Captives as a profit centre part 2: The future of corporate risk hedging
Part 1 of this series described the development of ‘Buyer’s Club 1.0’ towards the insurance industry of the 21st century. The cost structure and the generally prevailing insurance portfolio were examined, and it was determined that both are no longer truly in step with the times.
On the one hand, the benefits of digitisation (reduction of administrative costs) are not being exploited and, on the other hand, the portfolio of insurable risks has not adapted to market changes. For example, a survey by the BlockART Institute revealed that both the midsize corporates, the large corporates and also the captive owners, cannot buy optimal insurance protection on the market.
The past few decades—characterised by globalisation and digitisation—have seen a dramatic change in the risk map of the globally active corporate, and there is a noticeable delta of “risks to be insured” and “insurable risks”. In addition, the mega corporate and its suppliers are increasingly facing downsizing problems over the traditional insurance market, as they constitute a “cluster risk” (accumulation).
Figure 1: From status quo to innovative risk transfer (YRT)
The status quo of the insurance market can be summarised as follows:
- High administrative and regulatory costs;
- Challenge of capacity;
- Insufficient solution concepts for existence-threatening business risks of the 21st century; and
- Insufficient use of digitisation.
The captive solution was established on the market more than a century ago, which belongs to the alternative risk transfer (ART) market. However, the BlockART Institute’s research results show that the opportunities a captive can offer are not being fully exploited today.
In very few cases the single-parent captive is seen as a profit centre, and there are no known cases where the single-parent captive is progressively appearing on the market and exposing risks along its supply chain participants. Why? The preconditions have been sufficiently fulfilled.
A single-parent captive is an insurance from a regulatory perspective. Other parameters for success in the industrial insurance market are brand, money and data. These criteria have also been entirely fulfilled. The administrative expenditure is also no longer a pitfall today. Platform solutions and especially the emerging blockchain technology are increasingly minimising the administrative burden, and enabling the captive to act as a “profit centre” and market participant.
This would be a win-win situation for both the captive owner and the market participants it provides insurance to. After all, nobody knows the risk management needs of their (potential) customers as well as a company that itself is integrated in the supply chain or serves the same market. In the medium term, it would be conceivable to completely oust the traditional industrial insurers from the market or to accelerate market development.
A prevalent example is found in the automotive industry. With the Tesla S, Tesla is making a luxury vehicle that, due to its electric drive, is ushering in a new era of driving. The result is that even traditional market participants cannot escape this development, and have to adjust their portfolio. The result is a total change in the market.
While Tesla has not been able to generate significant market share via its USP, it has provided the impetus for a new generation of cars that will cause not only original equipment manufacturers (OEMs) but also suppliers to rethink and innovate. This also seems to be possible in industrial insurance. Digitisation and its associated technologies, such as artificial intelligence (AI) and blockchain, can to be identified as drivers in this.
Based on the Ansoff diversification model – an academic tool that provides a framework to help businesses devise strategies for future growth – there are three strategic directions: the formation of risk conglomerates in horizontal, vertical and lateral orientations.
Horizontal risk conglomerate
- Market participants at the same value creation level (automotive OEMs in this example);
- Back to the roots of industrial risk hedging—brokers, primary insurers, reinsurers—are bypassed, and your own risk conglomerate is founded: ‘Buyer’s Club 2.0’; and
- The insurance premiums are drastically reduced, and it is possible to launch insurance lines that are currently not offered on the market.
Figure 2: Horizontal risk conglomerate by OEM captive owners
Vertical risk conglomerate
- The leader in the supply chain or the captive, in our example a German OEM, offers insurance coverage not only to its own subsidiaries, but also insures Tier 1 to Tier 3;
- Calculation of premiums is easily done, because the necessary premium calculation data is known. Trust in the business relationship is strengthened and the existing business relationship, which already exists in risk management, is expanded and consolidated; and
- For example, the captive can underwrite an insurance line called “innovation fail”. This would make suppliers more prepared to take risks in developing new innovations that ultimately benefit the OEM and its products. This in turn leads to a market advantage over the competition and secures market shares.
Figure 3: Vertical risk conglomerate driven by the automotive industry
Lateral risk conglomerate
- Captive owners meet in a digital market place and take on their risks, as well as the premium amount they are willing to pay in that respect. Similar to other industries, there is a “match” or not;
- The risk takers in this scenario may be other companies with a single-parent captive, primary insurer or reinsurer. This approach increases the pressure on traditional industrial insurers, resulting in better wordings or lower premiums. Furthermore, there can be savings on brokerage fees. At the same time, the model is attractive for minimising the resulting insurance tax; and
- Since it can be an unregulated marketplace (more on this in Part 3), companies can take on any risk that they would like to have covered, because they are not tied to insurers’ wordings. A “match” occurs when the query finds an offer, and a risk taker is prepared to underwrite the risk at the stated conditions.
Figure 4: Lateral risk conglomerate driven by the global acting corporate
Due to megatrends, in particular digitisation and globalisation, the risk landscape of companies has changed dramatically. The existence-threatening risks of the past, such as fire and liability, have been replaced by risks such as innovation fail and market decline. However, there are no insurance solutions on the market for this.
The established corporations are dedicated to administrative streamlining of their processes and optimisation of existing underwriting lines. The consequence is that the customer side itself needs to become active by creating the “electric motor” of industrial insurance, in order to accelerate development.
Based on the BlockART Institute’s research results, in the third and last part of the ‘Buyer’s Club 2.0’ publication we will present a prototype that may be of importance in this market development.
Marcus Schmalbach is a lecturer in business administration at a university of applied sciences in Southern Germany and a PhD in the field of captive insurance companies at the University of Gloucestershire, UK. He is head of BlockART Institute which is doing research in the field of blockchain and alternative risk transfer. He can be contacted at: email@example.com