Practical Benefits of Captive Insurance Solutions

When it comes to insurance cover, companies are presented with a major dilemma: a hardening market with higher rates and lower capacity makes insuring risk more expensive, yet the list of global risks just keeps on growing.

But there is also the option to bring some of the risk back into a company: either through higher deductibles (and hope nothing will happen), or by setting up a captive – an in-house insurance or reinsurance company that can cover an increased retention in the traditional insurance program.

And if a company is not yet ready for all the regulatory and governance legwork that running a captive involves, there are new alternative products available, like virtual captives.

The need for self-insurance mechanisms stems from the fact that many companies are only just recovering from the fallout of COVID-19, but are now facing further risks from rising inflation, the war in Ukraine, clogged-up supply chains and cybercrime. Meanwhile, the insurance market remains at its hardest in two decades and our data shows that commercial insurance premiums will continue to rise over the next two years.

‘’We have a growing self-insurance market using captives, rent-a-captive [PCCs] or virtual captives and I expect this to continue,’’ says Thomas Keist, our Global Captive Solutions Leader. “That’s driven by the continuous hard market and corporates getting used to that form of self-insurance. It sort of becomes a must-have at this point.”

When a captive is well structured it lowers a company’s insurance costs and provides the financial stability that can’t be found through an easier solution such as higher deductibles.

That’s the main selling point to a company chief financial officer: an actuarial survey should show that “you will definitely expect to save considerable money”, Keist says. His second reason is that “the only way to keep predictability within an increased retention strategy is by way of an insurance vehicle, because in an insurance vehicle you inherently set up reserves for future losses”.

Captives are most useful if a company has a diverse portfolio of risks, as they can make use of the diversification effect – and you don’t have to insure every unit separately.

An insurance vehicle like a captive or virtual captive can be essential when a company's subsidiaries are not capitalised to sustain major losses that fall within a large deductible. For example, when a critical research facility overseas has flooded or burned down, but the respective loss remains within the traditional insurance program's deductible, the subsidiary owning the lab may need to be recapitalised to enable rebuilding. From a corporate finance point of view, the parent company can’t just send a cheque. However, a captive insurance structure can kick in more efficiently – based on the established insurance claims management process – and can pay quickly, in the right place.

As a rule of thumb, captives typically suit companies that have an insurance premium spend of at least USD 3-5 million annually.

On average, captives cover losses of between USD 10 million and USD 25 million, and sometimes up to USD 50 million, but won’t cover catastrophic events including earthquakes, floods and storms – these will need third-party insurance from providers like Swiss Re Corporate Solutions to cover the excess.

To begin with, an actuarial survey (a "feasibility study") will determine the layers of insurance required: what needs traditional insurance, what can be covered by higher deductibles and what can be efficiently insured via a captive.

We were the first to-market with a virtual captive offering in 2020, as companies were reeling from the COVID-19 fallout and the insurance market was in its third year of hardening – with little relief in sight.

A virtual captive has many of the benefits of a captive, but we handle the set-up and the administration of the supporting balance sheet instead. So, you can dip your toe into the captive world without having to commit long-term, as a typical agreement is for three to five years. 

Two years on, some of our competitors have followed suit and launched their own versions. This is good news for the insurance industry, as it widens choice and grows the market.

While virtual captives are a safe option for testing the water, it’s still a very new product so “we’ll expect to see the main growth in traditional captives”, Keist says. ‘’Virtuals will follow and evolve slowly but surely,’’ he adds.

The majority of captives still cover traditional risks such as property, Keist says.

There are, however, increasing calls for new lines of business such as cyber risks to be put into captives, because the insurance industry is unable to provide adequate cover at present, he adds.

A recent report by the Swiss Re Institute found that most firms are uninsured or significantly under-insured for cyber risks. In a recent survey, only 55% of businesses reported having cyber cover and fewer than one in five have cover limits above the median ransomware demand.

The overall risk is hard to quantify because of immature data and a lack of model consensus, the report says, and as a consequence limited insurability curbs capacity despite growing demand.

‘’The insurance industry has so far failed to provide an appropriate solution,’’ Keist says. “I believe, in the next few years, this will be one of the most important missions of the insurance industry. The establishment and use of captives to provide cyber coverage to corporates could be an important catalyst to this development’’

Cyber risks are a telling example of the increasing number of headwinds companies are facing. With the outlook for traditional insurance remaining hard and insurers developing more products to help businesses self-insure, captives are a viable, flexible option to meet future challenges.