Captive Development
From Single Parent to Association Captives, Side-Cars, Rent-a-captives and PCCS & ILS|. From Closed Captives to PORCs and Open Market Companies
Some of the largest conventional insurers and reinsurers have in their DNA, capital that originally emanated from the alternative insurance markets. ACE (purchased by Chubb in 2016) and AXA XL (with AXA’s purchase of XL in 2018) come to mind as they started life as association captives. Lines between the conventional, captive and alternative risk financing market also became blurred with captives increasingly entering the open-market arena in some shape or form.
Historically, the first captives were known as pure captives as they were single-parent captives and only insured risks of the parent. Over the following 100 years or so, Mutuals and Association Captives, RRGs, RPGs, PORCs, side-cars, rent-a-captives, ILS, PCCs, micro-captives and other vehicles flourished as each domicile endeavoured to carve out a differentiated, sustainably profitable proposition. Domiciles also continued to grow onshore in the USA and offshore centres west of the Atlantic to the Channel Islands, onshore and offshore EU, the Middle East, South East Asia and the Far East. The greatest changes in recent history in the captive arguably occurred post- early 1990s hard market when the captive industry experience another growth impetus.
Exit Stage Left: Soft Market Cycle
Breaking the 20-year cycle
We are exiting arguably the longest soft insurance market cycle in living memory. Premiums have been softening since before the Millennium and not even the dot.com bubble, Enron debacle or the great financial crisis OF 2006/7 managed to break the soft market cycle. Pricing did not follow any scientific logic and was held hostage by the market reality of excess and constantly growing supply. I remember, when working in the Middle East, that it was sometimes cheaper to insure a tower block for property and general third party liability than it was to purchase comprehensive motor insurance on an executive car!
However, the prevailing long-term negative interest environment, expensive natural disasters, the current economic slump and bleak, short-term economic recovery prospects have finally strengthened the arm of reinsurers, who are ultimately the puppet masters behind the primary insurers serving markets. A competitive environment dictates that companies can enter and exit markets with relative ease. Reinsurers exercised this option this by reducing or withholding capacity in markets or lines of business that do not deliver the technical returns expected by management or their investors. This translates into higher premiums and deductibles, higher client selectivity and more policy exclusions.
These harsh market conditions, with premiums increasing between 20% and over 100%, depending which on line of business, makes the captive proposition more attractive once again.
Enter Stage Right: Virtual Captives
A prelude to captives? Not just.
The latest in the repertoire of captive solutions is the Virtual Captive concept (VCC)pioneered by Swiss Re Corporate Solutions (SRCS). Why and for whom is their proposition even more valid today? To call it ‘new’ may not be strictly speaking correct since a similar concept existed in some shape or form since the late 1980s conventional market hardening and the term ‘virtual captive’ may mean different things to different people. But, SRCS have freshened up the concept, starting from conventional underwriting and risk appetite (and some ultimate risk carrying if required) as their spring-board to a ‘capacity-building’ product.
Captives remain valid today for the same reasons they were valid when they first started, i.e. companies with a loss history that is better than that of the conventional market and that are very serious about their risk management and who are not yet invested in captives, are still subsidizing the losses of others in the market.
If they are not yet invested in captives then the time to do so is now.
Investing in captives is not only a matter of putting in the required capital. Insurance companies (even captive insurance companies) are regulated entities that operate within a supervised regime and require structured technical and governance substance.
SRCS’s VCC is not, in itself, a captive; it is the prelude to a captive. VCC is a multi-year insurance contract that allows a corporate client to ‘build’ capital on SRCS’s balance sheet. How? The premiums paid by a corporate client are ‘ring-fenced’ by SRCS and used only for administering the policies of that client. Any surplus at the end of the multi-year period less any management fees IS repatriated to the client. This means that clients with a better than market loss ratio will, at the end of the multi-year insurance period, reap a return premium which can be translated into the minimum capital required for the client to establish a captive.
If the proverbial hits the fan and claims exceed the maximum expected losses under the multi-year programme , then there are mechanisms in place to ensure insurance continuity for the client.
Before taking the plunge and establishing a captive, the multi-year period can be used not only to build up the required capital, implement a stronger risk management framework but also to build the required technical and governance substance in anticipation of establishing a captive.
The virtual captive concept can also be used by existing captives. How? If captives are considering expanding their lines of business and would not wish to initially expose their balance sheet to potential liabilities from the new line of business, they can ‘sand-box’ the risk on the balance sheet of Swiss Re Capital Solutions.
It can, likewise, be used when captives are exiting a line of business. The virtual captive can be used as a ‘run-off’ solution by using the SRCS’s balance sheet for their exit strategy in respect of any unwanted risk.
