Captives are well placed to tackle climate risk

The head of captives and climate risk at WTW says captive insurance companies can have a key role to play in managing climate change risk. 

Captive insurance companies are sometimes better placed to insure climate risks for their parent companies than commercial carriers, according to a leading captive insurance and climate risk advisor. Peter Carter, the Head of Climate Practice & Head of Captive and Insurance Management Solutions at WTW, said climate change is “the single biggest source of risk that companies must navigate to be successful in the future”.

Carter, who took charge of the climate practice last October, said in a recent interview: “If you want to make sure that the job of managing the impacts of climate change are being properly attended to, then involving your risk manager and the captive, if you have one, is a great place to start.”

He added: “Managing the risks related to climate change is one of the biggest challenges of our time. Understanding the financial impacts of climate change is critical to developing strategies and action plans to improve resilience and protect long term value. Climate risk, as with many other risks, can be financed, and managed with the help of the captive applying sound governance and underwriting discipline.”

Carter, who has headed WTW’s captive and insurance management solutions since 2019, said every company must reconsider how climate change could affect the cashflows being generated by its physical assets and the assets throughout the extended supply chain. You must also consider any additional risks arising from the transition to a lower carbon economy which can give rise to risks such as from the use of new and untested technologies.

He said whilst regulation was pushing companies to be more transparent and disclose more information, more needed to be done to identify, quantify and manage the many risks in a systematic way. “If you've made commitments that you're going to get to net zero by a certain date, how are you going to do that? Specifically, what is the glidepath? What are the KPIs you're going to use to measure progress and confirm you are still on the correct glidepath?”

“What I like about bringing the captive to the table in helping to resolve these challenges is its ability to finance risk that traditional insurance markets may not be ready to insure today. There may not be enough data, or confidence in writing such a policy, but that's in the sweet spot for a captive to step in, accept these risks and start to incubate them. By building more data and information about the risk profile, you can improve the chances of financing these risks in more traditional ways over time.”

Asked if insurers of all sizes including captives were well equipped to calculate their climate related exposures, Carter admitted that this is challenging. This goes beyond simply being able to count carbon emissions in the portfolio of clients you have underwritten. More important than counting emissions, you need to understand how resilient the assets are on your balance sheet, he said.

They also need to determine how the value of investments today could be at risk of sudden price corrections because of more extreme weather conditions and to assess how liabilities could become more severe than predicted.

He said insurance is used to dealing with such complexity, but perhaps more relevant today is the ability to convert outputs from scenario planning to quantitative models more dynamically, as well as having access to more real time data to be able to confirm the accuracy and predictive power of any models used.

“Looking specifically at a captive, to the extent that it is only dealing with risks related to its parent then this may be a slightly less complex task than for a commercial insurer having to consider such exposures across multiple industries and sectors of the economy.

Turning to the overall state of the captive sector, Carter said: “The captive sector continues to be vibrant across most geographies as corporates wrestle with the best way to leverage their balance sheets with those of traditional insurance markets and alternative risk transfer solutions such as parametric and derivatives to hedge risks.

“We are seeing the formation of a number of new captives and cells, along with existing captives placing more risk into the captive, where the group can afford to retain this risk.” Carter said emerging risks included cyber threats and geopolitical as well as climate risk.

“Even though the insurance market has eased in some lines of business, new and emerging risks and exposure to natural catastrophe means some lines remain challenging. A captive programme continues to be very much in demand with CFOs searching for the best way to enhance the resilience of their balance sheet through combination with traditional insurance and alternative risk transfer solutions. And that's what is keeping the captive sector vibrant.”

The former banker and chief financial officer said the hard insurance market for property had affected the captive sector. Captives were being used to fill gaps in layers higher up risk towers “where clients have seen price inefficiencies, or they can't get all the cover they ideally would like”. But there are limits to this more intensive captive usage.

“Clearly, the last thing you want is to recommend that the captive plays an expanded role and then it runs out of capital due unexpected losses. Before confirming what role you want the captive to take in the overall insurance programme, you need to understand the context of the risk bearing capacity of its parent. And then can we help the directors of the captive, as well as the sponsoring CFO analyse and understand that they are not suddenly introducing a level of risk taking that goes beyond the Group's risk appetite.

Carter said he was not seeing captives struggling to secure reinsurance for their risks if they needed it, but it was getting more expensive.

“Not all captives have to buy their own reinsurance,” he said. “They can be participating comfortably below the excess layers or just in filling what the commercial carriers aren’t taking. So, I don't see reinsurance market conditions necessarily impinging on captive activity.”

Commenting on other trends in the captive market, he noted that multinational clients with European operations are using cell captives in Europe in a direct writing capacity in conjunction with a captive in another jurisdiction.

Most importantly, the hard market was again proving the value captives: “This is the positive of having the captive as part of the overall insurance programme. It gives you the opportunity to present better data on your risk and perhaps show how your risk might be of better quality than the industry average. “

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