Captives to the fore as risk managers grapple complex risk environment

Driven by a challenging risk transfer environment, risk managers have shown a growing interest in forming captives in recent years—a trend that is likely to continue, Laurent Nihoul, board member and chair of the Captive Committee, FERMA, told FERMA Forum Today.

“There has clearly been an uptick in captive interest over the last years. The captive insurance and reinsurance industry has experienced significant growth in both GWP and the number of entities, driven by increasing awareness of the benefits, a challenging risk transfer environment, and the evolving risk landscape,” he said.

He noted that Marsh reported in its latest “Captive trends and insights” report that between 2020 and 2023 it set up approximately 500 new captives, while its total captives premium managed increased from $49 billion to $73 billion between 2018—the onset of the hardening market—and 2023. 

Nihoul commented that, beyond the hardening market, which is now slowing down, other factors are driving this growth. These include developments such as the transition to net zero and the challenges in obtaining insurance for new technologies, and the evolution of emerging risks like cyber and increasing supply chain exposures which continue to require innovative risk financing solutions.

“I do not expect this trend to slow down. Firstly, because the risk landscape is continuing to evolve rapidly, and secondly because the insurance market is facing challenges in providing relevant solutions in a timely manner for these evolving risks. Captives will therefore continue to be an efficient means of addressing issues such as capacity shortages and restrictions in terms and conditions,” Nihoul said.

One key development also driving interest in captives was the recent Solvency II amendments, he noted. The first key change in the updated Solvency II Directive was the introduction of the concept of “small and non-complex” (SNC) insurance companies, which will bring much more clarity and consistency across EU Member States.

The second key change, Nihoul noted, is what he calls the idea of reversing the burden of proof. “This means that undertakings classified as ‘small and non-complex’ may use all proportionality measures, except where the supervisory authority has serious concerns in relation to the risk profile, provided this concern is duly explained.”

He continued: “This is more of an evolution than a revolution. FERMA expects that the vast majority of the European captive community will fall under the SNC classification which will enable them to benefit from further proportionality measures on reporting, disclosure, governance, revision of written policies, calculation of technical provisions, the Own Risk and Solvency Assessment (ORSA) and the liquidity risk management plan. Although it will not be a complete revolution, some relief may be expected for captives as a result of the reduction in these requirements.”

Recently, FERMA issued an EU Policy Note on Solvency II which explores the implications of the new proportionality framework for captive managers domiciled in EU Member States, highlighting critical aspects of the amendments and examining the specific thresholds and criteria. 

Nihoul also commented on the growing interest from some European countries in becoming captive domiciles. He said it mirrors what has happened in the US, where there has been a gradual shift to onshore domiciles over the last decades. In addition to the traditional EU domiciles, France has been one of the first to move, while there have been significant developments on the captive front in the UK, Spain and Italy. 

“It is still to be seen how significant the benefits of these developments will be for EU captive owners,” Nihoul said. “Solvency II means that regulatory regimes are similar across the EU, so there should not be any notable technical differentiations between countries. Further, due to the Freedom of Services rules, an EU-based captive already benefits from significant flexibility across Europe. If we compare that to the US, it is similar to having a captive licence to operate in all 50 states.

“While there are clearly potential advantages relating to proximity criteria and administrative and tax requirements in the owner’s country of origin, it will be a watching brief in terms of what the other benefits will be.

“However, as a general point any development that increases the potential choice for risk and insurance managers tends to be a positive one.”

“Captives can facilitate the growth of sustainable energy initiatives and contribute to broader environmental goals.”

 A greater scope

He also envisages the role of captives expanding to better meet the risk transfer needs of corporates. He said there are multiple ways in which the role of the captive can broaden to address evolving risk needs. 

Firstly, they can facilitate improved risk management practices by operating as a central unit leveraging detailed data analytics to understand and mitigate for instance the risks that underpin the net-zero transition more effectively, he noted. Such structures can enable more effective coordination of risk data and exposure analysis, risk management and prevention measures, and financing requirements.

Secondly, the captive provides a means of addressing specific gaps in the availability of standard insurance cover. Considered use of such vehicles can enable owners to structure Difference in Conditions (DIC) and Difference in Limits (DIL) clauses by combining coverage available in the insurance market with bespoke, insurance sub-covers or exclusion buy-back solutions.

Captives can also play a role in incentivising sustainability practices, he said. For instance, a captive might offer premium discounts for reduced carbon emissions, adoption of renewable energy, or the implementation of eco-friendly practices. This alignment can encourage the entire organisation to adhere to sustainability objectives.

“Supporting renewable energy projects provides another opportunity. Captives can insure renewable energy projects that may struggle to obtain coverage from the traditional market due to the degree of innovation and perceived risk levels. By doing so, captives can facilitate the growth of sustainable energy initiatives and contribute to broader environmental goals,” Nihoul said.

At the FERMA Forum, Nihoul hosts a discussion on “Captives: The UN Principles For Sustainable Insurance In Practice” in which delegates will hear from two risk managers whose captives have implemented the UN Principles for Sustainable Insurance. Also, Butch Bacani, head of insurance at the UN Principles for Sustainable Insurance & UN Forum for Insurance Transition, will be discussing the aims of the principles.

FERMA Forum Today is in partnership with Captive Review, part of Newton Media.

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