14 September 2020ArticleAnalysis

Hard market spurs growth opportunities

Captive insurance market in the US and Bermuda.

Business risks continue to grow quickly across all sectors and the captive insurance market is agile enough to address emerging issues such as cyber and COVID-19, while traditional commercial insurers are likely to be more reluctant and possibly slower to react to the new needs of the companies they are insuring.A few main drivers have pushed the growing trend of companies wanting to take on and insure their own business risks. The first major factor is the consolidation of insurance industry players.Operationally, mergers and acquisitions (M&A) activity has been high in the insurance space, putting the brakes on the active underwriting seeking expanding business there.The second is the continued rising premiums for commercial insurers in this prolonged hard market. Corporations are now willing to take on their own risks, not only through mechanisms such as captives but also via risk vehicles such as self-insurance programmes, large deductibles and risk retention groups (RRGs).The hard market itself will continue for a while. One of the big issues we’re seeing with the large traditional commercial insurers is that from a capital perspective they’re taking some large hits especially with the higher frequency and severity large events. If they have any sort of coverage, regardless of whether or not it’s a direct line they’re writing personally or a large cat event, these still impact solvency and capital for these insurers.A hard market perspective is likely to continue as long as these events keep generating large losses for the commercial insurers.The US market, and similar markets around the world, have seen a high frequency/severity of large loss events that have impacted large commercial insurers, kept premiums high across the industry and exacerbated this hard market. These events have had a direct impact not only on insurance premiums but also on the willingness to provide the customised coverage business owners need in today’s environment.Litigation and uncertainty
The US is considered a litigious environment, with some uncertainty related to how courts are ruling on recent emerging issues given the large backups and delays still ongoing in the courts due to COVID-19 lockdowns over the past couple of years.One major trend is third party litigation financing, which drives a lot of the claims that normally wouldn’t have been put through the court systems. With third party financing litigation now surrounding COVID-19 losses, how they’re ultimately treated is still uncertain, which will likely drive some conservatism in commercial insurers with regard to insurance offerings and pricing.Another hot topic is inflationary pressure. There is evidence from the US market that costs such as materials and labour are increasing across all sectors. Supply chain issues have increased the average cost of claims which is ultimately passed down to the customer.All these uncertainties combined in the US market present a valuable opportunity within the alternative risk finance space, such as captives and RRGs. These alternative risk financing structures can ensure the corporations cover all the relevant emerging risks to their business and ideally provide themselves with more competitive pricing options. They should be able to understand their business model much better than a large commercial insurer would.On the flipside of those inflationary pressures, interest rates are rising. This provides insurers, whether a partial insurer or a captive insurer, a hedge against large volatility on their balance sheet, on their long balance insurance programmes. We’ve seen corporates that have these kind of self-insurance programmes, such as a captive, push to implement measures such as better risk management practices and safer procedural programmes to limit claims and losses.These ultimately have a positive impact on their underlying business, and also the performance of their insurance programmes. Risk managers have been more open to explore any and all options for managing risk and volatility, including accessing the legacy market and working closely with them for tailored solutions on their legacy books business.All the pressures the US market is facing have created an opportunity for alternative risk financing but also the legacy space as well, especially as these corporates are creating insurance programmes to manage on their own.

“The US market, and similar markets around the world, have seen a high frequency/severity of large loss events that have impacted large commercial insurers.”

Ryan Heyrana, DARAG North America

The view from Bermuda
Bermuda has always been known as the premier captive insurance domicile, with committed, sophisticated regulators, and been known as the one-stop shop for the industry, with captive managers, accountants, lawyers all readily available on this very small but insurance-focused island.Given the challenges commercial insurers are facing, with pricing and customised coverage, turning to alternative risk vehicles such as captives will have direct impact over the Bermuda market and its ability to service those entities. There’s obviously a growing presence in captive originations in the US with good domiciles such as Vermont and Delaware coming in to play.That being said, the long-running history of Bermuda and its particularly friendly and available service providers will help it fill the demand especially if companies continue to find alternative ways to manage their risk.Bermuda has an established captive insurance structure: it has a state regulator with specific captive laws that have been tried and tested successfully over the years, plus the support of captive service providers on the Island, so from that perspective they are quite developed.Bermuda will always be the preferred jurisdiction for capital formation around the world. There is the potential for future tax rules that impact how companies approach captive formations—everyone is waiting to see how that unfolds.But in Bermuda there are years of regulation, regulatory and professional expertise that will continue to attract companies. It’s a one-stop shop, not only for their captive formation needs—it provides a different set of needs such as direct discussions with local reinsurers in legacy markets, given that the vast majority of reinsurers and legacy markets have stayed in Bermuda.The challenge of tackling emerging risk lies ahead. How local jurisdictions will handle COVID-19 ultimately is still relatively unknown. More relevant to the insurance industry is how much of the loss burden will have to be shouldered by the insurance industry as interpreted by local courts—impacting not only commercial insurers but also captives that have workers’ comp programmes.It is unclear if insurers will be held liable for claims related to business interruption. How will things be rolled in, especially in states such as California which should be quite liberal with regard to litigation surrounding COVID-19? How courts rule will directly impact losses and lines of business such as workers’ comp and business interruption.Claims costs
Another challenge on the minds of insurance professionals is the rising cost of claims, which is being driven by inflation and supply chain issues. That’s obviously at the forefront of government policy, so it is to be hoped that it gets reined in, but as inflation rises it’s natural for the cost of medical care to rise, along with those of raw materials and labour. These increases will have a direct impact on the ultimate cost of claims which are passed down to the insurable future premiums or in the captives to their respective losses on their balance sheet.Captives will feel the impacts of inflation but as there is more experience realised within their legacy books of business, this presents opportunities for partnerships with the legacy market to manage future volatility in older programmes that might not fit within their current risk appetite.One of the opportunities is in the legacy space. This can have a positive impact on the asset side. There’s been an uptick in interest rates which has helped with investment yields which have been extremely low over the past few years. This in turn can make firms practise better legacy pricing on longer tail books not materially impacted by inflationary pressures.With a growing number of onshore corporate entities turning to alternative risk finance solutions, risk managers are keener to learn about ways to manage volatility and risk within their retained insurance programmes.As a legacy provider, we are working with corporations whose core competency is not insurance and claims management, but they are looking to take advantage of a better understanding of their business model and underlying risks to get better pricing on items they need covered to run their day-to-day operations.This presents a key opportunity for us, as insurance professionals, to make a positive impact on the overall performance of book of business and release corporations from the capital and operational burdens of historical legacy programmes after the benefit of self-insurance has been fully realised.We see this as a trend whereby corporations and legacy providers can mutually benefit and excel in their respective areas of expertise.