Captive formation
Life after the pandemic
A hard market and challenging circumstances have been some of the drivers behind a period of substantial captive formation activity in the US. Captive International investigates.
“If you have a captive, you are likely to have a better ESG score as a parent company.”
Mike Serrichio, Marsh Captive Solutions
Despite the challenges of the COVID-19 pandemic, the captive insurance market has recorded a sharp spike in activity since the start of 2020, according to Mike Serrichio, managing director and America’s sales leader for Marsh Captive Solutions.
Serrichio told Captive International that Marsh formed 200 captives in two years during the pandemic and the challenging insurance market, representing about $3.4 billion of new premium.
“Of those 200 new captives, about 4 percent insured cyber liability, 4 percent insured D&O, a good amount insured property and excess liability, but an even larger amount, around 10 percent, insured some sort of third-party unrelated risk,” said Serrichio.
“During those challenging times, there was not only more corporate use of captives, but managing general agents, insurtechs and others also used captives for unrelated, customer-focused risks.
“There was an enormous number of captive formations over the last couple of years. But for the challenging market and the pandemic—where people were focused and not travelling—I don’t know whether all the different regulators and service providers would have been able to handle that volume of growth.”
According to Serrichio, the market has seen a lot of growth in property captives in those two years and a large portion did casualty, such as excess and workers’ comp, general liability and product liability. Other areas of growth included medical malpractice in the healthcare space as well as professional liability, with these two lines being driven by social inflation.
Serrichio said that previously D&O was never written in captives, but side A D&O is now being written at what he described as close to record rates, due to a new law in Delaware.
Similarly, he said, 15 years ago cyber was never in written in captives—but now it is. He explained that cyber is Marsh’s number one growth area right now, and that’s due to the challenging market. A number of clients who have raised their retentions and bought less coverage due to the market are now using a captive to insure those retentions and expand their limits.
Serrichio identified the topic of environmental, social and corporate governance (ESG) issues as something that is being talked about a lot in the US captives market.
“There’s a hypothesis that says if you have a captive, you are likely to have a better ESG score as a parent company because you have governance, discipline, oversight and more rigour around your risk management by the nature of running a captive,” he said.
“If you have that, then as a company, you probably are more socially responsible.
“On the ‘E’ side, you may or may not be doing anything there, but the ‘S’ and the ‘G’ really come to the fore,” said Serrichio.
“Marsh Captive Solutions is committed to supporting our client’s ESG journeys within their captives. This could mean helping them find responsible investments and environmentally favoured fronting carriers, reinsurers and vendors. This will be the next big trend in the captive insurance industry—how captives support ESG.”
Challenging times
Talk of the market being a challenging one is not confined to Marsh. According to the Council of Insurance Agents & Brokers’ “Commercial Property/Casualty Market Report Q1 2022”, the US commercial property market has seen steady hardening, with price increases of 12 percent in Q1 2021; 9.9 percent in Q2; 10.3 percent in Q4; 10.5 percent in Q4 2021; and 8.6 percent in Q1 2022.
A hardening insurance market is among the factors resulting in more captives, nearly 20 percent of which are protected cells. Excluding Bermuda and the Cayman Islands, cell activity was concentrated in four domiciles, all in the US: Delaware, North Carolina, Tennessee, and Vermont, according to a March 2022 report from Strategic Risk Solutions, which provides captive management and advisory services.
The report showed that the captive cell market is a constantly evolving one, with North Carolina seeing the biggest growth, with the addition of 157 new cells and the loss of 29 existing ones, bringing the state’s total to 667. Vermont added 100 new cells and lost 10 existing ones, which brought its total to 485 protected cells. In Delaware, 45 new cells were added, but 104 existing cells were lost, resulting in a total of 466. Tennessee welcomed 65 new cells while at the same time losing 35, for a total of 341 protected cells, the report said.
Marsh defines a protected cell company, also known as a sponsored cell or segregated account company, as an insurance company that offers the benefits of a single parent captive without the need, and associated time and expense, to create a separate legal insurance entity.
In addition, hardening markets present opportunities for new structures, according to AM Best’s August 2021 Market Segment Report “Captives’ Flexibility and Control Enable Them to Outperform Commercial Peers”. It points out that the cell structure is being more broadly developed under various names such as segregated account company, segregated portfolio company, protected cells or incorporated cells, according to the report.
The road ahead
Now that the market has reached the halfway mark of what has already been a remarkably busy year on many fronts, can any trends be discerned as we look towards the last quarters of 2022 and the start of 2023?
According to a report issued by Caitlin Morgan Captive Management(CMCM), there are some indications of what might be ahead.
Among some of the most notable developments that CMCM expects to see over the coming year is an increase in family offices looking for captives. Family offices aren’t necessarily family-owned businesses but holding firms that own many different assets. They are typically highly-structured businesses, such as real estate companies. Most have large workforces with various departments managed by individual leadership teams.
According to CMCM: “In recent years, family offices have found it increasingly difficult to obtain coverage that adequately handles the needs of each of their business holdings. Therefore, many have begun exploring captive insurance as an alternative to traditional insurance options. More and more of these organisations will turn to captive programmes’ custom risk management solutions in the coming months.”
Construction firms are another area identified by CMCM. Firms in the construction industry were among the earliest adopters of captive insurance. This insurance model is ideally suited to the needs of construction firms, given the third-party risks inherent in the industry. Captive insurance will continue to be useful for dealing with subcontractors and managing safety risks. More firms will also turn to this insurance model for cost-effective solutions for owner- and contractor-controlled insurance and defects and rework risk coverage.
Healthcare organisations are also singled out by CMCM. Captive insurance will continue to benefit healthcare organisations, particularly those in the assisted living and nursing care sectors. For these industries, it is vital to have enhanced coverage for professional liability and malpractice risks that could lead to class action lawsuits.
CMCM said that the main challenge facing firms in these industries is the high profile and greater public visibility of lawsuits. They may also be liable for large settlements, making traditional insurers wary of providing sufficient coverage. And with the COVID-19 pandemic placing assisted living and nursing care facilities under increased scrutiny, many are expected to turn to captive insurance instead of traditional insurance providers.
There could also be demand for captives from architectural and engineering firms. As engineering firms are under increased pressure to speed up projects and reduce costs, many are finding traditional insurers unwilling—or unable—to meet their needs. Many companies are also finding it more difficult to deliver the expected results when faced with extreme and unpredictable weather conditions.
Engineers servicing municipal clients have their own challenges to deal with. As the demand increases for experts who can operate sewer and water treatment facilities, many face new risks in the design, building, and operational aspects of their jobs.
“Because few insurance firms address these concerns, engineering and architectural firms will have to turn to captive insurance to provide alternative solutions,” said CMCM. “In 2022, we can expect more municipal engineers to establish self-funded captive programmes that address their specific requirements before they accept these types of projects.”
With five months left in the year, it remains to be seen what happens with the above predictions. However, it’s worth pointing out that other areas could also rise to prominence as 2023 approaches. There have been times in recent years when making predictions requires a lot of caveats, due to unexpected developments such as global pandemics. The market will be hoping for a more sedate ride ahead of it.
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