Supply chain disruption caused by geo-political risks and cyber are two risks that need immediate addressing from captive owners, say Zurich’s head of captive fronting for Continental Europe, Joshua Nyaberi, and head of captive services EMEA, APAC & LATAM, Paul Wöhrmann.

At the recently held EU Captive Summit in Amsterdam, several captive owners, service providers and other industry stakeholders discussed a broad set of topics. Among these topics was “developing best practices for geopolitical risks and supply chain disruption”.

Over the period 2017-2021, the findings of the World Economic Forum Global Risks Report showed that on one hand, geopolitical risks such as interstate conflict with regional consequences have stayed at the top of the rankings in terms of impact while on the other hand, environmental risks such as extreme weather events, and major natural disasters, have steadily maintained the top position in terms of likelihood of occurrence. These are current realities for most captive owners as they navigate the challenges of todays’ business.

This combination of environmental and geopolitical risks, which by themselves are both frequent and severe, create a perfect storm for major supply chain disruptions. For this very reason, major supply chain disruptions can no longer be considered or expected to be rare occurrences.

Many captive owners have extensive international operations with complex supply chain arrangements that are prone to the impact of geopolitical events, and we have observed that a number of captive customers faced challenges with their insurance programs triggered by current geo-political developments. The question that we would like to briefly explore is are there ways captive owners can plan, prepare and build best practices to prevent being caught by surprise?

Global events ranging from US-China trade wars, shortages in the semiconductor industry, COVID-19 pandemic, and most recently, Russia’s invasion of Ukraine, continue to rattle the global supply networks.

For captive owners with operations in Russia, it will be increasingly difficult to get a partner who can support participation in Russian risks under an international program. In response to the resulting sanctions regime, some captive owners had to make changes to their large international programs to ensure compliance with sanction regimes. Options that have been considered include cancellation of local policies, retaining local cover but excluding it from the international program reinsured through the captive, or buying new stand-alone local policies.

With some international fronting insurers exiting Russia altogether, local coverage in Russia will no longer be issued by “the usual” partner providing international programs. This may affect service quality and/or impact the capacity a captive has available from a purely local carrier.

Captive owners can still take steps in managing geopolitical risks and the impact of supply chain disruptions. In this regard, the following might be considered:

• Supply chains have become more and more complex with the advent of globalization. There is a case for local supply chains or near-shoring key supply arrangements. Additionally, supply chain disruptions once again call on organizations not to discard fully the old ways of running operations, such as maintaining buffer stocks in the event of interruptions.

• Concentration risk is a key area of concern and focus as organizations re-adjust their supply chains for robustness and resilience. Diversifying supply bases therefore becomes an urgent priority for companies, industries or governments that want to protect themselves.

• Application of technology helps mitigate supply chain risks by providing enhanced access to data, data exchange on relevant risks, monitoring suppliers and improving visibility across different types of risks and risk events. Technology augments the organisation’s posture to anticipate and respond in the event of a disruption.

• Supply chains entail complex interdependencies and therefore require trust among both internal and external stakeholders to ensure that a minimally viable operating environment can be jointly developed and maintained.

• Productivity improvements are required to counter or offset the increased cost of production and hence protect margins. Productivity gains may compensate for supply chain strain and allow for seamless order processing.

• Insurance solutions provide more than financial protection against loss or impairment of physical assets. They also protect the balance sheet because uninsured losses cause unplanned cash outlays that deplete liquidity. However, there are challenges in the current insurance market to get coverage that adequately addresses geopolitical risks and supply chain disruptions.

Another area that continues to draw the attention of captive owners is cyber risk and its financing. We observe an increased fronting interest among European captive customers in risk financing for cyber exposures. Since 2019, we have been tracking and analysing cyber fronting requests, showing us the following market picture:

− Submissions stem from diverse sectors, however financial services stands out in terms of number of requests and size of capacity required.
− The proportion of primary layer requests (captive retentions up to US$ 10m) represents 40% of the incoming requests.
− Many of the active frontings are net cessions and structured as excess of loss.

Broadly, the expectations of the captive customers seeking to place cyber risk in their reinsurance captive include among others professional captive fronting services with a distinctive pricing ability, reliable claims management capabilities and fit-for-purpose wording according to the customer’s needs. Often this becomes relevant in the context of an international program to cover all subsidiaries.

As a central risk financing vehicle, a captive can centrally collect and contribute high-quality information on cyber risk incidents and related claims data. In April 2020, we published an insightful podcast in which European captive opinion leaders provided their views that underlined the importance of captives in incubating cyber risk, which in many respects is still in its infancy stages .

Through the involvement of a captive, captive owners systematically receive their own risk data, which is helpful in building up cyber risk insights and in learning from their own loss experiences. These valuable risk and claims experiences could be shared by captive owners with the insurance and reinsurance markets to support risk modelling and pricing. This could in turn create greater underwriting appetite for risk transfer in favour of captive owners. Potentially, as capacity in the insurance industry remains constrained, cyber insurance-linked securities could be a significant source of capacity for reinsurance captives .

New connectivity capabilities such as application programming interfaces (APIs) will allow fast and transparent data transfer from both the insured to the fronting insurer (primary insurance level) and from the insurer to the captive (reinsurance level). It should enable captive customers to digitally track premium and claims statements on a daily or even real-time basis.

These developments should lead to a point where periodic (e.g., quarterly) settlements at the reinsurance level become a thing of the past as efficiency in the risk financing and risk transfer process becomes significantly increased.

As a fronting insurance provider with a proven insurance and reinsurance structure, Zurich can significantly increase efficiency with captive customers by availing these new interfaces and thus create added value for the customers.

Zurich has a vast network available for captive owners, with comprehensive global experience on all aspects of managing and utilising a captive. With this knowledge, we can help captive decision makers to find new strategic options and implement/execute respective solutions.