European captives market offers promising potential

The captive insurance market in Europe might be only a fraction of the size of the market on the other side of the Atlantic, but it does contain a huge amount of potential, according to recent studies.Gauging the size of the market is not easy, for a number of reasons. According to the Federation of European Risk Management Associations (FERMA), there are a number of complicating factors when it comes to gaining a true picture of the size of the market, not least being the fact that not every captive insurance company advertises itself as such.However, in May FERMA estimated to Captive International that the total number of captives in Europe was in the region of 700 to 800.That said, the size of those captives differs depending on their parent and their purpose. A

survey of European captives

owned by large industrial and commercial companies carried out by French re/insurer SCOR in November 2021 identified over 300 licensed re/insurance companies acting as captives.According to a

report

, also in November 2021, by rating agency AM Best, Europe’s top three captive domiciles (by number of licensed captives) are Guernsey, Luxembourg, and the Isle of Man. AM Best had expected an increase in the number of registered captives in Europe in 2020, as challenging economic conditions added to the rising cost of insurance, provide the ideal environment for corporates to look at how they might optimise their risk transfer programmes.However, the rating agency said that among Europe’s top three captive domiciles in 2020, only Luxembourg saw a small increase, with the number of new captive formations licensed slightly exceeding the number of licences surrendered.Guernsey and the Isle of Man recorded a small net loss of captive numbers. The explanation is likely a combination of the time it takes to set up new captives combined with merger and acquisition activity among corporations leading to redundant captives being closed down.

Swings, roundabouts and opportunities
However, the rating agency said, as of 2022 the number of European captives might soon increase, as the market seems to be set for further growth in the immediate future, especially because of recent events such as the global impact of the COVID-19 pandemic.Those European captives rated by AM Best typically have strong capital buffers that provide resilience against severe market shocks including the pandemic.AM Best pointed out that the pandemic resulted in significant financial market volatility and a global economic slowdown in 2020, generating increased claims activity and reducing the year’s earnings for a large number of insurers and reinsurers. However, the pandemic has proved to be less of an issue for most AM Best-rated European captives.European captives rated by AM Best predominantly follow a conservative investment approach as they do not tend to rely overly on high yielding investment strategies. Investment risk taken tends to be low, with investments held predominantly in short-dated fixed income securities as well as cash and cash equivalents.Material losses stemming from financial market volatility during the first half of 2020 were largely experienced by insurers with high exposures to equities—an asset choice that occupies only a relatively small share of the overall asset allocation of AM Best-rated European captives.AM Best added that the European captives it rates have not reported significant underwriting losses related to the pandemic, as they tend to operate in industries that have been able to continue to function through the crisis, and/or have no exposure to lines of business impacted by the pandemic.Although in some instances captives reported reduced premium volumes in 2020 driven by the slow-down of their parents’ activity, this was usually accompanied by a reduction in claims experience in some lines of business (such as motor, general liability and accident risks), offsetting the effect of lower premium levels on underwriting results.As a result, AM Best said: “These exclusions could open up opportunities for captives to offer such coverage to their parents. A captive which offers business interruption capacity to only its parent can strictly control the limit provided for pandemic-related coverage, and is not subject to the accumulation problems of commercial insurers that offer capacity to many different businesses.”In addition, AM Best pointed out that as the current insurance market has entered into a hard part of the market cycle, this also offers opportunities for captive insurers.The rating agency said that captives can offer tailored risk solutions to their parents on lines of business where commercial capacity has contracted, or where cover has become too expensive or even unavailable. Captives also provide owners with access to reinsurance market capacity. A captive can be an efficient vehicle to manage the risks groups are willing to retain relative to the price of cover.In its report the rating agency stated that: “Amid tougher renewal discussions, AM Best has observed an uptick in the use of existing captives, as owners seek optimal risk transfer solutions. A number of captives have increased retentions or limits on existing cover, while in some instances they have expanded into new lines of business as their parents have looked at increasing captive utilisation. Taken together, these factors contribute to an expansion of business volumes for the captive insurance industry.”SCOR’s study might be confined to the larger end of the European captive market, but it reported an increase in gross written premiums (GWP) over the 2018–2020 period. According to the reinsurer the total premium of the sample it used for its study was close to €4.4 billion, including €2.1 billion in Luxembourg and €1.6 billion in Ireland. The overall GWP of the sample grew by 3.2 percent between 2018 and 2019, and by 4.8 percent between 2019 and 2020.According to the SCOR sample, while the average premium per captive is €23 million, it admitted that its sample is “rather heterogeneous”. SCOR said that the largest captives exceed €200 million, while the smallest ones write less than €0.1 million. In addition, the top 1 percent of the captives account for 10 percent of the sample premium, which is as much as the bottom 58 percent, 10 percent of the captives account for half the total premium over the sample and half of the captives report less than €10 million GWP.

Lines of business, ESG, & the future
The SCOR study was able to go into more detail about the lines of business that the captives in its sample dealt with. Captives report on their premium according to the lines of business defined by the Solvency II framework, which can be grouped as: property & fire, liability, marine/aviation/transport, miscellaneous financial loss, motor, health. Others include credit & surety, legal expenses and assistance.Property business is the most frequent, with 72 percent of the captives writing some. Liability business is the second most frequent line, written by 60 percent of the captives. Motor is the least common line of business, written by only 13 percent.Twenty-two percent of the captives in the sample write direct business. This requires the captive (insurance captive) to be granted a licence by their national authorities for each of the lines of business in which they operate.When they have a licence to operate in one class, insurance captives can provide reinsurance services and take on any business from other insurance companies, provided their articles of incorporation permit it. Fifty-four percent of the insurance captives in the sample do this.Seventy-eight percent of the captives in the sample write only accepted business. To do so, they need only one general “reinsurance” licence. There is no regulatory restriction as to the classes in which a captive can provide reinsurance services. However, they need to have a partnership with a licensed insurance company (the fronter), from which they accept the business.Looking at future trends, AM Best notes that environmental, social and corporate governance (ESG) considerations are rising up the corporate agenda amid increased scrutiny from consumers and regulatory authorities and that a captive’s ESG approach is often closely linked with that of its parent organisation.According to AM Best’s report, a growing number of commercial re/insurers are formally integrating ESG factors in their strategy, notably in their underwriting operations. A consequence of this might be capacity shortages in some lines of business or sectors, which could create business opportunities for captives in so-called “toxic” industries.As ESG risks vary dramatically by both industry and line of business, captives may want to assess ESG exposures as part of their risk management activities to be able to recognise, measure and address the impact on their business. A failure to do so could present significant risks, be they financial or reputational.The rating agency also concluded that cyber risk and environmental liability are just some of the new areas of coverage for captives, and as such will likely lead to a fresh consideration of ESG factors for operators. In the case of cyber, coverage brings with it a focus on aspects such as social engineering and data security. Captives will need to be conversant with the potential impact of aspects like these to fully capture their exposures.