Rising above the hard market

The US captive insurance market has seen some significant changes in recent years, as it becomes more attractive for companies that seek to use the advantage that a captive insurer gives them.

According to rating agency AM Best, the operating performance of the US captives rated by AM Best continues to surpass that of their commercial market peers, as their inherent flexibility and control in managing risk drives profitability and retained earnings while creating value for their policyholders and stakeholders, regardless of market conditions.

John Andre, managing director at AM Best, told Captive International that it’s become standard practice for risk managers to form and use captives judiciously, to complement or assist with their risk management needs for their organisations.

“They also continue to grow their existing captives and have been creative in adding new lines and new products to support their members’ needs,” said Andre. “It’s a very solid market at the moment.”

An August 2022 report by AM Best found that the past few years have brought several new challenges for the segment. Not only have hardening market conditions been exacerbated by the COVID-19 pandemic, but many non-insurance corporate parents and small to medium-sized enterprises (SMEs) have had to consider potential liabilities and risks for communicable diseases as part of their commercial property policies, in addition to business interruption and contingent business interruption.

Nevertheless, AM Best said that few of the rated captives have been significantly affected by these issues to date. Although some captives had pandemic-related coverages in their policies, no significant amounts have been triggered under their policy language.

Difficult commercial market conditions typically highlight the benefits of the captive insurance segment and provide businesses an incentive to establish them. As AM Best points out, during hard markets some non-insurance companies may feel the commercial market does not understand or overprices their view of their own risks, so they investigate forming captives.

In other instances, smaller organisations may combine participants from an industry segment (eg, colleges/universities, farm cooperatives, not-for-profits, housing authorities, medical professionals, or trucking companies) to cost-effectively share risks through a group captive, a risk retention group (RRG), or exchange through which they can then efficiently face the reinsurance market.

When market conditions ease or normalise, the use of certain types of captives can become a less compelling alternative than the traditional commercial market.

The current environment allows captives to customise coverage for risks that may be uncommon or difficult to write or place in the standard market. To their benefit, captives can decide what self-insured retention they prefer, whether to provide coverage as deductible reimbursement, what reinsurance limits to purchase, what level of reinsurance participation (if any) is appropriate, and what coverages to include or exclude, such as pandemics or communicable diseases. Excluded coverages may be addressed more efficiently by the parent outside the captive in the traditional market.

Fred Eslami, associate director at AM Best, said that the hard market can be considered as an engine for captive creation, but at the same time, once captive owners see the results that these captives provide for their members and corporations, hard or soft markets become meaningless. The benefit is there: once they create these captives, they see the benefits.

Andre agrees and thinks that there has been a change in the way captive owners view their captives. “Maybe years ago, when the commercial market pricing was softer cheaper or easier, some owners would shelve their captive, or the captive would shrink—you don’t see that any more, the captive is now a fixed solution, despite what the commercial market is or isn’t doing. They form because of a need, they want more control and better pricing.

“Frankly, if a captive owner is confident in the company’s abilities, they won’t want to give that profit away. We rarely hear: ‘We’ll shut the captive down because I can get a better price from the commercial market’ any more—they open and they stay open.”

Hard market fallout

According to a 2022 report by Stephens Insurance, the hardening of the commercial market during the past several years has further contributed to the difficulty of traditional platforms providing tailored insurance solutions. Between 2011 and 2020, net premiums written in the US P&C insurance industry rose by over 47 percent, from $446.6 billion to $658.3 billion.

The Stephens report said that average premium rate changes for commercial P&C insurance went from falling by 5.4 percent in 4Q 2010 to rising by 8.9 percent in 3Q 2021, and increasing for a 16th consecutive quarter, according to the Council of Insurance Agents & Brokers (CIAB). Multiple factors led to the increases over the last decade, but the primary drivers are 1) predictive analytics and digitised underwriting; and 2) an increase in loss activity, namely natural disasters.

The report added: “The economics of the US commercial insurance market have been leading larger carriers away from providing highly customised coverages. Several recent drivers—notably cybersecurity, climate patterns and COVID-19—appear to have accelerated that trend. As a result, companies in sectors as diverse as construction, healthcare and finance are exploring single parent captive programmes to meet their risk management needs.

“The captive insurance market has proved to be an increasingly viable alternative to traditional lines of insurance in 2021, and is poised to continue growing throughout 2022.”

Normality and creativity

This year’s Vermont Captive Insurance Association (VCIA) was a welcome return to normality after COVID-19 for the US captive insurance industry, as it was the first time since 2019 that the conference was in-person instead of being mostly virtual.

Eslami said that at the VCIA meeting he’d met many people, including risk managers, who had either created or reactivated their existing captives over the past several years.

“They didn’t consider themselves to be mature captives, but the same test is definitely there, and the value is recognised by corporations and groups that use them. 2021 was a great year for US domiciles such as Vermont and 2022 is also very active so far, based on my conversations with Sandy Bigglestone and Dave Provost at the Vermont Department of Insurance.

“The focus for healthcare remains in Cayman and in Bermuda for the bigger, larger corporations.”

Andre, who was also at VCIA, said that in terms of recent captive formations he had heard about interest in D&O and E&O, with some captives formed to do just that. He had also heard about employee benefits that continue to make use of captives.

“I heard of a cyber-only one being formed just before the conference,” he told Captive International. “The new ones are the new, more challenging risks. Solutions for these risks are from both the standard commercial market and the captive industry. They’re taking a judicious approach, given commercial market pricing and the challenges of the new classes. Again, it’s a measured approach—a captive is not a quick fix.”

As Eslami points out, companies don’t rush in to the creation of a captive nor add any line which is a bad risk. They think about these captive vehicles, and they take their decisions and due diligence very seriously.

Looking ahead to 2023, Andre predicted that the market will probably see more of the same. He said there’s creativity in the captive space. He stressed that the various departments of insurance in the US enforce their standards and requirements, but they are open to some creative approaches.

“They’re licensing only those that they think are appropriate,” said Andre. “We’ll have a combination of creativity and responsive supervision as participants react to the needs and demands of the market.”