12 June 2022ArticleAnalysis

Formation activity and captive trends

In the last two years, Marsh Captive Solutions has formed more than 200 new captives globally and we are continuing to see historical growth in our business. In Europe, formation activity was somewhat subdued prior to 2020, but we are now seeing captive formations occurring in all our onshore and offshore European locations. Historically, new formation activity tended to happen in a handful of domiciles but this is the first time we have seen formations in every domicile, even in some of our more mature locations.Difficult commercial insurance market conditions are driving much of this activity; according to

 Marsh’s Global Market Index

, global composite insurance rates rose by 13 percent in Q4 2021, which was a slight moderation from the preceding two quarters where rate increases were 15 percent.Slight pricing moderation is good news for insurance buyers but after 17 quarters of pricing increases, many are approaching their fourth renewal with a bar set considerably higher than it was at the start of these challenging market conditions. Also, while pricing increases may be moderating, insurers are adding coverage restrictions and reducing coverage in many key areas.Issues such as the ongoing war in Ukraine, rising inflation, natural catastrophes and weather-related events are adding complexity and uncertainty to the landscape, pushing more and more companies to look for alternative risk financing mechanisms to lessen reliance on the commercial insurance market.New captives in Europe are primarily writing traditional lines of insurance such as property damage & business interruption and liability, and increasingly are being formed by companies who have looked at the captive option for the first time. We are also seeing increased enquiries to write less traditional captive risks such as cyber, directors and officers (D&O), and trade credit, largely stemming from continued challenging market conditions with these insurance placements.In addition to new captive formations, we are seeing a dramatic rise in premium written by existing captives. In 2021 the premium written by the captives we manage globally rose by over 12 percent from $60 billion to almost $68 billion. In all regions premiums rose by over 10 percent but EMEA domiciles saw an unprecedented increase of 18 percent.This increase is from new formations combined with a large volume of premium and risk flowing into existing captives. For instance, a number of direct writing captives formed initially in response to the last challenging property insurance market in the early 2000s have extended their licences to other classes of business. Many other captives have increased retentions and premiums within existing classes.

“We are now seeing captive formations occurring in all our onshore and offshore European locations.”

Lorraine Stack, Marsh Captive Solutions

While global insurance pricing increases are decelerating for a number of lines of business, cyber rates continue to rise, largely due to increased ransomware claims. We have seen 127 percent growth in the number of captives writing cyber in the last five years. Premium growth among captives writing cyber increased by 50 percent in the last year alone.Until recently it was unusual for cyber to be included for assessment in a new captive feasibility study but this is becoming an increasingly common coverage line. In addition to funding cyber retentions we are seeing captives being used to provide tailored coverage for risks excluded by commercial insurers such as ransomware events, and for emerging risks such as cyber terrorism.D&O
Another area where we have seen increased activity is in D&O which was not historically a common coverage written by captives. Just over 50 of the more than 1,500 captives we manage are writing the coverage but D&O premium has increased 50 percent in the last year to over $75 million indicating that many are using their captives to fund increased retentions.Typically a single parent captive can only be used to write indemnifiable risks (sides B&C coverage) but side A coverage, which is not indemnifiable by the corporate, is unsuitable for a captive, a group subsidiary. While the use of captives for side A D&O coverage remains mostly untested, protected cell captives are an increasingly popular alternative for companies who cannot obtain the coverage from commercial insurers. We currently manage 11 side A cell captives, three of which are in Guernsey.In response to demand from corporations for alternative D&O risk funding, Delaware has introduced legislation to allow companies to provide side A D&O coverage through a captive. There are some complexities to navigate though, including differences between state and federal rules so careful consideration needs to be given to the location and structure of the captive writing side A coverage.A cell can often be a simpler solution, being faster to implement and more arm’s length than a single parent captive. We also recommend that side A D&O exposure be fully funded to ensure funds are available to pay claims in the event of a bankruptcy. It is also important to appoint independent claims handlers, and to seek legal advice before embarking on this route.Strategic reviews
Our consulting teams have seen a significant increase in demand for strategic reviews from existing captive owners over the last six months. Many of these reviews are being conducted on relatively mature captives where owners are seeking to re-evaluate captive strategy in the context of rising inflation and funding rates, supply chain disruptions, and geopolitical shifts, which are changing business models.We are supporting these clients in assessing whether the captive structure is still appropriate, whether the captive is in the right domicile, and what structure and number of captives will be required to meet demands over the next three to five years.Summary
In summary, captive insurance growth is happening in all European captive domiciles. Our expectation based on consulting activity and new formation pipelines is that this period of growth will continue for at least another 12 to 18 months and maybe longer.Lorraine Stack is international advisory and s