Captives and natural catastrophes: Growing challenges and strategic solutions

Captive owners aim for dynamic risk management and proactive risk mitigation, aligning with corporate insurance goals.

In Europe, captives have become more important for risk management as they are now applied in a more active way. Today, multiple lines of insurance that cover different risk exposures of the owners are frequently transferred to their captives.

Between 2019 and 2022, premium volumes in the global captive insurance market increased by 24.8%, reaching $72 billion in 2021. Recent market insights suggest that this growth trajectory is likely to persist in the coming years ¹. 

Critically, there are several trends driving this growth.

First, large European captive owners are increasingly focusing on a holistic view of risk given the implementation of the European Solvency 2 regulation which provides benefits for risk diversification. We have noted that the expanding use of captive reinsurance across multiple business lines has heightened market demand for cross-class captive protections.

Second, new risks such as cyber are often being fronted and substantially reinsured within captives, primarily to protect the balance sheets of local operating subsidiaries and collect cyber exposure and claims information.

Third, a new trend in the use of captives is emerging in Europe – specifically, the management and financing of increasing natural catastrophe risks, with these having become a challenge for captives for several reasons: 

1. Higher claims frequencies: The rise in natural catastrophes is leading to more frequent claims and greater overall losses ². Consequently, captive insurance companies covering specialized risks for their owners may face increased claims payments.
2. Concentration of risks: Captives are sometimes designed to take on specific risks that traditional insurers may not cover. If these risks are exposed to natural catastrophes, it can lead to a concentration of losses, which could jeopardize the captive’s financial stability.
3. Reinsurance protection: Captive insurance companies often depend on reinsurance to mitigate significant losses. However, as natural catastrophes increase, reinsurance costs are likely to rise, with partners potentially reducing capacity, driving up premiums and limiting availability.
4. Regulatory requirements: Depending on the jurisdiction, captives face specific regulatory requirements. As natural catastrophe losses rise, regulators may impose stricter capital requirements or other measures to ensure the captive’s financial stability.

To tackle the challenges posed by rising natural catastrophes, captive owners need a clear view of their exposures, policies, losses, and risks that can be easily assessed, analyzed and modeled.

Swiss Re has developed a solution that provides insight via a digital twin that has been built on key underlying information, enabling seamless integration with services across the captive management value chain, from automatized submission update and policy & loss analysis to NatCat scenario impact analysis and NatCat limit review.

The benefits for captive owners include: 

• Realistic and dynamic picture of the underlying information of the captive.
• Relevant risk alerts enabling fast actions.
• Ad-hoc simulation capabilities.
• Accurate costing and program structuring focused on NatCat. 

With the ability to analyse and quantify NatCat risks and determine target balance sheets for captive retention, captive owners can evaluate both traditional and alternative risk transfer solutions. 

If capacity constraints arise, parametric (re)insurance may offer balance sheet protection for reinsurance captives. These alternative risk transfer solutions can help captive owners to hedge risk by setting predefined parameters that automatically trigger a payout when a certain event occurs, helping to avoid lengthy claims processes and preserve liquidity.

Of course, it’s important to a company’s individual needs and risks to ensure that parametric solutions are an appropriate option. At Swiss Re Corporate Solutions, we’re ready to work with you in providing expert advice on this matter.