It's no surprise to most insurance professionals that the current insurance marketplace has become increasingly distressed in recent years. The first quarter of 2022 marked the 18th consecutive quarter of commercial property and casualty premium increases, with average increases across all account sizes at 6.6%. Furthermore, double-digit increases continued on particularly distressed lines such as umbrella at 10.5% and cyber at 27.5%.1

The ongoing fallout related to the COVID-19 pandemic, climate change, the increase in nuclear verdicts and litigation costs, and inflation have all played a role in driving rate increases. The global risk environment is arguably more complex, uncertain and volatile than it has been in recent decades.

Q1 2022 was the 18th consecutive quarter of commercial property and casualty premium increases.

What is a captive?

A captive is a licensed, regulated insurance company owned and controlled by its policyholders that is designed to provide insurance. The captive manages a loss fund; accrues investment income on premiums; pays losses to the policyholder from the loss fund; and returns underwriting profit to the policyholder(s). These are the same functions that commercial carriers perform, but it's common for mid- to larger-sized companies to self-fund insurance by forming a single-parent captive. Captives traditionally are formed to handle property and casualty coverages, however, can be used for a range of additional insurance purposes, including medical stop-loss.

As challenging market conditions persist, the pace of new captive formations continues to surge as clients look for alternatives. All major U.S. domiciles, as well as Bermuda and the Cayman Islands, saw strong numbers of new captive formations in 2021. Vermont, as an example, noted 2021 as its fourth-highest year on record for new formations, trailing only its first year as a captive domicile and the two years following 9/11.2

Captives have been increasingly attractive to organizations as they decide how to retain vs. transfer more risk, access additional capacity and achieve greater stability over the long-term. As insurance brokers navigate these decisions with clients, they must understand when and how to deploy a captive strategy as an effective alternative and how to appropriately set expectations with clients.

As the old proverb goes: "The best time to plant a tree was 100 years ago. However, the second-best time to plant a tree is today." The same concept holds true for a captive insurance strategy. While we cannot change the current conditions of the market, we can advise brokers on best practices and alternative solutions so they can be better positioned to help their clients in the future.

The management of risk.

Before we discuss the role that captives can play in navigating a hard market, it's important to first address the concept of risk management, which plays a crucial role in the success of a captive insurance program.

The most effective way for an organization to gain greater control across their insurance program is through the assumption of risk. Once the client's organization is comfortable assuming risk, the conversation needs to shift to "How are we going to manage the risk the client now assumes?"

Many of our successful captive clients work in conjunction with their insurance brokers to build a robust risk management program that incorporates best practices, various loss control initiatives and a proactive plan to manage claims when they do occur.

Whether that control comes in the form of using a third-party administrator for claims handling or having choice of counsel, insurance companies will only relinquish those elements of control when the insured — the client — commits to assuming a portion of risk. With a comprehensive risk management plan identified, brokers and their clients can then begin to evaluate different risk financing mechanisms such as captive insurance solutions.

As an insurance broker, it's important to identify the dos and don'ts of implementing or recommending a captive strategy for your client. What better way to address these than addressing some of the myths within the market? Below are a few of our favorites.

Myth #1: A captive will save me money immediately.

Instead of immediate cost savings, the captive focuses on financing risk more efficiently over the long-term. In most cases, the captive may be comparable or even more expensive to the traditional marketplace. However, captive strategies are designed to provide clients with long-term stability, which spans three, five, ten-plus years across hard and soft market cycles.

Captive solutions are most effective when they become the centralized hub for the overall risk management plan, providing clients the flexibility to be nimble with the captive's assumed portion of risk as market conditions change.

Myth #2: A captive will replace my entire insurance program.

It's actually very rare that a client will be 100% self-insured across their overall insurance program. In most cases, clients will still transfer a portion of risk to the marketplace for claims that are too hard to predict or catastrophic in nature. This element of risk transfer can take the form of a stop-loss policy, excess policy or various (re)insurance transactions.

As a result, a captive won't replace the entire insurance program. Instead, the captive will look to take on a layer of risk that is predictable for the client to assume.

Myth #3: A captive can be a quick fix.

Ample time is one thing that is absolutely needed for a captive evaluation and overall integration to be successful. Captive insurance solutions take time across different platforms.

