The 2017 Aon Global Risk Management Survey found that the pipeline for new captive and protected cell company (PCC) formations over the next five years is particularly healthy, if reports in North America, the Asia Pacific and the Middle East are anything to go by.
The 2017 Aon Global Risk Management Survey found that the pipeline for new captive and protected cell company (PCC) formations over the next five years is particularly healthy, if reports in North America, the Asia Pacific and the Middle East are anything to go by.
The survey, conducted in Q4 2016, found that, currently, companies in North America are more likely to have formed a captive or PCC, with 25 percent confirming that they currently use a captive or PCC, while in the Middle East and Africa, this figure is 19 percent.
The equivalent statistic stood at 10 percent for European companies, 8 percent in Latin America and 7 percent in the Asia Pacific. This finding is consistent with what Aon has seen in its own captive business.
The report said: “Over the past decade, there has been greater interest in new captive formations in North America. Relatively speaking, the rates of captive or PCC usage in other regions of the world are surprisingly high, reflecting the respondent profile from those regions.”
The survey also revealed that 9 percent of North American companies plan on creating a new or additional captive or PCC in the next three years.
Aon commented on these figures: “We suspect that this could be driven by factors such as the confidence gained by most industries from positive economic growth in the last five years, growing interest in captives from middle-market and upper middle-market organisations and continued improvement in the science applied by organisations to assess, quantify and mitigate their own risk.”
Similar figures were also reported in the Asia Pacific and Middle East at 9 and 10 percent, respectively. Aon explained that, although these figures are similar, there were fewer respondents in these regions, most representing larger companies.
Although the Middle East has shown interest in the captive concept, there are still only a handful of captive formations.
The majority of Asia Pacific captives are owned by Australian parents, but Aon has experienced an increase in interest from Asian companies in both captives and risk management.
Aon reported that the Asian captive market grew at a “steady pace” in 2016, with 71 captives active in Singapore, 40 in Labuan, 18 in Micronesia and three Hong Kong.
Peter Mullen, CEO of Aon Captive & Insurance Management, says: “The captive concept is taking hold very slowly in Asia and appears to receive a disproportionate amount of press relative to the results. Hong Kong has recognised the need to be more attractive to captives, which is great to see.”
Mullen suggests that for captives to expand in Asia in any material way, risk management needs to come first with more companies considering the concept of retaining risk and in the process taking control of their programmes.
He says: “To do this they need to consider disciplines that will help them understand their risk profile, which will require an initial investment in risk identification, assessment and quantification processes. Once their risk profile is understood, this opens up numerous options for risk retention, transfer and mitigation, which will ultimately help to reduce their total cost of insurance risk. Large corporates need to move from an insurance buying mentality to a risk management mentality.”
In addition, in both Europe and Latin America, 4 percent of organisations surveyed said they plan on creating a new or additional captive in the next three years, which Aon called a “material increase”.
Larger companies are still more likely to own a captive or PCC, with 10 percent of surveyed organisations above $15 billion planning to create a captive or PCC in the next three years.
“Although the majority of this growth will come from North America, we expect a continued upward trend in all other regions as well. This includes Europe, where they have been contending with the implementation of Solvency II for the past few years. Given more certainty around the regulatory environment, we are again seeing an interest in new captive formation.”
Would you like a beverage with that captive?
The survey found that the top four industries that own captives are the healthcare, energy, beverage and conglomerate industries.
More than a third of healthcare organisations surveyed, 34 percent, owned a captive, as well as 33 percent of energy companies. Of beverage companies, 31 percent said they own a captive, along with 25 percent of conglomerates. However, the top industries in which companies plan to create a captive or PCC in the next three years were hotels and hospitality, and machinery and equipment manufacturing, with 14 percent of respondents from each of these industries expressing plans to launch.
The life sciences and energy followed closely behind, with 11 percent of respondents from these categories planning to launch a new captive or PCC.
Aon said it was “surprised” that there were no organisations in the printing and publishing or restaurant sectors that reported to have a captive, or that plan to have one in the next three years.
“This probably reflects the fact that most participants are smaller companies. In our captive business, we have seen captive usage in these segments, particularly in restaurants.”
Property damage and business interruption and general liability continue to be the most popular lines underwritten in captives, and the largest lines underwritten, in all regions. However, lower down the list some regional differences emerged.
Workers’ compensation, auto liability and professional liability ranked highly for organisations in North America, while companies in Europe showed they are more concerned with product liability.
There has been an increase in the use of captives to underwrite cyber or network liability, employee benefits, and credit and warranty.
While 12 percent of respondents currently use a captive to underwrite cyber or network coverage, 23 percent said they plan to do so in the future.
Equally, 10 percent currently use a captive to underwrite employee benefits, and 20 percent plan to in the future, while credit and trade underwriting is expected to rise from 10 to 18 percent and warranty underwriting is expected to increase from 2 percent to 7 percent.
Mullen explains that cyber will continue to be a popular line to be considered for your captive.
He says: “The risk transfer market for cyber risk has been expanding rapidly and is expected to continue this expansion and as a corollary of this, clients will be looking to consider pre-funding their retention in a captive.”
“What will also help here is the continuous improvement in risk assessment strategies in the cyber space as well as an increase in awareness of cyber risk at board level. In terms of other lines, based on the survey we expect to see an increase in credit, warranty and employee benefits.”
Mullen suggests that the increase in warranty business could prove to be an ideal line for captives given its low volatility, profitability and as a source of third-party business.
He adds that the continued interest from multinationals in reinsuring their employee benefit programmes in captives is driven by the need “to reduce expenses, retain cash flow inside the organisation, align risk retention with group risk appetite, and gaining greater transparency of the programme data”.
Strategically speaking
Captives, for most organisations, lie at the core of their risk management strategies. Aon found that the use of captives as a strategic risk management tool has increased significantly from 18 percent in 2013 to 37 percent in 2017.
The increase is underpinned by a number of factors, including increased volatility to the risk landscape, the ease of operating on a multinational level, organisations becoming more scientific in the assessment and quantification of risk, and finally, for organisations that measure total cost of risk, the captive serves as an excellent mechanism to collect auditable risk management data.
The percentage of companies using captives for tax optimisation has increased from four to six. Aon noted that over the past five years, this has been a growing trend in the US, where companies form smaller captives and file under section 831(b) of the US tax code.
Regionally, results showed that 44 percent of North American companies form captives for strategic purposes, while owners from the Asia Pacific region rank cost efficiencies as the most common reason for forming a captive.
In Latin America, using captives as a strategic risk management tool is the number one reason at 42 percent, followed by cost efficiencies at 32 percent.
“Based on our experiences, captives are used more strategically in regions where there is a higher level of risk management maturity and the driving factors often vary with company size,” Aon reported.
“Larger companies use captives in more strategic ways while smaller companies tend to focus on reducing insurance premiums and controlling insurance programme costs.”
Looking ahead
Mullen expects to see continued growth in the US market over the next five years, while outside of the US, there will be some growth but this will not be material relative the growth in the US.
He says: “Captive managers will need to invest in processes and systems to help mitigate the burden on regulation on their clients and multinational clients will reorganise their captive operations to be base erosion and profit shifting compliant.”
“In a broader sense changes in demographics, economics and geopolitics, coupled with the impact rapidly changing technology will continue to impact clients risk profiles, creating a need in the risk management community to be constantly looking to identify new risks and the interconnectivity of known risks.”
Where the insurance market cannot keep pace with these emerging risks and patterns of connectivity, captives can be used to help incubate risks, collect data, affect behaviour and plug coverage gaps.
