Organisations looking to expand their lines of captive business in response to the hard market must consider the longevity and impact of this decision, warns industry professionals.
Speaking at a session at the Airmic annual conference, Barry Beard, director of European global services and complex multinational at Chubb Europe, began by outlining the motivations behind why companies are looking to either expand existing captives or make new formations.
He notes that insurance buyers are increasingly cognisant of the challenge of purchasing the same insurance cover with the additional pressure of increased prices in the current hardening insurance market.
Captives are a beneficial solution in this scenario as the risk in the captive acts as a reinsurer of the fronting company, allowing it to get some of the money back while taking on risk, which is more palatable to companies than spending more gross premium.
Beard says captives are also a more effective tool in a hard market cycle, rather than simply increasing deductibles, because the latter may be acceptable in one jurisdiction but not in another smaller subsidiary that is unable to take a higher retention in that specific claim or territory. For this reason, captives are a huge benefit as they allow an organisation to operate with the same deductibles as before, but with a centralised group retention and appetite from ceding the risk into the captive.
Owen Williams, global programme and captive regional director, UK and Nordics, AXA XL, adds that it is fundamental for organisations to consider what is impacting their risk price, as well as to gain clarity around a particular risk or peril, and how this will affect risk transfer pricing.
He notes that flexibility in the hard market allows the flow of risk out of the captive to reinsurers, which provides more options for risk managers to access the reinsurance market. In this current market cycle, any risk manager appreciates options — this is the changing dynamic driven by the market, according to Williams.
Richard Cutcher, captive ambassador at Airmic and chair of the panel session, observes that existing captive owners are writing new lines of insurance driven by capacity in the hard market.
This is affirmed by Peter Child, chair of the marketing development committee at the Guernsey International Insurance Association, who identifies these new lines to be more distressed lines of cover, such as directors and officers (D&O), professional indemnity, cyber, environmental, and employee benefits (which is a reversal of the previous structure of property and casualty risks then diversifying into employee benefits).
Cutcher observes much variance in putting D&O into captives among Airmic members; some are very against this while some have been doing so for a while. It is particularly seen in new emerging sectors, for example, the Canadian legalised cannabis industry has set up some captives in Bermuda that are currently driven by D&O but will likely see future lines of business.
Karen Jenner, insurance premium tax (IPT) client engagement director at TMF Group, observes several consistent trends in these new formations of captives, including inquiries for reinsurance captives to write on a direct basis, as well as a demand for more innovative solutions to fill coverage gaps.
Considerations
Williams emphasises an overarching message of early engagement throughout the planning and execution processes with insurers and fronting partners when exploring these new lines of business.
He adds that if a company is driven by market response to expand a captive or bring a new risk in, they absolutely do not want to be scurrying around at the last minute, because the clock will run out — instead examine why you are moving into this new line of business because this will dictate the challenges along the process.
For a distressed line of business, the motivation is generally because of either a lack of capacity or pricing challenges in the market.
Beard notes that as a fronting company, Chubb is always open to new lines providing firms have the appropriate insurance license to write that risk. He adds that there is also a multinational aspect to introducing new lines — an organisation must ensure its programmes and policies work across all lines of business, as onshore domiciles often have better diversification opportunities for lines of business.
Jenner adds that the principal compliance considerations for IPT are location of risk and whether you have the appropriate licenses, as well as determining if the responsibility for tax compliance rests with the local business — if so, do they have the necessary resources, appetite and knowledge to do this in the context of their relationship with and access to commercial markets?
A mechanism for resilience
Child identifies that the leading motivation in a hard market for captive solutions is often transactional. He notes that, in theory, the pre-authorisation cell scheme in Guernsey means that a company can have a cell up and running to be able to write a captive solution in just two weeks. However, to get the best value from a captive, the reasoning behind formation should be strategic not transactional, he emphasises.
Child notes that captives set up in the early 2000s for a single purpose were generally confined to write that single business for 15 years. In a soft market, they did not do much from a purely financial view and some were shut down.
Now in the current hard market companies are looking to re-establish the captive. If they had taken advice from a strategic view, they may not have closed down their captive and would have been able to write bespoke coverage based on a unique understanding of their own risk — “this is a mechanism for resilience”, Child says.
Williams affirms the importance of exit strategy in distressed lines such as D&O, underlining that there is a reason why they are distressed — because they are not making money at a macro level. A feasibility study will examine an exit strategy for new lines, but in the rush to solve immediate problems and the subsequent neglect of such considerations, these companies may face greater problems in the future.
Domiciles
The session concluded by considering the current leading captive domiciles. Cutcher identifies that most industrialised nations are looking to be more hospitable to captives, while Guernsey, Luxembourg, Malta, Dublin and the Isle of Man are established captive hubs in the European region.
Cutcher notes that in the last few years France and Italy have expressed interest in developing as captive domiciles in this region.
Williams cites the efforts of London Market Group to create a captive environment in the UK, but acknowledges several important questions: is the economic benefit enough to generate government interest? What is needed to make it a success? What needs to be changed?
The Lloyd’s captive syndicate concept aims to make it possible to set up a captive in Lloyd’s as a syndicate, which would provide international licenses and therefore remove the need for fronting companies. However, there is also a lot of uncertainty around this idea, chiefly relating to higher costs, application fee speculation and the fact that structures would be managed by managing general agents rather than captive managers.
With all that is currently happening in the captive space in the context of the hardening market, it is imperative for companies to consider the impact (whether short-term or long-term) of the expansion of their existing captives or formation of new structures and retain their focus on longevity.
