Spotlight on Captives 2024 - Managing an uncertain global risk landscape

Captive insurers, long considered alternative risk transfer mechanisms, have earned a place in the mainstream insurance market. No longer are they thought of only when other options are exhausted but are now considered a well-established solution for financing any number of risks.

As a risk management tool, captives have served as a way to smooth market cycles, gaining popularity when conditions were tight while allowing owners to return to the traditional market when pricing and terms became attractive. While they continue in that role, as was evidenced when the market hardened in 2019 and companies once again turned to their captives, the insurers are now much more than a way to manage insurance costs.

Captives have become a strategic risk management tool, says Oliver Schofield, a captive consultant with RISCS CWC. “I have always maintained that captives are not just for the hard market – they bring benefits to owners at every stage of the market cycle,” he adds.

In the recently released Commercial Risk Spotlight on Captives Report - Dealing with an uncertain global risk landscape, experts from Zurich, along with risk managers, consultants, captive owners, brokers and others discuss the creative ways captives are being used to address such varied risks and opportunities as climate change, cyber risk, microinsurance, employee benefits and more.

“Captive creation and use will remain strong,” says Joshua Nyaberi, Zurich’s Head of Captive Fronting. “In a world increasingly faced with new and emerging risks that are either difficult to insure or uninsurable, the captive’s value increases both for companies who already operate one and for those that have an interest and can create their own.”

Statistics bear out Nyaberi’s claim. The number of captives worldwide has increased from 5,879 in 2020 to 6,181 at the end of 2023, according to Business Insurance’s annual captive ranking. Much of that growth is from the creation of U.S.-based captives domiciled onshore.

Captives and the environment

The Commercial Risk Spotlight on Captives Report focuses on some of the risks highlighted by the World Economic Forum’s Global Risks Report, many of which are related to sustainability. Captives are expected to play an increasingly larger role in helping their organizations meet sustainability and ESG goals, whether they are related to climate risk, the transition to net-zero or employee benefits and well-being in general, the captive report notes.

“As businesses prioritize sustainable practices, captives offer multiple strategic benefits, such as providing customized insurance solutions for ESG-related risks that traditional insurers might overlook or not underwrite adequately,” says FERMA Board member Laurent Nihoul. “These might include environmental liabilities, climate change impacts and social responsibility issues.”

It’s no surprise to risk managers that rising natural catastrophe losses have made climate-related risks more difficult to insure. Research by Howden and Boston Consulting Group forecasts that global insurance premiums for climate resilience and property exposed to natural catastrophes could reach $250 billion by 2030, a 50% increase, as losses from climate events grow, exposures become broader and other factors.

Experts say captives can play a role in sharing with traditional insurers some of the climate-related risks, or, in some cases, tailor their own coverage to address the exposures.

“Captives offer a nimbleness that is often not found in, or even possible for, traditional insurance structures,” says Mark Elliot, CEO of Polo Insurance Managers. “Captives can create an effective means of managing and financing all, or portions of, an organization’s specific risks associated with climate change.”

Captives may also have a role in helping mitigate biodiversity risks, which pose “severe consequences for the environment, humankind and economic activity,” according to WEF’s Global Risks Report. There is a serious dearth of data around the risks, which makes them difficult to insure, experts point out.

“Capital may be available in the insurance sector for these risks, but a lack of data makes modelling and pricing difficult,” says Peter Carter of Willis Towers Watson.

Malcolm Cutts-Watson of RISCS CWC agreed, adding that captives are “a fantastic tool for data collection and analysis – data that can be shared and jointly interpreted with insurance markets.”

Transferring transition risk

The transition to a net-zero world is raising concern among risk managers that new and sometimes untested technologies, along with greater use of renewables, is making adequate or affordable coverage difficult to obtain. Captives may be able to help, the Commercial Risk report notes.

In the transition phase, new technologies generally have poor loss experience and the risk isn’t understood well enough to enable modelling and pricing by traditional insurers, Nyaberi says. A captive can provide the formal structure to fund a risk that might otherwise be uninsurable, he adds.

“We see captives acting as an incubator for a number of these net-zero challenges, especially where the captive can then access the ART markets to smooth the impact of claims in the early years of incubation,” said Cutts-Watson.

From cyber risk to microinsurance

Captives can be a mechanism for insuring cyber risks, as long as it is done carefully, according to the report.

Before writing the coverage, a cyber risk management framework should be in place to ensure the organization’s IT ecosystem is secure and continuous monitoring is in place to reduce the potential for losses within the captive, Mike Matthews of Artex advises.

Cyber captives are primarily used to fund deductible buybacks and/or replace upper layers of large cyber coverage towers, Matthews says. “We’re also seeing cyber MGAs forming captives to participate in their cyber portfolios,” he adds.

Companies are also finding a place for employee benefits in their captives, a trend that is picking up speed. It’s an approach that benefits employers and employees, as well as the captive that is able to diversify its risk portfolio. Including employee benefits into a non-life captive reduces expense ratios by generating underwriting profits, creating financing efficiencies and lowering operating expenses, the report points out.

Captives are being used to provide capacity for microinsurance arrangements that provide coverage for small risks such as farming operations in low-income areas that have little or no access to insurance.

Supporting microinsurance not only helps meet basic human needs, it also strengthens supply chain resilience, experts note.

“Making sure that the supplier is strong and resilient and has coping mechanisms is actually good for business,” says Jaime de Piniés, CEO of Blue Marble, a microinsurance consortium. Doing so helps the supply chain withstand shocks and can create loyalty to the firm, he adds.

John Scott, Zurich’s Head of Sustainability Risk, says captives are well-placed as mechanisms to help their owners better manage risks of all sorts. There’s more to managing risk than simply transferring it to someone else, he adds. “It’s also about finding ways to manage the risk in a better way. And I think that’s the kind of innovation that really will create enormous opportunity, and captives can be a part of that.”