Retaining More Risk: The Call of the Captive Grows Louder

As premium rates continue to rise, big European corporate insurance buyers are taking risk transfer matters into their own hands. Instead of ponying up two figure percentage rate increases for their property-casualty coverages, more businesses are turning to captive insurance arrangements to manage their cost of risk.

“We’ve definitely seen an increase in cessions to captives over the last few years, in response to market shifts. Many clients have sought to retain higher limits for existing lines of business in their captive but also to place new lines of business,” according to Marine Charbonnier, global programs and captives regional director for Europe at insurer AXA XL. “Parent companies are leveraging captives to optimise premium conditions or to compensate for a lack of capacity in some areas.”

Robert Geraghty, international sales leader at Marsh Captive Solutions, agrees, pointing to a bumper year in 2020 when Marsh set up 100 new captives and a similar growth trend for 2021. Marsh now has 1500 captives under management for corporate clients.

“The pandemic pressured companies to make decisions more quickly. They would have had a longer lead time in previous years. But cost pressures during the pandemic drove companies to make quicker decisions on new captive vehicles or cells,” he says.

“With captives already in place, we saw big increases in usage with companies taking higher retentions and adding new lines of business. The larger captives we have under management — those with more than US$20m in the captive — rose from a 23% share in our portfolio to 27% in 2020 as a result of that trend.

“So the existing captives under management grew bigger and we have had more formations,” Geraghty adds.

The captive expansion is set to continue, says Thomas Keist, Global Captive Solutions Leader, Swiss Re Corporate Solutions. Many clients believe that there will not be another soft market in the near future, he notes. “They see the need to think about higher retentions in their [insurance] programme and how they manage those retentions in a more strategic way. The obvious option is a captive.

“The uptick is very clear. We have seen new captives appearing on a weekly basis. The trend will be longterm, on the basis that there is a leadtime for would-be parents between the internal decision being made to actually forming the captive.”

It isn’t just cost of risk driving driving the trend, however, Geraghty points out; there are qualitative advantages as well.

“The coverage aspect is very important. Where companies see they aren’t getting sufficient coverage they can add in coverage that wasn’t there before. In a challenging market, tighter wordings, exclusions and less policy flexibility, reinforce the potential to look to a captive for coverage,” Geraghty says.

While start-up captives cut their teeth with property, transport and general liability risks, longer established captives are broadening their reach. Cyber risk is an obvious choice, according to Swiss Re’s Keist, because the legal and regulatory framework around it is not particularly problematic.

There’s also a perception that the mainstream insurance market is not meeting corporate clients’ cyber protection needs in terms of value for money.

“There are still open questions for the commercial insurance when it comes to covering cyber risk: coverage needs to become more effective and pricing more predictable,” Keist says.

D&O is another line that captives can help with, although Keist advises caution. “It is a complex business involving certain regulations and considerations. And when there is a big case, the captive’s assets can be at risk.”

AXA XL’s Charbonnier observes clients also placing new and emerging risks into their captives, including environmental impairment liability, employee benefits, and even niche risks that are very specific their group’s activity.

“In addition, we’re seeing an uptick in interest from captive clients with regards to parametric solutions. These aren’t new but there is clear interest from those more sophisticated risk managers who tend to also have captives as part of their risk management strategy,” Charbonnier says.

With tailored parametric risk solutions, payments are triggered by an event measurement or index movement, rather incurred losses.

As a captive manager, Marsh works with its own actuaries to help clients bring new lines of business into their captive by examining loss projections numbers and capital implications, for example.

“But new premium, diversification, and spreading risk through new business is actually helpful in a captive,” Geraghty reckons. “Adding in third party business, such as extended warranty, is another potential way to add revenue and boost diversification for B2C businesses especially.”

European captive insurers tend to be synonymous with “offshore” financial centres, from Bermuda to Guernsey in the Channel Islands and Dublin, Ireland. But change is in the air as “onshoring” is starting to look like a more realistic option for some owners than it has done in the past.

“Historic captive domiciles, such as Luxemburg — and Malta for cell captives — remain popular, but we are seeing an increased interest for onshore domiciles and some re-domiciliations,” Charbonnier says. “In some countries, clients are responding to their risk management bodies having expressed a preference for captives’ governance to be more explicitly linked to the risk management of the parent company, and are considering moving the domicile of their captive closer to home.”

Swiss Re’s Keist agrees. “I expect to see more countries like France and the UK making an effort to introduce onshore captives. It makes sense for them to retain this growing financial activity in Europe,” he says.

Keist also says that Luxembourg has done a good job developing its reputation as a solid captive domicile that’s "onshore" from a European Union passporting perspective. As captive locations, Dublin, Sweden and Malta also provide the capability to write across the EU.

Single parent captives are the longest established and most popular vehicle for self-insurance but protected cell companies (PCCs) are the fastest growing group.

Charbonnier says cell captives — whereby the owner of a core facility holds regulatory capital, insurance licences, as well as managing the day-to-day operations, rents a cell to third-party organizations — have made it possible for small and mid-sized organizations to enter the market.

Also known as segregated portfolio companies (SPCs), segregated account companies (SACs), or incorporated cell companies (ICCs), they are relatively easy and quick to set up, boosting their appeal during the pandemic.

“Interest in cell captives is growing but, in Europe, there are only a very limited number of domiciles that are appropriate for these types of solutions, from a regulatory standpoint,” Charbonnier says.

Guernsey, for example, has a fast-track operation taking a week or two versus two to three months for a captive. Malta also has a PCC regulatory framework.

Another low entry level alternative (offered by Swiss Re CorSo, for example) is the so-called virtual captive. Effectively a multi-year insurance agreement between a customer and an insurer, a contract replaces the legal entity of a traditional captive but retains much of its self-insurance mechanisms.

Keist says that companies frequently prefer to trial self-insurance by first using a steppingstone such as a PCC or a virtual captive — and decide whether or not to form a captive later: “Sometimes the client will stick with the multiyear agreement however and the existing infrastructure it provides.”

In all their different forms, captive insurance arrangements are designed to insulate their owners from the vagaries of the open market. But captive owners do need to consider ESG issues around their captive insurance arrangements in the same way as mainstream insurance companies have to.

While EU rules on ESG disclosure don’t apply to captives, an increasing number are considering incorporating them into their operations, AM Best pointed out in a recent segment report on EU captives.

Best’s uses the example of a corporation looking at using its captive in a capacity shortage situation caused by incumbent insurers pulling out of a perceived “toxic” industry risk, such as fossil fuel.

Captives may want to address their ESG exposures, Best’s says, warning that a failure to do so could present significant risks - be they financial or reputational.

Thomas Keist believes captives can actually be a positive force in terms of ESG, however: “Using a captive encourages better risk management and enables the financing of renewable projects, for example” he says.

An important regulatory development with ESG implications that’s being followed closely by European captives owners relates to the European Commission’s review of Solvency II.

The good news is that changes currently proposed by the EU will strengthen the concept of proportionality, and even create a new class of “low risk-profile undertakings”.

In terms of governance, the proposals would allow for one person to hold several key functions — a welcome change for small and medium sized captives.

Beyond ESG — and arguably more important — the proportionality measure would allow captives lighter treatment under the capital adequacy and reporting regime.

“Captives exist mostly to write their own parent’s risk, not third party risk, so it is important that policymakers bear that in mind when framing insurer solvency rules,” Marsh’s Geraghty says.

It does appear that policymakers are more and more open to accommodating captive insurance companies, both onshore and offshore, however. This official acceptance, combined with growing cost of risk for corporations, can only add further impetus to the captive movement in Europe.