14 October 2022ArticleAnalysis

Navigating rough economic waters

“The lack of good, qualified staff familiar with this type of work is becoming an issue.”

Jeff Kenneson, Davies Captive Management

The captive insurance industry has helped companies navigate some pretty rough waters over the last few years. The market started to harden before the COVID-19 pandemic—a good thing as people move into captives more due to a hard market. But then several months later, the pandemic hit and everybody realised that these were uncharted waters—we didn’t know what was going to happen next, so everybody put things on hold.After the first five to seven months of the pandemic, all of a sudden we were at the third and fourth quarters of 2020 and everybody was suddenly moving forward with their captives again, as people realised the world wasn’t going to end because of COVID-19.Things therefore started to become crazy in terms of captive activity at the end of 2020 and continued that way in 2021, as we again had a rush of new formations.Fast-forward to today and inflation is now hitting the US economy. People are viewing this as a new phenomenon and are wondering how they can use their captive to mitigate some of it, due to increased level of costs and other factors. Because of the arrival of inflation people are again looking to captives as a tool to mitigate its impact.This is because with a captive you are more focused on your insurance costs and your claims activity, versus paying a high price for your premium to a traditional carrier and you’re done. With a captive you’re transferring money into the captive and you’re more focused on claims so there’s more thought about loss control, claims prevention, and looking to see where the quality but cheaper services are.Because of inflation, the cost of a claim today is higher than the cost of that same claim two, three or four years ago.

Managing inflation

Captives are being used to cope with those circumstances. We are seeing a lot more formations in the property management space and that is a reflection of how, with a hardening market in the captive space, we’re seeing more people covering property in their captives. Property is not a coverage that is put in a captive—full stop. That’s more a function of the market because with captives the inclusion of property coverages is less for tax efficiency than for some other reason.When we see property coverages coming into captives that’s an indication to us, the captive managers, that the market is hardening out there. We have seen a lot more formations in property management-type entities and increases to property coverages of existing clients.Due to inflation, people are paying attention to collateral as well. There are three different ways to collateralise your insurance transactions: there are 114 trusts, letter of credits, and funds withheld. We’re seeing more people investigating the funds withheld than is customary. The cost of the 114 trust and the letter of credit is becoming higher, so it’s more of a decision point than it used to be: the cost of a 114 trust versus cost of a letter of credit versus the non-cost option of funds withheld. Of course, there may be some opportunity costs associated with funds withheld.At the moment, people are thinking about collateral and bringing funds withheld into that decision more often than not.

Staffing issues

For captive managers, the lack of good, qualified staff familiar with this type of work is becoming an issue.Throughout the captive insurance industry everybody’s looking for people and we’re having to pay a premium for new employees; these elevated salaries could be a problem in the long run. Some people are hiring captive staff with zero experience for higher wages, and because of that we have to increase the wages of our current staff who actually have experience, so they stay above the inexperienced new people from a salary perspective.That’s been a real issue for the captive managers. I’m hearing anecdotal stories of firms standing outside another firm’s business and as the employees walk out at the end of the day say: “We will double your salary if you come to us”. It’s probably an exaggeration but that’s what we’re hearing—firms are poaching people, offering these huge salaries just to get bodies through the door.We’re struggling. The US captive insurance industry is facing staffing issues and shortages, and claim inflation as well as pay inflation, when we’re trying to encourage more people in, so it’s very much an employee’s market at the moment.On top of that, finding qualified people to do the job is an issue. Three or four years ago we would go to a head-hunter and they would say they had 10 people for every job vacancy. Now the head-hunter says: “I have one qualified person for every 10 jobs”, so even the recruiters are struggling.Looking to the future and the current hard market I’d say it seems to have levelled out a bit. I don’t know if that’s a short-term thing or an indication that it’s heading back the other way. In my 30 years in the market, it seems that we have 10 to 12 years of soft market, begging and needing a hard market to hit—and when it does it’s here for 12 to 18 months but then it goes back the other way for a long time. Are we at that point where it’s levelling off, or are we heading back towards the soft market again? We don’t know, it’s too soon to tell.If the market follows form then it would indicate that we’ve had the hard market for over 12 months so we must be heading back the other way. However, inflation will probably slow that downward spiral, so maybe inflation is helping the hard market to linger.