New ideas and new captives in Vermont

Every year industry representatives in insurance, accounting, finance, operations, risk management gather in Vermont to network and to gain insight into some of the most up-to-date trends happening in the world of captive insurance.

The tagline of this year’s conference was ‘Mission: Possible’, exploring the number of different ways in which captives can be utilised.

Captive International reported live from the conference, both speaking to industry executives and attending sessions.

Significant discussions were held regarding the various types of captive structures being formed, for example protected cells and the new agency captive law in Vermont.

Captive insurance companies are maturing, and unpredictable risks or increased volatility are being handled within them.

“Once a captive utilisation becomes a philosophy of the corporation, it’s expected to operate in all risks, whether they be emerging or unpredictable,” says Steven Bauman, global head of captive programmes at XL Catlin.

“Captive utilisation is planning for an adverse future event. It’s always been the same in that it’s a long term thought process in risk retention and risk management.”

New structures

The captive industry is exploring new ways to finance and transfer risk, and one such example can be seen with the introduction of the idea of agency captives.

After seeing a few examples of how the agency captive concept could work, David Provost, deputy commissioner of the captive insurance division for the Vermont Department of Financial Regulation, along with his colleagues embraced the idea, which was then signed into Vermont’s captive law.

An agency captive is a captive formed an owned by an insurance agent or a broker, intended to provide reinsurance to its insured clients. Unlike traditional captive structures, the captive is not owned or controlled by the insureds.

Sandy Bigglestone, the director of captive insurance for the state of Vermont, explained: “We know the agency is going to form the captive for a profitable book of business, it’s going to be beneficial not only to the agent, but it will also be beneficial to the clients in their book of business, the insureds and the fronting company.”

The idea aligns the interests of the agent or broker with the carrier regarding risk selection, pricing and loss control, as explained by Bob Gagliardi, global director of captive management and US fronting at AIG Insurance Management Services; Jesse Crary, shareholder at law firm Primmer Piper Eggleston & Cramer; and Peter McDougall, attorney at Paul Frank + Collins.

“The same type of reinsurance relationship the carrier may have with any commercial reinsurer they will have with the agency captive,” said Gagliardi.

The panel suggested the best type of business that is appropriate for an agency captive is programme business that is homogenous in nature.

“This should be the place where the agency puts its best performing business. So ideally if the agency says ‘this is my best business, I’m interested in it, I own it and I’m going to take a part of it and share the risk.’”

The minimum capital requirement of the agency captive in Vermont is $500,000 and the captive must be ‘owned or directly or indirectly controlled by one or more insurance agencies or brokerages’.

Furthermore, the agency or broker with control or ownership over the captive must remain in good regulatory standing, according to Vermont law. The captives must only insure risks of commercial policies placed by the agency or broker owner and the captive must disclose to the policyholder the nature of its affiliation with the broker or agent and relative limitations, rights and obligations of the captive as compared to the policyholder.

Crary added: “There’s going to have to be a disclosure that will likely appear in the policy that is being issued that will explain the affiliation between the insured’s broker and the captive insurance company that is acting as a reinsurer. So that’s going to be visible to the insured.”

Emerging risks

“There is a saying in the industry: you’ve seen one captive programme, you’ve seen one captive programme. They’re all very customised structures,” says Steven Bauman.

While the ‘bread and butter’ of captive utilisation is still multinational programmes for property and casualty, captives have now matured enough where unpredictable risks or increased volatility can be handled within them, he adds.

And this idea around the versatility of a captive was explored in depth at the conference. Brian Johnson, CEO and consulting actuary at Risk International Actuarial Consulting, said there are even more sophisticated methods of figuring out the costs of any particular risk the owner is worried about.

“The environment these days is that we can use actuarial methodologies to figure out how to place almost any risk into a captive, so don’t let anything limit your vision as to how you want to cover this risk and to expand your captive programme,” Johnson said.

In the cyber insurance market, Bauman suggested captives could be a very appealing alternative to the traditional market, which may not offer the coverage they need for their particular exposure. He also noted that cyber is still very much an emerging risk, where there may not be a lot of information available.

However, the modular nature of cyber insurance policies is leading to a struggle among captive managers to arrive at a common understanding of the definition of ‘risk,’ according to Robert Parisi, managing director of Marsh USA.

Adam Peckman, global practice leader at Aon Risk Solutions, adds: “Back to Robert’s modular view of what that coverage looks like, 95 percent of clients are saying they can’t get their head around the diversity of coverage around them.”

95 percent of Aon Risk Solutions’ clients suggested a lack of clarity surrounding the terms and conditions of cyber coverage is why they haven’t proceeded with using their captives for this purpose.

Policy wording was found to be the most important issue among clients, and 75 percent of larger companies felt the loss adjustment process and coverage interpretation is not well understood.

Peckman notes that captives must able to identify cyber risks and assess the security posture against common standards that are utilised by the insurance markets for their underwriting process.

They must then evaluate the materiality of the financial exposures arising from a range of cyber risk scenarios, and determine the optimal programme structure, in terms of pricing retention and limits, he explains.

In 2006, about 10 million malicious websites were identified, whereas in 2016, the number jumped to over 218 million, as highlighted by Ryan Spelman, senior director of the Center for Internet Security.

According to Aon’s cyber captive survey and report, businesses are losing $450 billion from cyber crime, growing to an estimated $2-6 trillion by 2021.

The Aon survey highlighted that only 9 percent of companies are utilising their Aon-managed captive for cyber risk, but it is projected this figure will reach 20 percent by 2022.