- Senior Vice President and Risk Finance Practice Leader for Lockton Companies
“I think we’ve come full circle since the financial crisis, when many captives thought they were losing.”
We believe all are winners. There are a number of entities that find financial benefit from captive insurance activity – either through owning their own captive or using an existing captive facility. Whether it’s organic or acquisition growth of an organisation, or a change in business focus, we see many organisations that can benefit from the use of a captive strategy.
From a domicile perspective there are centres of excellence that continue to attract business and new domicile entrants that have attracted new captives. For example, in the US a number of captives have changed domicile, but several have kept captives in the original domicile and set up another captive in a different jurisdiction as well. I think we’ve come full circle since the financial crisis, when many captives thought they were losing. Now we’re in a position to support captives in other jurisdictions too.
2) What geographical trends or changes are you witnessing, and where’s popular right now? NB - current spread is 30% onshore US, 18% European market, 48% Bermuda and Caribbean, 4% rest of world.
The large majority of the captives with which we consult are owned by US entities. We’re seeing a deeper penetration into midsized corporations with and without international operations. And with the adoption of captive legislation in a number of US states, we’re seeing consideration given to the opportunity for entities to own and operate a captive close to home. The decision is balanced with the expertise and access to the state captive regulators.
The fact that there are now so many states with captive legislation allows companies that considered captives before but did not form, to reconsider. If it is determined that it is easy to operate their own captive in their own state, they may begin formations, and this will probably expand the captive industry as a whole.
For captive managers, there are now more regional hubs. This means they don’t have to sit in a particular domicile to manage captives there, which in turn is expanding their role. It may be they need to know the regulators in several states, for example, and they can compare pros and cons with several different domiciles in the region in which they operate.
3) Is Solvency II a burden for all, or an opportunity for some? How do you see the rest of the world (outside the EU) responding to the directive?
For the adequately capitalised captive, Solvency II is not a substantial factor. Clients with captives in jurisdictions that require compliance have had the increased burden of actuarial support of the capital balances, but in our experience the burden has not made a material difference in the captive operations or costs.
4) What innovation have you seen in the industry recently? And what new alternatives are you aware of? E.g. ILS. Are new structures/models appearing?
We see captive innovation in select industry sectors. Businesses use their captives in ways that tie in to the risks of their organisation. Examples of innovations are healthcare and benefits programmes, subcontractor default, brand protection and supply chain.
We continue to see innovation on employee benefit programmes so I would say that’s a definite trend. And while we haven’t implemented captives for pensions yet, it’s being thought about. We’re also seeing a large amount of concern in the right sectors for cyber liability. In fact, we’re seeing clients with captives already in place wanting to potentially use their captive to increase retentions and buy commercial insurance with a broader limit, which might be more valuable for this type of risk.
5) Is captive insurance still as effective for risk management, and why? What other risks are coming into play and how can CI provide for these? E.g. cyber, environmental, conflict?
Yes, captive insurance is an effective risk management and risk financing tool. Reporting of the captive financial performance keeps attention on the loss activity, which encourages more oversight and control over loss outcomes. We find that retained cyber liability risk is becoming more prevalent, as well as other retained risk. A captive is a valuable tool for aggregating risk across multiple lines of coverage so aggregate protection can be purchased more cost-effectively.
6) To what degree should captive insurance be a profit centre for its parent? And how can captive companies improve their returns?
When there are vendors or customers with an insurance need, there are opportunities for a captive to offer an insurance programme and participate in the risk assumption. The insurance offered must meet the needs of the third party and with appropriate risk pooling and risk mitigation techniques, the captive has the potential to profit. Captive margins are enhanced when more favourable risks are priced competitively to encourage participation by the better risks. Captives are also able to improve returns by implementing comprehensive investment strategies. Investment portfolios with investment managers specialising in captive portfolios can make meaningful enhancements in investment returns.
