Sergey Khakimullin /
13 February 2018Analysis

Captives meet the final frontier

What do Queen Isabella, President Thomas Jefferson, and King Charles I of Spain have in common? They financed some of the greatest explorers of all time: Columbus, Lewis and Clark, and Magellan, respectively. Exploration is the human condition. History shows that where explorers venture, the capital markets follow. From the humble beginnings of mapping the seven seas, the seafaring trading industry was born. Shortly thereafter, merchants met in a coffeehouse in London to discuss the world’s first modern insurance mutual.

In modern times we can thank NASA for mapping low Earth orbit extraterrestrial territories. Just as with the explorers of the seas, the astronauts of the 20th century gave rise to the modern commercial space industry. As always, where the capital markets venture, the insurance carriers follow. There are many private enterprises in the commercial space field: Virgin Galactic, XCOR, SpaceX, and Blue Origin lead the way. Corporate stakeholders need insurance to protect their investments and innovate their service offerings. Commercial space launch insurance is one of the key requirements for humankind’s continuing its quest to the stars.

Fortunately for brokers and agents, this multibillion dollar market is heavily regulated. Portions of the commercial space flight industry have no meaningful risk financing solutions. This is a classic example of where brokers and agents should know when to pitch a captive insurance solution. Millions of dollars of untapped commissions await the savvy broker who understands when to pitch a captive insurance vehicle.

Traditional space insurance is a commoditised transaction. Thanks to the US Federal Aviation Administration (FAA), insurance coverage for commercial satellite launches is routine, with copious data for actuaries and underwriters to leverage in setting premiums. But there is a new booming sector in the space industry: commercial human space launches. Welcome to the age of space tourism.

Since Yuri Gagarin’s orbit in 1961, citizens from 38 countries have flown in space. Space tourism insurance started with American engineer and eccentric multimillionaire Dennis Tito. In 2001, he was issued a life insurance policy via Russian insurer Avikos for a private trip into outer space. No other coverage was available. Tito’s brave voyage created a whole new industry of space tourism overnight.

The current dynamic in the space tourism insurance sector involves self-financing the risk through a mix of life insurance and commercial launch operators securing third party insurance coverage. Many life insurance companies are starting to decline claims made pursuant to space launch mishaps. Consequently, potential plaintiffs (and their attorneys) are hunting for any relevant general liability policies. Commercial launch companies need adequate coverage to continue to grow.

A void in the commercial market is an opportunity for brokers and agents to penetrate the industry before commoditisation funnels the opportunities into a race to the bottom. This situation is a prime situation for a captive insurance solution.

A tool for space tourism

Given the many unknowns regarding liability for space tourism, captive insurance should be a tool for all space tourism providers. Realistically, self-financing 100 percent of the risk related to space tourism would be cost-prohibitive for all but the largest companies. As such, space tourism companies may want to consider a buyback deductible captive. With this strategy a single parent captive would be used in conjunction with a large deductible insurance programme offered through a traditional carrier.

The captive then reimburses the space tourism parent company for losses up to the amount of the deductible. This model is often used with workers’ compensation captives; it obviates the need for expensive fronting carriers and such captives are frequently formed in Vermont and other traditional domiciles.

However, there may be need for a fronting company. Regulators frequently limit the size of deductibles that insureds may take (workers’ compensation and Federal Housing and Urban Development [HUD]-financed properties are notorious for this). Consequently, limited deductible amounts may preclude the application of a large deductible buyback. In this situation the captive may reinsure a fronting carrier for some layer of risk, reducing its overall insurance premium spend. If the space tourism company enjoys a favourable loss history (ie, few explosions) then the captive may turn the cost centre into a new profit centre for the parent company.

Of course, there are other applications via risk retention groups or protected cell companies. Qualified captive managers should be able to build various types of programmes to meet the regulatory requirements while optimising the risk financing costs for the parent company. The exact structure for any company will be a function of the risks underwritten, whether international treaty issues are in play, and the overall loss history of the company. This is where captive managers shine. Brokers herd the opportunities while captive managers design the self-insurance programme.

The space industry is a highly regulated field. The Commercial Space Launch Act prohibits satellite customers from suing launch providers, but this statutory waiver does not extend to space tourists (14 CFR §440.3 [2006]). Consequently, the space tourist operator retains a large exposure in the event of a catastrophe. Space flight operators may demand tourists to sign liability waivers, but these contracts are unlikely to survive judicial scrutiny as waivers are not favoured by courts in general.

Virginia and Florida generally prohibit any legal action against commercial space providers under state law except for cases of gross negligence or wilful misconduct, but these state law prohibitions on suits against space tourism operators do not apply in federal court. These considerations only heighten the necessity for quality paper that will protect the insureds in federal court.

In a sense, space tourism is no different from any other heavily regulated industry. The steep learning curve associated with various state, federal, and international regulations requires the risk management professional to craft very specific policies for every insured. This regime is where captives shine because they are absolutely flexible to the owner’s specific needs.

The final frontier is exciting. Risk management professionals have a large role to play in helping humans reach for the stars. By utilising a proper mix of traditional insurance and captive insurance the space tourism market will continue to grow.