10 September 2022ArticleAnalysis

Bermuda continues to serve captive industry

Over the past 22 years, the operating performance of the captive insurers rated by AM Best has readily surpassed that of their commercial market peers. Their inherent flexibility and control in managing risk drives profitability and retained earnings, while creating value for their policyholders and stakeholders, regardless of market conditions. This pattern has been evident since the formation of the first captive and the principles supporting this construct remain the same in 2022.As the legend tells us, the term “captive” was coined in the 1950s by Fred Reiss, known as the ’father of captive insurance,’ who formed American Risk Management in 1958. During this time, US regulations made it prohibitively expensive to form and operate captives in the US. Sixty years ago, in 1962, Bermuda assisted Reiss in forming what is believed to be the first modern day captive. Since then, Bermuda has become the home to the largest number of captive insurance companies globally and a dominant domicile with more than 670 captive insurance companies.Of more than 220 captives AM Best rates worldwide, 26 are based in Bermuda. These captives continue to outperform most measures, notably the US commercial casualty composite on underwriting and operating profitability. They have performed well for a number of years, and the issues surrounding the COVID-19 pandemic have not appeared to affect their performance materially.Almost all of AM Best’s rated captives in Bermuda maintain a long-term issuer credit rating of “a” (Excellent), which translates to a financial strength rating of A (Excellent) representing a highly capitalised group and single-parent captives, with adequate or strong operating performance and appropriate enterprise risk management (ERM) frameworks. For the most part, the business profiles of these captives are neutral due to global nature of their operation and diversity of coverage.While the pandemic may have slowed down new captive growth, some captives have added, or are looking to add, new coverages to meet protection requirements arising from the pandemic. The benefits and consistency of local captive management and a captive-friendly regulatory environment have enabled Bermuda and other key domiciles, to not just maintain, but even expand, their foothold in the captive insurance market.

“AM Best’s financial strength ratings on its Bermuda captives remain largely in the A- to A+ range.”

Fred Eslami, AM Best

The majority of AM Best-rated Bermuda captives are either owned by US-based businesses or, in the case of group captives, aligned with US groups and associations, albeit some captives are sponsored by a broad group of owners in Japan, Taiwan, Colombia, Saudi Arabia and a number of European countries. The largest captive managers, banks, accounting firms and other advisors have Bermuda residency and therefore a broad global reach, providing services that go well beyond the local domicile and location of the owner/sponsor. This has bolstered retention and growth in the number of captives in Bermuda.AM Best’s financial strength ratings on its Bermuda captives remain largely in the A- to A+ range, reflecting the companies’ generally robust balance sheets, integrated risk management practices, in-depth management knowledge of the risks insured, and the inherent advantages of being owned by member insureds or by larger organisations with extensive resources and financial flexibility.The companies’ traditionally solid operating performance and supportive risk management capabilities are also consistent with these ratings. Captive owners/sponsors deal with third-party users as well as AM Best and position themselves accordingly with regard to their capitalisation and operating fundamentals.AM Best’s ratings on captives recognise the unique nature of these structures and incorporate how these companies fit into an organisation (single parent) or among their member insureds (group). For captives, qualitative aspects such as a company’s specific purpose, direct access to the business, additional financial flexibility afforded by stakeholders, nature of the business written, and management understanding of the captive’s risk management capabilities and risk tolerances are all critical analytical factors.At the core of AM Best’s rating process is a transparent, in-depth evaluation of an insurer’s balance sheet strength, operating performance, business profile and ERM. This building-block approach is used for all rated insurers, although the conclusions drawn from these assessments can differ dramatically from those of third-party commercial insurance companies, owing to the nature of captives and their inherent advantages and limitations. Captives have traits and operating fundamentals that would not carry nearly as much weight if they were aligned with traditional property and casualty insurance companies.The balance sheet strength assessment of more than 90 percent of the rated captives is at the “very strong” and “strongest” levels. This assessment gives no credit for implicit parental support, which is considered in our analysis as rating enhancement via parental lift (or drag); it reflects a standalone view of just how well-capitalised these companies are relative to their individual business risks.
The Bermuda captives’ operating performance for the most part is better than the overall commercial casualty property/casualty industry performance. The operating performance assessment of the vast majority of these captives is either at the “strong” or “adequate” level, with only a relatively small percentage assessed at “marginal.”
The business profile assessment of the majority of these captives is “Neutral.” This assessment takes into account not just a captive’s line of business and geographic diversity, but also the organisation’s loss control practices, safety, risk management, risk awareness and competitive advantages. Given the mission of captives, especially single-parent captives, the distribution of the business profile assessment is understandable as their profile is inherently limited.
Finally, all of these captives have been assessed as having “Appropriate” ERM. This assessment takes into account not only the captive’s risk framework and risk profile relative to capabilities, but also how well the captive is integrated into the ERM framework of its parent or owner, the source of the risks for which it is providing coverage. The single-parent captives in this group, as well as virtually all of the rated global single-parent captives, serve as integral parts of the overall risk management framework of the owner/sponsor.