Tuesday, May 21, 2024

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Responding to the rise and rise of captives

Douglas Plenty is a Partner in Insurance Consulting at Ernst & Young LLP, based in London, United Kingdom.
Imogen Gammidge is a Senior Consulting in Insurance Consulting at Ernst & Young LLP, based in London, United Kingdom.

Unprecedented disruption, a hardening (re)insurance market, and the onset of new major risks have increased interest in captive use by corporate risk managers. The captive market – once seen as an alternative to traditional commercial insurance – is establishing itself as a valuable risk management tool and a market in its own right. 

Changing risk profiles, from tangible assets, including physical property, to intangible assets, such as intellectual property, has meant that corporates are seeking alternative methods to provide coverage or capacity where traditional insurance cannot.

We estimate that the captive market grew to a total gross written premium of US $250bn in 2022 (Source: EY Nextwave Insurance – commercial and reinsurance paper). Through offering flexible and sophisticated insurance solutions, captives have expanded globally and diverted premium from the open market – and there’s every reason to believe they will continue to do so. 

Addressing the changing needs of corporate customers

The changing needs of customers in the commercial market, including corporate risk managers, global businesses, and mid-market organisations, is a major driver of this growth.

Customers are seeking tailored insurance solutions that meet their exact risk profiles and reflect their virtual asset base, operating models, and geographical footprints.



Large corporations have been examining their insurance strategies and selecting captives to provide a range of capabilities unavailable on the open market and will continue to if traditional insurers cannot meet their requirements.

For many smaller corporates facing new and more costly risks, captives are also being seen as a potential tool to manage the impact of pricing shifts which have substantially hit some industries.

As businesses expand their operations into new markets and increase their reliance on technology, they also become more vulnerable to intangible risks, such as climate events, political volatility, changes in regulation, and cyber-attacks.

With the increasing value of intangible assets from corporate companies, the demand for coverage, and more robust protections from cyber and climate threats through advanced risk insights, is ever increasing.

Companies of all sizes and sectors are now seeking effective risk advisory services and packaged solutions that feature data and analytics services, provision of risk engineering and market-specific offerings, tailored to local laws and regulations.

Solving for intangibles and new threats

To solve for the rise of intangible risks, which now comprise most of the value on company balance sheets, many corporate risk managers have embraced self-insurance for coverage and risk insights that are not readily accessible on the open market.

Corporates have realised the potential for captives to provide advanced analytics and insight generation capabilities, which has led them to master their parents’ risks and build effective loss prevention strategies.

Reduced losses, in combination with use of sophisticated reinsurance purchasing, has resulted in a reduction in portfolio volatility and captives becoming increasingly comfortable taking on more risk.

Captives are further deploying data analytics tools to enhance their risk retention reviews, pricing and coverage negotiations, and risk management efforts. Having grown increasingly self-sufficient and profitable, many large captives see little reason to turn to the open market.

The largest captive insurers are going beyond covering their own risks because they see an attractive path in commercializing their capabilities.

Insights into specific customer needs also means that captives can generate innovative solutions to protect society from its greatest threats. For instance, captives are being used more frequently as incubators for product development, including cyber threats and parametric coverage for intangible assets, to understand companies’ evolving exposures.

Captives offering cyber insurance emerged in response to reduced capacity and rising pricing of this product line in the traditional market. Cyber cover provided by captives now typically forms a fundamental component of their parent’s cyber risk management strategy.

Similarly, a withdrawal of carriers willing to underwrite “brown” risks, due to increasing ESG concerns, has led customers to consider bifurcation of their “brown” and “green” exposures through captives, or bundling of these exposures to support the onward transfer of risk.

The role of brokers and insurers

There is huge opportunity for brokers and insurers to be doing more for their captive clients. Specifically, around alternative revenue streams, including risk advisory and data-led services to provide expert advice on risk management, regulatory compliance, and industry benchmarking.

These services can help captive owners to regularly evaluate their insurance programmes and identify opportunities for improvement. Captives are a tool to solve problems that cannot be solved in the commercial marketplace, and they should work in harmony with the wider ecosystem.

Brokers and insurers have the capabilities to facilitate this relationship and in doing so, support both themselves and captive owners seize further revenue and growth opportunities.

To support clients in their decisions to build out captives and gain the benefits of continuous product development, advanced insurance strategies and risk insights, collaboration may be the best path forward for insurers and brokers. In turn, new growth opportunities may be realised for captives, too.

A success story in this space is the collaboration between captives and managing general agents (MGAs).

There is US$100 billion worth of revenue in the global MGA marketplace (source: EY Nextwave Insurance – commercial and reinsurance paper) and MGAs are growing more profitably and rapidly than any other market players.

Their flexible structures allow for captives to support in a myriad of ways, primarily through providing access to reinsurance markets.

The prevalence of these arrangements is in its early days. However, we believe there are more opportunities for MGAs to exploit – and more innovative captive partnerships on the table to drive growth.

Conclusions

As demand for non-traditional risk cover rises, so will the need for alternative insurance solutions. Corporates and their (re)insurance partners that are ambitious in their action to together navigate changing risk profiles and demands stand to realise benefits from new insurance strategies and considering the role of captives.

Within a complex and ever-changing environment, a combined cross-(re)insurance industry approach, centred around the needs of customers, is imperative.

Those that succeed will invest in the opportunity to form early alliances with captives to drive innovation and build the capabilities needed to add value to customers and protect wider society.   

Disclaimer: This Publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Member firms of the global EY organization cannot accept responsibility for loss to any person relying on this article.