Since Frederic M. Reiss, “the father of captives” implemented the first captive insurance company there has been a continuous growth in net numbers, a trend which is still ongoing with annual growth of approx. 5%. Captives would cover “traditional coverages” such as Property/Casualty and were used as a risk management tool (Bawcutt, P. 1997) to
- Provide a funding mechanism
- Reduce the cost of risk (lower external premium spent, lower overhead cost, in offshore domiciles tax advantages, underwriting profits on good loss experience, investment income, pressure on direct insurers)
- Risk Management focus for global programs (cash flow co-ordination, segregation of funds)
- Provide cover not available in the market or not available at the right price
- Balance corporate and business unit risk appetites
- Gain access to the reinsurance market
- Taxation and Accounting benefits
Developments in recent years have had an impact on the above list of reasons to form and maintain an insurance captive – to the point where some of those items are literally eliminated. For example countries tightening up on admitted/non admitted insurance and the impact on global insurance programmes. Solvency II and equivalent are leading to an increased administration and financial burden for captive insurance companies. In combination with almost zero or even negative investment income this will more or less eliminate items 2, 3 and 7. Reinsurance companies have provided means to access them in an easier way (item 6) and the market for most property- casualty insurance coverages has been soft for years (items 1, 2 and 4).
Item 4 on above list is of course still applicable to industries where P&C coverages are impossible or very pricey to obtain through commercial carriers, e.g. financial institutions, healthcare, manufacturing and oil and energy and item 7 still has some validity for 831b captives.
So what is it that makes worthwhile creating/running captives?
Very recent trends appear to be responsible for the continued growth in numbers and may drive other significant developments for captives.
- Unavailability of coverage (limits amounts and/or availability at the right price) for non-traditional coverages such as terrorism, cyber, supply chain BI, trade credit, employee benefit coverages (Marsh 2015 Captive Benchmarking report indicates a year-on-year growth of 11%).
- Global trend to consolidation of both corporates and commercial insurance carriers
The A.M. Best January 2016 captive update features an interview with Towers Watson’s director of Consulting (www.ambest.com/captive). He points out that due to M&A/consolidation activities, corporates often find themselves with 3, 4 or even more captives and instead of running them off, see what additional values these captives can bring to the corporate, e.g. diversification. This in combination with the effect of ongoing commercial carrier consolidation leading to fewer options for effective diversification of risk transfer may very well lead to captives taking on even more non-traditional risks.
This could mean employee benefits actually being underwritten by captives and even pension risk being taken on by captives. The large corporations will obviously lead the way but there may be a significant shift in the use of captives going from covering the traditional risks to the non-traditional risks in the future.
Informed decision making will depend first and foremost on the available data. This will be the key criteria today and going forward: The ability for a corporation to store, report on and share reliable and auditable data across all of its activities and with regards to the captive in particular concerning any risk the captive underwrites or may underwrite in the future.
