New doors open for captives
Firming commercial insurance prices and reinsurance capacity shortages, along with the COVID-19 pandemic, could present opportunities for the US captive insurance segment to increase its footprint in several lines of business, say AM Best’s Susan Molineux and Fred Eslami.
“Although captives are not intended to be profit centres, the profitability of AM Best-rated captives has been excellent.”
Susan Molineux, AM Best
“AM Best expects cyber to continue to grow, albeit slowly, as companies are finding they need to invest sufficiently in IT to improve their cyber defences.”
Fred Eslami, AM Best
Historically, captives have focused on providing coverage for exposures unavailable in the commercial market. Today, public and private companies of every size use captives to help them manage and control risks. Captive structures have evolved, and now much smaller companies or business owners can benefit from conscientious loss control and mitigation with the assistance of third-party captive insurance managers.
The market has entered a hardening phase, similar to hardening periods in the past that first gave rise to the use of captives—most notably in the 1960s, when the first captive was formed in Bermuda, and the 1980s, when the Liability Risk Retention Act became law.
The difficulty and expense of placing insurance in a hard market may encourage enterprises to expand the use of their existing captives, or form new captives, or a combination of both, as part of their risk management strategies.
Captives are balancing risk appetites with self-insurance savings in determining whether, or how much, to increase net retentions or to participate up the reinsurance tower to manage costs.
Among the coverage offerings being explored by captives—particularly, single parent captives—are employee benefits and medical stop loss. Rising health insurance costs are supporting an increase in medical stop loss writings, as more companies look to self-insure employee health insurance plans.
Interest in third-party stop loss coverage and broker-sponsored programmes to supplement major medical coverage owing to high deductible plans also continues to grow.
Captives may also look to write traditional lines of business where rates have climbed following catastrophe losses, as well as for ongoing uncertainty related to COVID-19. Rate increases for lines such as directors and officers, errors and omission and commercial auto may also spur interest.
Insureds seeking to include coverages for communicable diseases as part of their commercial property policies, including business interruption and contingent business interruption, present an opening for the captive insurance market. Few, if any, commercial carriers are currently offering this coverage; consequently, this presents a huge opportunity for captives and their insureds.
The rated US captives in AM Best’s captive insurance composite (CIC) reported another strong year in 2019, with a pre-tax operating income of $918 million. Although this was down 16 percent from the $1.1 billion in earnings reported in 2018, the market remained extremely profitable, once again exceeding the commercial casualty composite (CCC) by a wide margin.
Overall, the captive insurance industry’s 2019 underwriting performance reflected sequential weakening since the resurgence of natural catastrophes late in 2017 after several benign years.
The CIC’s average five-year, post-dividend combined ratio of 92 percent compares favourably with the 100.8 percent posted by the CCC. In fact, the CIC surpasses the CCC in just about every financial category.
The reasons for the CIC’s outperforming the CCC remain largely the same year after year: controlled costs; focused underwriting; efficient and innovative management and mitigation of risk; robust loss control and risk management practices; and use of flexible reinsurance.
“This favourable view reflects the composite companies’ exceptionally conservative reserve philosophies.”
Additionally, between 2015 and 2019, captives added $3.8 billion to their year-end surplus and returned $4.4 billion in stockholder and policyholder dividends, representing $8.2 billion in insurance cost-savings that captives retained for their own organisations by not purchasing coverage from third parties in the commercial market.
Although captives are not intended to be profit centres, the profitability of AM Best-rated captives has been excellent, and barring any unforeseen issues, its results should again compare favourably to those of the CCC in 2020.
Some margin compression is likely, owing to persistently low interest rates and uncertainty about the effect of COVID-19 on claims. However, captive insurers focus more heavily on loss control and capital preservation than on generating high rates of return.
Cyber is profitable
Cyber coverage is one of the fastest-growing lines of business, generating exceptional results for US captives. Approximately 15 percent of AM Best-rated US captives write cybersecurity policies for their parents or group members. Based on National Association of Insurance Commissioners’ (NAIC) “Report on the Cybersecurity Insurance and Identity Theft Coverage Supplement”, captive insurers wrote premiums totalling $18.2 million for standalone and packaged cyber policies in 2019, up 5.7 percent from 2018. However, the number may be significantly higher when companies that do not file NAIC statements are considered.
The COVID-19 pandemic and the resulting shift to remote working for the majority of the US workforce has created a greater likelihood for Distributed Denial of Service (DDoS) attacks such as ransomware on government entities and companies of all sizes. These disruptions could result in an increase in fatalities and be considered COVID-19-related.
Escalations of political and diplomatic tensions with rogue nation states add even more importance to defending against complex cyber attacks, which can cause billions in economic and insured losses.
Cybersecurity has therefore become a key topic of discussion among major stakeholders. AM Best expects cyber to continue to grow, albeit slowly, as companies are finding they need to invest sufficiently in IT to improve their cyber defences.
Captives maintain vigilance and profitability
AM Best’s overall assessment of the captive insurance industry remains favourable due to the segment’s consistent and positive long-term underwriting results. AM Best believes that the majority of captive insurers are extremely well capitalised to withstand the impact of the COVID-19 pandemic.
This favourable view reflects the composite companies’ exceptionally conservative reserve philosophies and close proximity to insureds, which allow them the ability to quickly identify and manage risk as it emerges as a kind of “first responder” for the captive owner or the captive’s members.
Regulators and key constituents such as reinsurers and potential member insureds (in the case of group captives) generally have minimum capital requirements, but the healthy capitalisation and balance sheets of the rated captives are more often a function of conservative risk tolerance and the captives’ mission to be a viable and stable market for their stakeholders.