Captives in Europe: do they still make sense?

Sweden seems to be something of a European captive insurance hotspot. Why is that?
There are 46 captives in Sweden, a large number for a country with only nine million inhabitants. This is no accident: captives have thrived in Sweden because of the strong risk management culture that exists in the country, particularly among its many multinational companies.

It is not only a captive owner that benefits from having a captive—society as a whole benefits from the increased competition that follows from the growth of the captive sector.

In the 1980s Skandia had a near-monopoly on insurance in Sweden, which has eroded over time, in part due to the growth of the captive insurance sector. Captives have introduced considerable competition and stability into the insurance sector. For a company of the size of Sandvik there are maybe five or six global insurance companies with the resources to provide the coverage required, but for companies of any size the option to use a captive, and then access the reinsurance market to manage the risk within the captive, provides a valuable alternative to the local insurance market.

When and why did Sandvik launch its own captive?
Sandvik established its captive in 2003. The real incentive was that the captive allowed Sandvik to optimise the cost of its insurance and improve its internal risk management. The company wanted to keep the profits that insurance companies were generating from it for itself, and ensure it could tailor coverage to its precise needs, allowing it to mitigate its risk far more effectively than it could in the market.

The captive gave Sandvik greater control over its risk premiums, which did not always seem to be priced correctly when buying insurance from the commercial market. Creating a captive protected Sandvik from the risk that an insurer might price certain coverage prohibitively because it wanted to reduce its own exposure in a particular area.

In the past there has also been a tax advantage to having a captive in Europe, but that was never the main driver.

What coverage do you write within the captive, and what do you still take from the commercial market?
Over time Sandvik’s captive has written an increasing amount of its owner’s insurance coverage. The largest areas of coverage are in property, liability and business travel, but as the market hardens the captive could branch out into new areas, such as some financial lines.

Sandvik currently buys its cargo insurance in the commercial market, but has been looking at whether this could be moved into the captive. It has also conducted gap analysis on its cyber exposures and is considering writing cyber coverage through its captive.
There are no plans to launch a new captive, although the composition of its existing captive has had to be adapted to reflect changes to Sandvik’s business where they have implications for the company’s financial position and risk exposures.

What is the biggest concern for Sandvik’s captive at the moment?
Regulation. The problem is that Solvency II is applied in exactly the same way to small insurers such as captives and to large multinational commercial insurers, although the two are not comparable in terms of their potential systemic risk. If a captive became insolvent it would not represent a risk to anyone other than itself and its owner, and perhaps a few multinational reinsurance companies that have plenty of capital to absorb that loss.

The multinational insurers that have the systemic risk the Solvency II regime is designed to contain have large teams of compliance professionals, allowing them to cope. For a small insurer such as a captive, complying with the burdensome requirements of Solvency II is so time-consuming and costly that it diverts resources from other activities that would be more beneficial to everyone, such as business development.

Unfortunately there is little sign that EU authorities are listening to the feedback they are getting from captives about this issue. At the EU level it seems that other concerns are a higher priority.

It means that companies with operations in the US have to consider whether it makes sense to have a separate US captive to insure its US-based risks. Sandvik has around 4,000 US-based employees. It is something we think about.

It would be a real shame for the European market if captives like ours started looking to the US because doing business in Europe is so expensive. Perhaps European policymakers would wake up to the advantages of a healthy European captive market if they started losing business to the US.

Is the regulatory issue serious enough to drive captives out of business or to stop captives launching in Europe?
Before Solvency II, launching a captive in Sweden was not a huge challenge, but the onset of that regulatory regime has complicated matters. Under Solvency II captive owners are required to provide much more detailed risk assessments and internal controls than were previously needed. This has made the process of obtaining a licence to run a captive considerably more cumbersome, and expensive, than it was in Europe before Solvency II, or than it currently is in the US.

Increased focus on strategic planning and risk management adds value whereas many of the internal controls that must be implemented are not proportional to the limited operational risks of a captive.

The rising cost of compliance has implications for any company considering launching a captive. In some cases a captive that made sense under the Solvency I regime may no longer look viable, due to the additional time and cost in consultancy and management fees.
Most captive owners will conduct periodic assessments to establish whether the benefits of owning a captive, including improved risk management and optimised coverage, outweigh the ongoing costs of maintaining it.

These assessments are themselves time-consuming. While the benefits of having a captive are relatively easy to measure, for example in the difference between the cost of coverage from the captive versus the cost of similar coverage from the commercial market, the costs incurred by the captive can be harder to quantify. Compliance costs, in particular, are very difficult to measure accurately.

Does it still makes sense for Sandvik to maintain a captive?
Sandvik conducted an assessment into that question around three years ago, and concluded that the benefits continue to outweigh the costs. In recent years the softness of the broader insurance market may have made it difficult for some companies to justify the costs of maintaining their captives, but as the market hardens and insurance coverage gets more expensive, the business case for having a captive will get stronger.

Fredrik Finnman is head of group risk management at Sandvik and a board member at the Captive Insurance Companies Association. He can be contacted at:  fredrik.finnman@sandvik.com