Captive insurance grows in importance as a hard market continues

March 2022  |  SPECIAL REPORT: MANAGING RISK

Financier Worldwide Magazine

March 2022 Issue

There is growing concern among European companies about the continuing hard insurance market and diminishing risk transfer capacity for major risks, such as climate-related events and major cyber attacks. Captive reinsurance companies are one of the favoured risk management tools for companies when the market does not provide enough capacity or prices it uneconomically.

Captives are regulated insurance undertakings. In the European Union (EU), and so far, the UK, they are subject to the local implementation of Solvency II along with all other types of insurance carriers. However, the solvency of a captive insurance company that is underwriting risks only for its parent company clearly does not pose the same concerns as a multinational insurance group.

The Federation of European Risk Management Associations (FERMA), therefore, continues to advocate for proportionality in the regulation of captive insurers. We have now urged the French presidency of the Council of the European Union (CotEU) to push for a final text for Solvency II that will make captives low-risk entities by default, unless there are good grounds for doing otherwise. France holds the presidency of the Council of the EU, which along with the European Commission (EC) and Parliament drives political decisions at EU level, until 30 June 2022.

This amendment, we believe, would further reduce complexity for small and less risky insurers, including captives, which is one of the five main problems that the EC addresses in its review of Solvency II. It would also streamline captive regulation for national supervisory authorities.

Uninsurable

The topic of an insurance protection gap has re-emerged over the last few years as a result of losses from natural catastrophe events. For example, the French risk management association AMRAE has found that over 60 percent of risk managers are concerned that certain business activities or locations will become uninsurable. This is especially disturbing since the frequency and severity of climate-related events are increasing.

Climate change hazards were at the top of long-term risks to business identified by risk managers in our ‘European Risk Manager Report 2020’. We expect that the 2022 survey now underway will confirm or strengthen this finding. The World Economic Forum ‘Global Risk Report’, published in January 2022, shows how likely this is.

In this very extensive survey, 31 percent of respondents identified extreme weather and 27.5 percent a failure of climate action as critical threats to the world in the short term. On a longer horizon of five to 10 years, 42 percent named climate action failure as the greatest threat and 32.4 percent said extreme weather.

Options for risk transfer are, therefore, more important than ever, and captives are part of a solution. They need to be able to fulfil their role without disproportionate administrative burdens or capital requirements that are suitable to a commercial insurance enterprise serving the public.

In comments to the EC on the revision of Solvency II, we acknowledge that there has been important progress on proportionality. However, we strongly believe that more should be done to make Solvency II truly risk-based and suitable for appropriate local supervision for captives.

Established and efficient

Captives are an established and efficient risk management tool for businesses and are also a part of a vibrant and competitive European insurance market. The term ‘captive insurance company’ is now more than 60 years old. They typically come into their own during hard insurance markets when capacity is scarce or expensive. This has been the case over the last two or three years.

In 2020, in response to our European survey, 43 percent of risk and insurance managers said they were considering use of a captive for hard to place risks, compared to 15 percent in 2018. Of these, 27 percent said they would use an existing captive for such risks, compared to only 1 percent in 2018, a clear signal of how the insurance market evolved over the period.

In the short term, however, we do not expect significant growth in the number of new captive formations for two reasons. One is that this is a mature industry; most large companies that could have a captive already do. Second, setting up a captive requires extensive management consideration and a capital commitment.

In the medium to long term, if regulation under a revised Solvency II becomes more captive friendly, we could see more captives created or even reshored in EU countries. In the meantime, large companies are putting more business into existing captives in three ways. The first is the usual approach of increasing retention of frequency exposure. Second is to also retain medium level severity exposures. And third, they are looking at additional lines of business that were not formerly in the captive.

For such companies, insurance is one method of financing risk, and they compare it with other tools. The current insurance market conditions of higher prices and greater restrictions make the traditional insurance risk transfer mechanism less attractive, and logically push more business to consider using captives or other risk financing tools.

Capacity pressures

Today, the insurance market remains hard, even if in some classes of business the rate of increase has slowed. Insurers are not only concerned about natural catastrophes but other peak exposures such as cyber risks. Brokers are widely reporting substantial increases in the cost of cyber risk insurance and shortage of capacity for some industries. Insurers also face pressure to demonstrate sustainability in their underwriting and investments, which can affect the capacity they make available to certain industries or activities.

We therefore expect captives will become more important for non-traditional lines of business, such as cyber. This was already the prediction of 56 percent of respondents to the 2020 survey.

Captives serve a wider purpose, too. Because of its unique position within a corporation’s insurance process, a captive can be a central unit for data collection from all the subsidies and operations, especially loss statistics. Such information from the captive, which will be more detailed than a market insurer provides, is valuable for the company owner’s risk and loss analyses. It helps increase understanding of the factors responsible for losses and so provides support to effective loss prevention and control policies and actions.

Captives are a genuine risk management tool for multinational organisations. Regulatory requirements for captives that are truly proportional to the risks will provide European enterprises with more risk management options, especially for difficult to place exposures.

 

Typhaine Beaupérin is the chief executive of the Federation of European Risk Management Associations (FERMA). She can be contacted by email: typhaine.beauperin@ferma.eu.

© Financier Worldwide

BY

Typhaine Beaupérin

Federation of European Risk Management Associations (FERMA)

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