models are constantly evolving, with regular updates incorporating new loss data as it becomes available. One major shift has been the integration of more detailed loss history, which enhances the accuracy of predictions.”
He adds: “The way risks are evaluated has become increasingly complex. Where earlier models may have focused on primary and secondary risk characteristics, newer iterations now delve into tertiary and even more granular factors. This deeper analysis broadens the understanding of loss probabilities and makes the models even more sophisticated.”
A growing trend in cat modelling is increased transparency and flexibility. Li says: “Cat models were once seen as black boxes, but today, (re)insurers can adjust model outputs based on their own data and experience rather than relying solely on standard vendor models. This shift allows companies to form their own views on catastrophe risk, improving decision-making and capital efficiency.”
Another key advancement is improved modelling of secondary perils. “Historically, reinsurance purchases were mainly driven by primary perils like hurricanes and earthquakes,” Li explains. “However, with the increasing frequency and severity of secondary perils such as floods, wildfires, and severe convective storms, better modelling of these risks has led to a rise in reinsurance demand.
“This has been a major factor in the hard reinsurance market over the past few years, as insurers adjust to the growing impact of secondary perils and how Cat models now reflect them.”
Krattiger builds on this, noting: “Actuarial modeling based on reliable data aims to quantify the impact of Nat Cat events on the captive owner’s insurance programmes. The captive owner can then benchmark this information with the availability of Nat Cat capacities and cede any capacity gaps to the captive, thanks to sufficient solvency, or to the (re)insurance market based on respective credit strength.”
For captive owners, these insights are crucial in determining risk retention levels and structuring reinsurance arrangements that align with their risk appetite and financial strength. “Such models are very helpful in the entrepreneurial planning of new business premises,” says Krattiger. “They allow companies to proactively manage their risks rather than simply reacting to losses.”
A look to the horizon
The LA wildfires serve as a stark reminder of the urgency to rethink traditional approaches to Nat Cat risk. As extreme weather events become more frequent and severe, the demand for innovative and flexible solutions has never been greater. Smith says: “One of the biggest short-term challenges is finding capacity — ensuring there’s enough insurance market capacity to protect the company and its exposures.
“That is the immediate concern. In the longer term, the question shifts to where things will be in 5 to 10 years. Is there an emerging trend? Are we dealing with isolated weather events, or is there a broader climatic shift that will fundamentally change how we approach risk retention?”
There is no one-size-fits-all solution. Succeeding in a world of growing climate risks depends on a company’s ability to anticipate challenges, adapt strategies, and embrace innovation. As Pozzo puts it: “Climate change is reshaping the frequency and severity of natural catastrophes, prompting businesses to rethink their risk management and risk financing strategies.
“Rising sea levels, intensified storms, and shifting weather patterns are creating new challenges for insurers and captives alike. To stay ahead, companies are investing in adaptive risk solutions, including dynamic reinsurance programs and scenario-based planning tools.”
Nat Cat risk management is evolving rapidly, driven by technological advances, new insurance models, and shifting market demands. Digital transformation is at the forefront, with AI playing a growing role in how businesses assess and mitigate risks.
“AI-driven tools can analyse vast amounts of data, predict emerging risks with greater accuracy, and improve decision-making,” says Pozzo. “From optimising catastrophe models to personalising risk transfer solutions, AI is enabling a more proactive approach.”
Li echoes this sentiment, highlighting AI’s untapped potential in cat modelling: “The potential applications are vast — from enhancing model development to standardising data and integrating insurance contract terms into modelling frameworks.
“AI could bring a revolutionary shift in cat modelling if we find effective ways to embed it into the process. There is a lot of promise in this space, and I believe it will play a transformative role in the reinsurance industry moving forward.”
Meanwhile, ESG considerations are becoming integral to risk strategies, with captives increasingly used to fund climate resilience initiatives.
“The insurance market in some cases is demanding ESG solutions to provide capacity,” Pozzo adds.
He also highlights that the increasing complexity of Nat Cat risks is driving deeper collaboration across the industry. “Public-private partnerships are emerging as effective mechanisms for funding disaster recovery and resilience-building efforts,” says Pozzo.
“These collaborations enable businesses to share knowledge, pool resources, and address systemic risks more effectively.”
The recent LA wildfires may mark a turning point, accelerating the shift toward a more coordinated, data-driven approach to risk management. Smith sees the greatest opportunity in managing Nat Cat exposure through risk managers fully leveraging the wide range of tools available to them — captives being just one of many.
He stresses: “The strength of a captive’s balance sheet and the ability to self-fund part of the exposure are key advantages, but the reinsurance market is constantly evolving, becoming more complex and dynamic. Beyond traditional reinsurance, there are alternative risk financing mechanisms such as insurance-linked securities, catastrophe bonds, and parametric coverages.”
In an era of escalating climate threats, those who embrace innovation and proactive risk strategies will not just weather the storm; they will help shape a more sustainable future.