For context:

  • Clients need time to understand the fundamentals of captive insurance strategies, how they can be used, and what strategy and risk level is appropriate for them.
  • Actuaries and underwriters need time to review the risk profile and model the projected loss scenarios for the captive's assumed risk.
  • Captive regulators need ample time to review the application, understand the proposed business plan and ultimately issue the captive license.
  • Brokers need time to build out the remainder of the insurance placement outside of the captive's assumed risk and negotiate with other markets.

At a minimum, captive solutions can take anywhere from three to six months to implement successfully into an overall insurance program.

In our opinion, the best time to evaluate a captive insurance solution is immediately following a renewal to prepare for the following year or at least 6 months in advance of the renewal.

Emerging trends for captive insurance solutions.

By debunking these myths, brokers can better understand how to deploy a successful captive solution despite market continues and also clearly communicate with clients to effectively evaluate a captive insurance solution.

Recently, the emerging trends for captive insurance solutions have been in the following areas:

  • Increased retentions on primary lines of coverage
  • Participation in quota-share arrangement in higher layers of the tower
  • Filling in insurability gaps in capacity or coverage
  • Increased cell formations as an expedited fashion to enter alternative risk market
  • Cyber liability
  • Directors and officers (D&O)
  • Medical stop-loss
  • Third-party insurance programs

These emerging trends have become most prominent across several industries. Most notably, transportation, construction, healthcare and large real estate companies continue to see a benefit from integrating alternative risk solutions like the establishment of a captive insurance company.

As we continue to face headwinds within the marketplace, we have also seen an increase in higher education and financial institutions evaluating captive insurance strategies as a way to mitigate the pressures from the marketplace.

Key considerations early in the captive process.

While these exciting trends within the captive industry highlight flexibility in a dynamic market, they also serve as a reminder to the importance of appropriately setting expectations with clients. It's imperative that brokers properly identify the goals and objectives of their clients at the outset of the captive evaluation process. The client needs to understand both what is realistic in terms of captive potential in the immediate future and develop a well-thought-out strategy for the captive to evolve over time.

There are a number of key considerations for brokers, and their clients, to contemplate early in the captive process.

  1. Understand market implications. Determine which lines of coverage to include in the captive and what the impact may be to other lines of coverage placed in the traditional market, with either one or multiple carriers.
  2. Understand the difference between group captives and single-parent captives (SPCs). SPCs can provide clients with more flexibility in terms of structure and coverage offerings, but many middle-market organizations may not have the scale to effectively use an SPC. Additionally, SPCs often require more capital investment on the front end and more lead time for the captive formation.
  3. Impact of adverse loss results on the captive. A one-in-100 year event is as likely to happen in year one as it is in year 100. It's important to address whether the client has the financial capacity to absorb potential losses early in the captive life cycle.
  4. Financial and time commitment. Impact of capital requirements depends on the scope of the captive. Rarely do captives require an organization to hire additional staff, but they will require oversight from the risk management and finance teams.
  5. Evolution of the captive. As the captive matures and builds surplus, the captive can evolve to provide additional value beyond the original scope. Successful captives have a long-term strategic plan that's designed to flex as the client's goals and objectives change over time.

Many clients may be unable to address all of these considerations at the onset of their captive formation, which is quite normal. However, the brokers who effectively position captives as a viable alternative for their clients are those who involve a trusted captive manager early in the process. An effective captive manager will by no means look to replace or supersede the role of a broker, but rather act as a partner in helping the client to address the key considerations and navigate the alternative risk marketplace. At Artex, we're here to support our insurance broker partners as they navigate the captive industry on behalf of their clients.


Sources

1"Q1 P/C Market Survey 2022," The Council of Insurance Agents & Brokers (ciab.com), 25 May 2022.

2DuChene, Courtney."2021 Was a Busy Year for Vermont's Captive Industry. What Will 2022 Bring?" Risk & Insurance, 18 Jan 2022.

The Art of Risk

At Artex, we believe there is more to alternative risk management. As a trusted leader and provider of diverse (re)insurance and ILS solutions, our global team operates at the intersection of art and science — where creative thinking meets expertise and superior outcomes are made. That's how we're able to fully understand our clients' needs and deliver the most comprehensive solutions available.

 

Established in more than 35 domiciles internationally, we're here to help you make empowered decisions with confidence, reduce your total cost of risk and improve your return on capital. At Artex, we believe in finding you a better way.

Author Information

Chelsea Carter
Chelsea Carter
Account Executive – Business Development, North America
Ryan Santacrose
Ryan Santacrose
Assistant Vice President – Business Development, North America