As we are all stridently aware, the onset of the coronavirus pandemic in the western world from March 2020 lit the fuse in the world of captive insurance. Battle stations were manned, with risk managers reassessing their risk and asking ‘how on earth do you manage the risk of a global pandemic anyway?’. Those organisations who had captives were wondering how a pandemic may impact them, and for those that didn’t already have a captive, many looked to form one to better deal with a fluctuant and uncertain commercial marketplace.
While the oft-stated misconception that the words ‘crisis’ and ‘opportunity’ are represented by the same character in Chinese Mandarin, this is a rather applicable dictum to the captive industry at the present moment. The pandemic and the already hard market coalesced, bringing about undoubted crisis while also bringing about opportunity and setting in motion a transformative period in the captive industry unprecedented in modern times.
Per the most recent global insurance market index report by Marsh, by Q3 2021 rates in the commercial marketplace had risen by 15%. Such figures had begun to reduce compared to figures from Q1 2021 but are still worrying to risk managers. Along with spiralling rates seen in 2021 across all lines (but most notably in property and casualty, cyber, and business interruption) the ‘new world order’ and the continued disruption from the coronavirus pandemic left an indelible mark. Business disruption has continued across many sectors, along with a regrettable increase in vulnerable touchpoints with which cyber criminals could tap into with a distributed workforce. With such factors in mind, captives really found themselves at the vanguard of securing such exposures, and especially so over the last two years.
With the spotlight on captives and those new entrants setting captives up in 2021, how is the marketplace looking at the dawning of 2022? It would be premature to assume the pandemic is entirely over, the Omicron variant only having recently made its way through the UK in recent weeks and sent Chinese cities into panicked lockdown ahead of the upcoming Winter Olympics in Beijing. This article, at the fresh start of this new year, seeks to attain what the lay of the land is, and what the opportunities and continuing challenges for captives in 2022 may be.
A continuation of challenging conditions
In confluence with the already strained conditions in the commercial market, the coronavirus pandemic created a perfect storm. The marketplace continued to be constrained in 2021, and capacity remained scarce. Meanwhile rates rose in a number of lines, notably property and casualty (P&C), cyber, directors’ and officers’ liability (D&O), and business interruption. In short order, these became some of the most highly sought coverages post-March 2020 as it became clear the pandemic was set to have wide-ranging and lengthy consequences which would continue to impact the captive marketplace in 2021.
“2021 has been challenging for our large customers because they can’t get capacity to a reasonable price. Further challenges have existed in attaining sufficient capacity and experiencing shortness in some lines of business including nat cat [national catastrophe] exposure, property, financial lines and, in particular, for cyber,” Paul Wöhrmann, head of captive services Europe, Middle-East, Africa, Asia Pacific and Latin America at Zurich, told Captive Review.
Onshore preferences for US entities
One emerging trend in 2021 has been the increase in onshore re-domiciliation for US parent companies, and it seems this sentiment will continue throughout 2022. While many currently domiciled in an offshore jurisdiction have no plans to redomicile, there has been a slight increase in US captives moving their structures back onshore (and in some cases moving their captive to not only their country but home state). Those US companies setting up captives are primarily looking towards a US state domicile given the strong development in many, according to Adam Miholic, senior consultant at Hylant Global Captive Services, said.
“A lot of my clients are based here in the US and their risks are primarily located in the US and in those situations, I’m not seeing overt interest to go offshore,” Miholic told Captive Review.
“Whereas in the past there were perhaps a handful of state domiciles, [captives gravitated to]. Even though there were 35 plus states [with active captive legislation], there were four or five of them that rose to the top US domiciles.
“Nowadays most of the active domiciles are contenders for situating a captive, and especially if the client is either located in one of those states or has business in multiple states.”
Miholic also reported that recent changes in US state laws has made the environment even more friendly to captives in the country, allowing smaller entities to form structures and not just mega-corporations.
“US-based laws have been updated to reflect the current landscape of captive owners,” Miholic explained. “[Captives] are not just reserved for the Fortune 500 anymore and a lot of middle market and core businesses are joining group captives or setting up cell captives.
“The fact is that captives are being used for appropriate risk management purposes now, not tax aversion, post 2016 regulation in the IRS. Therefore, a lot of states have changed their view towards understanding that captives are legitimate insurance companies.”
