RISK TRANSFER: A STRATEGY FOR RISK MANAGERS

Captives and their parent companies manage through every market cycle by utilizing the best financial and risk management strategies available to achieve optimal business outcomes. Risk transfer is a valuable risk management strategy that should not be overlooked.

A challenging business environment

The past two years have produced some of the most unpredictable and difficult circumstances for the financial wellbeing of every business. As a result, many companies suffered significant financial setbacks as they were forced to adjust to an unprecedented shift in fundamental business dynamics.

At the same time, the era of historically low interest rates will begin to disappear as developing market forces will reduce market liquidity when government stimulus payments to consumers and businesses end, inflation continues to rise, and the Federal Reserve increases interest rates and pares down monthly asset purchases. Borrowing costs will increase in 2022 and beyond.

Capital and carried reserves

This evolving marketplace presents an opportunity for captives and their owners to explore risk transfer as a strategy to eliminate liabilities on the captive’s balance sheet. Risk transfer replaces selected liabilities on the captive’s balance sheet with a loss portfolio transfer (LPT) or novation reinsurance agreement that transfers those liabilities to a re/insurer’s balance sheet. Since the financial strength of the assuming re/insurer is typically stronger than the captive’s, insurance regulators have consistently given approval to these transactions. Once the transfer is completed, any capital determined to be excess can be redeployed by the company.

One might ask, how can there be excess capital when the captive has diligently maintained adequate reserves for outstanding claims? The reality is that any reserve is an estimate of future liability where history has proven that reserves increase over time, driven higher by accelerated claims payouts and adverse development.

In addition, open claims from prior years are subject to economic and social inflation that will continue to drive the ultimate cost higher. Those economic factors produce uncertainty as to the ultimate cost of a claim.

A risk transfer strategy eliminates the uncertainty of financing open claims to their ultimate cost. A transfer might include all lines of business for the oldest years or only the lines of business with the greatest potential for adverse development.

Risk transfer structure

No two captives or their owners are the same. That is why each retroactive transfer solution is customized to the individual characteristics of the outstanding liabilities. The transfer can be structured in a number of different forms or combination of forms; from the more common LPT or adverse development cover (ADC) reinsurance agreements to a hybrid specifically designed to meet the company’s goals. The objective is to reduce uncertainty on the captive’s balance sheet.

Virtually any line of business can be transferred from a captive to a re/insurer. Although the most frequently transferred line of business is workers’ compensation, re/insurers have a broad appetite for a variety of lines including medical malpractice, healthcare, product liability, commercial auto and environmental.

How GJS Re can help

Having partnered with captive owners, captives, and risk retention groups across a broad spectrum of market segments, GJS Re has collaborated on every aspect of their business including licensing, fronting and reinsurance, as well as risk transfer. GJS Re can offer the resources of our teams’ extensive insurance experience and expertise to discuss how captive owners and their captives can benefit from risk transfer.

Jerry Sullivan is the chairman of GJ Sullivan Reinsurance. He can be contacted at: sullivanj@gjs.com

Thom Smith is the executive vice president of GJ Sullivan Reinsurance. He can be contacted at: smitht@gjsre.com