In the 1960s, Frederic Reiss devised a revolutionary risk management concept that he named “captive” insurance.
In the 1960s, Frederic Reiss devised a revolutionary risk management concept that he named “captive” insurance. In doing so, he became widely recognised as the inventor of the modern captive. Today, captives are a well-established risk financing tool used by organisations.
Through hard and soft market cycles over more than 50 years, captives have continued to grow in number and evolve.
What many overlook is that Reiss also pioneered the concept of captive reinsurance. This idea was even more revolutionary; using an insurance subsidiary to access the exotic world of professional reinsurance.
How have things changed?
Since their creation, captives have continued to evolve in sophistication and size. However, it has been noted that there has been a steady decline in the application of captive reinsurance with some estimating that less than one-in- three captives buy any reinsurance at all.
Roy Baumann, director of captive solutions at Swiss Re, endorses this view: “The current market favours net strategies. Also, higher risk maturity and the regulatory frameworks seem to have shifted captive optimums to net positions in many instances.”
He continues: “Net captives are the predominant form of captive operating today.”
Why utilise reinsurance?
In examining the benefits of using captive reinsurance, it is helpful to revisit how reinsurance influences, and in many cases, drives the main benefits that organisations enjoy when utilising captives. This viewpoint can best be illustrated through the eyes of a global conglomerate such as A.P. Moller-Maersk Group (Maersk).
Maersk utilises the concept of a ‘private placement’ for its captive, Maersk Insurance A/S (MIAS), which is based at its headquarters in Copenhagen, Denmark. The captive writes a large gross line of primary and low excess coverage, and partners with specific reinsurers to optimise its cost of risk and risk appetite.
Below are some of the benefits of using Maersk’s structure:
Control
The insurance value chain for any major corporation can be complex and include one, or a combination of: insurers, reinsurers, retrocessionaires, intermediaries, adjusters, risk management advisers and consultants.
The provision of capacity that addresses an organisation’s risk profile is one of the key roles of the risk manager. A captive rather uniquely consolidates this risk information and imparts discipline on the various service providers and other stakeholders to facilitate an effectively functioning risk and insurance programme.
Control of reinsurance is therefore a key ingredient in accomplishing corporate objectives.
Within a conglomerate such as Maersk, this is an even more complex challenge, due to the diversity of its risk profile. In addition to being a leading independent energy company, Maersk runs the world’s largest shipping fleet and is a top-three global marine port/terminal operator.
“Our captive’s ability to control the deployment of capacity on our account has better enabled us to build more strategic relationships and leverage our broad spread and diversity of risk. This has benefitted both Maersk and our partner (re)insurers,” comments Lars Henneberg, who is vice president and head of risk and insurance at Maersk.
A large complex insurance programme is a bit like an onion: layers of reinsurance, retrocession and facultative reinsurance can make identifying the risk retaining party difficult. Using a captive to buy this reinsurance directly mitigates this problem.
In addition, any premium arbitraging or frictional transactional costs can be accrued to the captive’s benefit.
Risk management
Captives transform insurance from a cost into a profit and loss item. This in itself heightens the profile of risk management within any organisation, demonstrating the maxim, ‘what gets measured gets attention’. Captives convey to carriers a more sophisticated approach to risk management through deployment of capital corporate risk appetite and risk-sharing. This is attractive to reinsurers.
David Ball, major and global risks director at HDI-Gerling Industrial Insurance, comments: “We see clients that utilise captives with real ‘skin in the game’ as particularly attractive partners and long-term players and we look to deploy our capacity in a meaningful way for such clients.”
”The private placement mentality undoubtedly builds stronger relationships with the market, which only benefits buyers in the long-term.”
Reinsurance also enables the development of a broader selection of market relationships.
In a conventional arrangement there is generally a lead carrier that sets the terms and writes a significant share of the programme.
By using reinsurance, there is still a lead carrier but the captive can also partner with markets on key parts or layers of its reinsurance programme.
Not only does this give diversity to a panel of markets, it creates a natural succession plan for the lead market(s).
Henneberg comments: “Our captive gives us the ability, through our retrocession programme, to partner with markets that deploy meaningful capacity in key layers which would otherwise be difficult to achieve.”
Cost reduction
Underwriting is both an art and a science. While models can guide decision making, they only act as a barometer. What is also clear is that underwriters have different appetites, growth pressures, return-on-capital-employed targets and many other external influences. This means that a captive retrocession programme can give underwriters the opportunity and flexibility to deploy their capacity in the most competitive way possible. Some call this arbitrage between insurance and reinsurance but we prefer to call it optimisation.
Captives can access a greater diversity of capacity and the increased supply and competition normally results in reduced costs. In a challenging economic climate this can be of huge value to an organisation.
Example of deployment of a private placement
A company, or captive, (both illustrative) has a risk appetite of $10 million, and wishes to buy a limit of $100 million, inclusive of its risk appetite. A conventional captive programme structure would generally be marketed in two parts:
Deploying the captive in writing a larger gross line involves a direct (or fronted) policy of $100 million.
The difference in these two structures can be dramatic in terms of both impact and profile. The captive can now:
Henneberg comments further: “At Maersk, we are serious about risk taking and therefore risk management. We have a fair risk appetite and deploying our captive in such a way that we engage with a broad segment of the insurance and reinsurance market is key to our strategy.”
Are captive owners missing a trick?
Captive reinsurance structures as described above could not necessarily be applied to every programme and there are hurdles that would need to be overcome, especially with regard to fronted programmes and the security needs of the fronting carrier.”
“At Miller, we believe that organisations that are serious about their captive approach should consider using reinsurance to engage strategically with the insurance market and create a high profile for, while reaping the benefits of, their risk management efforts.
How and why did Carey Olsen get involved with the establishment of the BT Pension Scheme’s captive?
