Why captives will stick around after a hard market

Canada’s P&C insurance industry is showing signs of market softening in some lines, but captives remain a viable option for commercial clients — particularly in fledgling tech industries such as cryptocurrency. 

Alternative risk transfer solutions have merit even when hard market conditions dissipate, one insurance brokerage executive told Canadian Underwriter at the Rims Canada Conference in Ottawa last week.  

A form of self-insurance, “captives allow you to customize your insurance coverage to your specific needs,” said Mark Morency, senior vice president and financial institutions practice leader for Gallagher in Canada. “You can get precise coverage for exactly what you do, as opposed to something that’s generic to your industry.” 

Given the cyclical nature of the property and casualty insurance market, even if you set up a captive now and the market conditions become soft, corporations with a captive will be well-prepared for any future hard market cycle, Morency said.   

“Even if it’s a soft market and you can find affordable insurance coverage, inevitably the market will return,” he said. “The captive provides a stable source of insurance coverage and pricing, which can be beneficial in a volatile market.” 

If the market for primary insurers is soft, the same usually holds true for the reinsurance market as well, Morency points out. And so captives can take advantage of low rates in a soft market by reinsuring a larger portion of the risk.  

“The lower cost of reinsurance allows the capital to possibly lay off some of its risk, and then build its reserve base,” Morency said.  

As costly as it can be to set up a captive, businesses may become more proactive on risk management, since they’re retaining that risk themselves. A captive could ultimately become a profitable part of the company.  

“The business is incentivized to implement strong risk mitigation measures, ultimately leading to improved loss prevention and lower claims over time,” Morency said, “which also means, by having the captive, you’re essentially paying the premiums yourself.” 

Morency said about four captives have been set up in Alberta this year thanks to new legislation allowing captives to domicile in the province. Globally, they’ve been growing in certain domiciles (regions) such as Vermont and South Carolina in the United States, Europe, Asia, and Latin America.  

There are ways to control costs when establishing a captive. For example, initial expenditures of time and money can be reduced by doing preliminary strategizing.  

“Potential cost savings can be found in various ways,” Morency said. “Just by creating the captive, you’re going to restructure your insurance program, you can increase retentions on your primary insurance, so this drives down the excess costs that you otherwise would have had.

“We find the formative costs pay for themselves, or they can generally pay for themselves in the first few years of operation.” 

Rent-a-captives are another way businesses can save “up to 50% less in operating costs,” he said.  

With a rent-a-captive, organizations rent a portion, or “cell,” of a captive facility. This gives organizations the benefits of captive insurance, without the upfront capital investment or maintenance costs of starting one from the ground up.  

“It’s like renting a little hotel room for your risk versus building a house for it,” Morency explained. 

Captives are especially useful for less traditional coverages like cyber, as opposed to property or casualty. For example, the construction industry is benefitting from captives. And, captives are becoming increasingly popular for crypto companies, since primary carriers have less data to model the complex risks emerging from these new technologies.

“As an industry that has a real difficulty in finding insurance, [crypto companies] may be able to more effectively retain their risk in a captive, or use the captive to lay off the risk through the reinsurance market.”

 

Feature image by iStock.com/erhui1979