Overall it seems that those prompted to consider captives in light of global events has led to an unprecedented rise in interest for captive insurance. The three largest domiciles in the world—the Cayman Islands, Bermuda and Vermont—have seen some of the highest numbers of captive formations in a decade.
The difference now is that the captive world has matured since its last big burst of formations after the 2008 financial crisis, and most organisations seem to be going in with their eyes wide open.
As things continue to moderate, it’s good news that there isn’t such a panic-stricken approach in the marketplace in general. For those looking to form captives, whether those be pure, group or cell captive structures, the jolt has also given impetus to those who have a captive to start looking at the way they use their captives in broadly terms and to revaluate the general sentiment about what their captive can do for them.
“Over the past two years, we have seen the pandemic change the way businesses operate on a global scale,” Erin Brosnihan, president at Kensington KY, said. “Companies are more focused than ever on risk management, managing cashflow and becoming more agile. The value proposition of the captive model aligns perfectly with these goals.”
“While the primary risks insured in the Cayman Islands remain healthcare, workers compensation, property, and general liability, there has been an increase in the number of captives writing third-party business and generally expanding their book of business.
“In addition, mature captives have increased existing retentions and also added lines of coverage such as cyber liability, catastrophe and environmental pollution.”
It seems clear that the past few years have given rise for utilisation for newer lines such as cyber, which have had a light shone on them and their necessity demonstrated by the pandemic’s influence. While it’s been a challenging time for the commercial marketplace, it’s undeniable that captives have been given a huge opportunity to shine.
“The number of new captive formations in the Cayman Islands continues on a solid trajectory,” Brosnihan said. “All signs point to another strong year in the domicile as companies look for ways to diversify.”
Possible opportunities for capacity
Climate change and natural catastrophes also remained a key issue in 2021, with global insured losses caused by adverse weather events reaching an estimated $105bn in 2021 according to Swiss Re, the fourth highest since 1970.
Wöhrmann told Captive Review that Zurich has calculated that to quantify the effects of climate change, captive owners may be faced with a raise of insurance capacity of 30% in the coming years.
“For the customer, the question becomes: do you have sufficient capacity as Zurich or as an insurance carrier? And if not, where I can get additional capacity on the insurance side?” Wöhrmann said. “A captive can approach the insurance market and try to buy more reinsurance cover and try to bring this into the insurance coverage, and we are happy to front this as an additional layer.”
Highlighting the ongoing shortness of capacity in cyber and nat cat lines, Wöhrmann also pointed to the possible role ILS (insurance-linked securities) could play in realising additional capacity. “I am interested to explore whether there is an interest for the investment community to work as retrocessionaire behind the captive so that captive owners have an additional opportunity to get access to insurance capacity, which is not only driven by the reinsurance or insurance industry,” he said.
2022: regression to the mean?
Moving into 2022, capacity undoubtedly remains constrained; however, it appears that the immediate aftershocks of the pandemic combining with the hard market environment are regressing to the mean.
“The positive thing as we head into 2022 is that with the exception of some micro industries and specific lines of coverage, rates in the marketplace appear to be flattening and are no longer jumping three, four or five times anymore which was the case in the last 18 months,” Miholic said.
“What I’m hearing from our clients and brokers is that volatility of renewal rates seem to be lessening. Eighteen months ago clients were looking at their captive and they weren’t having any losses, yet their premiums were going up by as much as 300%.
“We’re no longer having as many of those conversations. It’s now more of a transition towards focusing on individual risks which the traditional marketplace continues not to have much of an appetite for; but now it’s this transition more from wholesale concern over the market pricing and rates to more of a risk-by-risk concern.”
Conclusion: calming waters
The broader insurance industry continues to face challenges. However volatility in the marketplace appears to be easing up and rates, while continuing to rise, are not doing so in such alarmingly precipitous fashion. Across the last two or so years, captives have certainly been able to step in to cover insurability gaps, and this looks set to continue. As a result, what has been a tumultuous time for many is likely to be eased with the continuing uptake of captives. Moving forward, this will only strengthen the captive ecosystem in years to come and looks certain to continue driving the innovations and captive use-case as alluded to in this article.