Captive investment strategies are important, especially once the captive has some activity under its belt. For new captives, investment strategies are more straightforward when the programs are in their early years, but some captives grow asset balances very quickly. And the attention to investments due to interest rates means captives need to actively invest their funds or there won’t be any yield.
Captives are flexible. Most companies realise that what they’ll be able to do with captives in five or so years time is much more than at the inception of the captive. Captives need to build surplus, which can then be used to leverage financing risk in the future. They can use excess and deductibles as an influence on behaviour and can set out pricing methodology to collect what’s appropriate for the risk. But that’s what being a captive is all about – doing all you can to improve outcomes and make the captive profitable.
There is an increased emergence of captives for middle market companies. Much of the activity we see is for companies that, 10 years ago, would not have thought a captive would be a valuable solution. Now, we have a sizable percentage of captives that fall into the middle market space.
We have some captives that start out smaller and then grow. It comes down to having enough business to capitalise the company and put the risk into a captive. For some captives this may mean staying fairly small but if they still have enough value, they’ll want to continue operating it. From a consultation point of view, there just needs to be real risk.
We’ve worked with captives that have started out as quite small but as their surplus has grown, they’ve been able to add more premium and more risk, for example increasing their premium from $1m to more than $10m. It’s a question of what they’re comfortable starting with, and maybe layering in additional coverage as they have surplus to support the business.
I would say that 831(b) captives provide some incentive for small companies to look at a captive. But it depends on whether it makes sense for the type of risk you’re writing. If you’re writing risks but not planning to increase your margin by much, this sort of captive won’t add much value. You need to look at the offering as if it’s risk you’d be willing to buy in the commercial market at that price.
8) What changes are you witnessing in the size of businesses using captive insurance, and how do their performance priorities differ with an organisation’s size?
We do see smaller organisations becoming more comfortable with the captive concept. Captives can provide value if the facts and circumstances of the company are such that a financial benefit may result. We do not believe that a captive is an appropriate tool for every company, and we have seen examples where captives have been formed when the benefit is marginal.
It’s a different scenario to 10 or 15 years ago. Knowledge of captives is more and more prevalent these days due to a greater number of captives. It’s unusual to meet someone who is unaware of captive insurance. More and more organisations are asking whether a captive makes sense for them.
9)When interest rates eventually rise, what impact could this have on captive insurance assets? And what action could they take to address?
If interest rates rise and you already have a portfolio of investments that you’re keeping in a fairly conservative investment strategy, then you’ll benefit.
10) Given the ongoing squeeze from regulatory and risk versus return pressures, does captive insurance have a future and why? And are your reasons positive or negative?
We believe there will always be a place for properly structured captives with a valid business purpose. The risk management and financial benefit of a captive should be frequently monitored and reviewed. If a captive continues to motivate the correct behaviour and the cost of captive operations are more than offset, the captive will likely provide benefit.
A captive strategic review would reveal if there were questions regarding the captive benefit. Following the financial crisis, there has definitely been a shift towards sending funds back to the parent, but this is balanced by what cashflow is needed at the captive level. Based upon the regulatory environment in the US, we believe that the captive industry is here to stay and will be a vibrant industry for the foreseeable future.
We believe captives will be more entrenched in employee benefits – both group programmes and single employer programmes. The employee benefits captive space is really still in its infancy and we believe pension, retiree medical and other benefits will be an area of growth for captives.
The captive industry looks set to move quite quickly. I think any organisation with a substantial amount of US employee benefits will see a major change in how employee benefits are financed by employers and that captives will be an integral part of it. We already have several programmes where the captive is issuing stock block coverage and increasing stock blocks retentions on commercial stock blocks.
And we’re also seeing those retentions growing with a fair bit of risk being put into the captive. Meanwhile, companies that don’t buy any stock blocks may look to captives for some level of coverage – and a more mature captive gives you the ability to start looking at that type of risk.
Since the financial crisis, there have been many people who’ve voiced concerns about the future of the captive industry. But I’d say captives have been steadily growing and it’s an industry that’s here to stay.