Spring Consulting Group
Optimising risk during the COVID-19 pandemic
COVID-19 has dramatically changed the insurance landscape. Captives provide an excellent way for businesses to navigate these changes, says Peter Johnson of Spring Consulting Group.
“On the employee benefit side, the analysis determined that the organisation would save about 22 percent, resulting in an overall return on investment of more than 14 percent.”
Peter Johnson, Spring Consulting Group
Earlier this year most could not have imagined a scenario where the total US gross domestic product would contract by 5 percent in the first quarter, and by another 32.9 percent (on an annualised basis) in the second quarter. COVID-19 has created a unique set of circumstances in the insurance markets.
Prior to the pandemic, property and casualty (P&C) and life insurers were at an all-time high, from a surplus perspective. These lofty surplus levels were a factor of a decade of favourable underwriting results and positive investment returns. As we have seen in market cycles of the past, periods of soft markets can be followed by elongated periods of hard markets.
The pandemic has accelerated the hardening of markets. From an insurer’s perspective, there are two major ways for them to generate revenue: through underwriting income and through investment income. The correlation of deteriorating underwriting experience across certain risks during recessionary times and continued volatility in investment returns are putting a lot of pressure on commercial carriers.
Most carriers are responding to these market conditions by focusing on generating underwriting income by increasing premiums. Another factor yielding hardening market conditions is the fact that numerous carriers are exiting certain markets and coverages.
A variety of other issues have arisen, such as:
- A significant slowdown in the claims-handling process, with courts being closed and businesses across the country shutting down;
- An uptick in workers’ compensation claims due to COVID-19, particularly for front line workers, compounded by the fact that the premium base of payroll has decreased for the system overall because of layoffs and/or furloughs;
- Business interruption policies, which generally cover only revenue loss due to property-related loss triggers and not virus-related ones, are being tested. Regardless of the outcome of the various court cases against carriers, it is clear that there is a coverage gap;
- Increases in cyber incidences due to an expanded remote workforce;
- Coming into the pandemic, commercial auto liability risk had been rising in tandem with a booming economy, increased traffic volume and density on the roads. Many carriers were posting significant rate increases to counter the issue although the instant economic slowdown has reduced the need for aggressive rate increases; and
- The unknown impact on insurance programmes due to the shift to a work-from-home environment for many companies (in some cases a permanent move).
All these factors, in conjunction with changing market conditions, are resulting in a steep rise in insurance premiums, making it more expensive or, in some cases, unaffordable, to purchase coverage.
We are seeing the impact of these changes in our work with clients’ renewal discussions. The pandemic has resulted in shifting trends for many coverages, putting pressure on the entire insurance system while creating an opportunity for captives to step in and play a role in creating a better insurance framework for organisations.
Captives provide a dynamic and nimble solution to help organisations deal with these changes in the insurance landscape. For example, a retailer evaluated the potential of using its captive to underwrite the gaps in its commercial workers’ compensation coverage. The gap it identified was the implication of employees returning to work and an increase in COVID-19 cases. Traditional workers’ compensation policies will not provide coverage for this exposure.
“The current hard market cycle is driving more clients towards solutions such as captives as they look to gain coverage for previously unfunded risks.”
Gain control over your own destiny
A mid-sized healthcare system (the insured) wanted to maximise cash flow, minimise claims and examine a number of alternatives including a captive programme. Over the course of the last several years the company undertook a number of acquisitions, creating a patchwork of insurance programmes.
The organisation wanted to gain the synergies that it had hoped for through the acquisition process and standardise and scale with minimum disruption. In addition, it was interested in:
- Creating a framework in which it could protect itself against uninsured business interruption risks in the commercial market;
- Developing a common insurance purchasing platform for its many companies; and
- Generating savings for the organisation by using size and scale of the company as a whole.
By taking a view in the aggregate across benefits and P&C risks and looking at a captive, the insured developed a solution that accomplished these goals. This began with the collection and thorough analysis of all policy, historical loss and exposure data of the insured. While simultaneously reviewing retained risk scenarios to adverse economic outcomes and analysing the correlation of risk between lines, the ideal coverage retentions and captive retention in the aggregate emerged.
In tandem with this analysis, the feasibility of different structural options, such as the use of reinsurance above certain captive retentions, fronting carrier arrangements and deductible reimbursement policies was assessed.
By taking on large deductibles for the P&C programmes (medical professional liability, workers’ compensation, general liability, management liability, property, other P&C coverages) and funding these retentions through a single parent captive, the insured is expected to generate savings of over 27 percent compared to its programme structure today.
It included evaluating the current employee benefits programmes (medical stop-loss, life insurance and disability) and how these programmes interact with certain P&C coverages. On the employee benefit side, the analysis determined that the organisation would save about 22 percent, resulting in an overall return on investment of more than 14 percent.
Finally, the organisation was able to address the commercial coverage gap issues by having the captive insure a difference in conditions between its old policy and what is required in the new COVID-19 world.
The current hard market cycle is driving more clients towards solutions such as captives as they look to gain coverage for previously unfunded risks, create efficiencies in insurance purchasing to lower their total costs of risk, gain access to reinsurance markets and develop a holistic strategy to reduce the financial impact of a hardening market.
In conclusion, companies will continue to see captives play a vital role in providing coverage for companies of various sizes with significant savings over the long term. Addressing some of the issues related to COVID-19 is only one of the many benefits to a captive insurance solution.
Organisations that already use a captive are likely to offset a large part of the increase in costs due to existing captive retained earnings and the flexibility to quickly change the risk profile of the captive and take on more risk if needed.