Michael Zuckerman, Temple University Fox School of Business
The COVID-19 crisis has exposed how interdependent risk has become in the modern world, and the extent to which a single event can devastate whole economies, let alone individual businesses. The world must respond by becoming much more creative in its approach to risk management, and captives should be at the heart of those efforts, says Michael Zuckerman of Temple University’s Fox School of Business.
The philosopher and thinker George Santayana observed that those who cannot remember the past are condemned to repeat it. This concept of appreciating the past is vital for identifying and assessing risk. Risk managers need to know history to understand risk and the tools required to manage it.
History teaches us that new threats, or risks that seem to be unique, are not emerging but are evolving risks. Pandemics, for example, are not new: according to the Centers for Disease Control and Prevention (CDC), the 1918 H1N1 virus (Spanish flu) pandemic was the most severe in the modern era. Medical technology has advanced exponentially since then, but the COVID-19 pandemic has taught us that risk evolves and will continually test our resourcefulness and ability to respond.
The CDC’s history of the 1918 pandemic tells us that absent a vaccine or pharmaceuticals to treat the virus, the formula for control and mitigation of the H1N1 virus was to isolate, quarantine, practise good personal hygiene (wash hands), use disinfectants, and limit public gatherings. Sound familiar?
“Such forward-moving programmes will reduce reliance on governments, which often act hurriedly to develop a response during the crisis.”
Adverse global events such as climate change and pandemics are not monolithic. We are in a global health crisis, which has triggered a global economic crisis. In 1918 the Spanish flu followed World War 1. And post-World War 1 was not a period when the global powers worked together to foster lasting recovery. The US emerged from World War 1 as the leading world power, yet it turned inward.
The prosperity of the 1920s was followed by the 1929 stock market crash, which was followed by the worst drought in North America in 1,000 years. There were three droughts in the 1930s, and then the Great Depression and World War 2.
Although a drought does not necessarily cause a stock market crash, risk managers need to be aware of historical events and understand them. They must ask whether their organisations are prepared to respond to multiple crises. Indeed, the COVID-19 pandemic, a healthcare crisis, has triggered a global economic crisis, which now may create an environment that could foster a geopolitical crisis.
Governments must be forward-looking and cooperate to avoid a geopolitical crisis. Such an event will inhibit efforts by local governments and organisations to mitigate the impact of the pandemic. Global leadership will enable scientists to access the credible data needed to model the extent of the pandemic’s spread and impact, helping them identify medical and non-medical solutions.
Post-World War 2 cooperation among Western powers significantly contributed to the advancement of solutions to global risk management issues. This contribution is a critical component of the public-private risk management partnership.
It is fair to question the lack of government, corporate, and healthcare preparedness for the COVID-19 pandemic, especially considering that we were on notice. David Quammen wrote about the transmission of viruses from wild animals to humans in his 2012 book “Spillover: Animal Infections and the Next Human Pandemic”.
Quammen explained to Scott Simon on National Public Radio on March 28, 2020, that he was not surprised by the COVID-19 pandemic. The scientists he interviewed researching his book told him about this possibility 10 years ago.
What surprised Quammen was how unprepared we are for the COVID-19 pandemic. How many times have we heard the phrase: “We are building this plane in midflight” to characterise our response to the COVID-19 pandemic? We cannot build planes mid-flight. We should have had the aircraft built, fuelled up and ready to go. History repeated itself with vigour: 1918 Spanish flu, 2003 SARS, 2009 swine flu, 2014 Ebola, and now 2020 COVID-19.
Captives: part of the solution
How does this situation relate to the future of captive insurance companies? History tells us that the future for captive insurance companies is bright. I wrote an article, “The future of uncertainty: captives and ERM”, which was published by Captive International in November 2019. In that article, I noted that the disruption of business operations is a significant source of uncertainty for most organisations—“which include climate change and climate change migration, disruptions to ecosystems and water supplies, cyber attacks, pandemics, and mass killings, to name a few”.
My premise was that a mature enterprise risk management (ERM) programme that proactively engages a captive insurance programme as a strategic risk management tool could more effectively address the spectrum of business disruption perils and hazards it faces.
Current events are highlighting just how interdependent risk is, and how a single event can impact an entire enterprise. We must, therefore, consider a new formula:
(ERM + environment, social, and corporate governance [ESG] strategy) X a strategic captive insurance programme = preparation for the next global event
The post-World War 2 Marshall plan taught us that ESG investing is productive and drives stakeholder value. The fact that the Marshall plan contributed to the greater good is not questioned. The Marshall plan strategy stands in stark contrast to the failed post-war retribution policies of the past, and it was an ESG-based policy.
The US led post-World War 2 investments and created strong global alliances with past enemies. Strong alliances such as NATO, The Trans-Pacific Partnership, and the Paris Climate Agreement further enhanced the US’s advanced post-World War 2 investments and global leadership, which were focused on avoiding political, economic, and business disruption.
This policy has changed recently, putting more pressure on organisations to improve preparedness for evolving cyber, pandemic, and political risks, to name a few.
The captive insurance industry has a strong history of being proactive when addressing emerging and evolving risks. I contend that Zachariah Allen founded the first group captive based on ESG principles in 1838, because he was willing to share his fire loss prevention and mitigation and technology with other mill owners.
Allen made improvements to his mill to increase its resilience and decrease the likelihood and impact of a fire. When his property insurance company declined to credit his risk management improvements, he formed a mutual property insurance company with those mill owners who shared his risk management vision and mission. That benefited the local and the regional economy.
Allen could have looked inward, treating his risk control inventions as proprietary to gain competitive advantage over the other mill owners. Instead, he was willing to share his inventions to the benefit of society. A group captive insurance programme was central to this initiative. Allen’s group captive grew into F.M. Global, a major mutual property insurer. Its solutions are driven by research, data, and evidence-based loss prevention and mitigation strategies to build business resilience.
Another example of a captive insurance programme that would solve an evolving risk management issue was the 31 medical technology companies, all members of the Healthcare Industry Manufacturing Association, now AdvaMed, which formed a Bermuda-based group captive insurance company in 1979.
The captive provided product liability insurance coverage to its member insureds to address an evolving exposure arising from the development of new technology. This captive moved onshore to Vermont as a risk retention group in 1986. Today Medmarc, now a part of ProAssurance Corporation, offers a myriad of coverages and risk control solutions to the medical technology and life sciences industry.
There are many historical examples of captive insurance companies solving risk management challenges, such as Oil Insurance, Nuclear Electric Insurance, physician-owned insurance companies such as Physician Insurance Association of America, and Harvard/CRICO. These captive-based risk management programmes made an important contribution to the global private-public risk management partnership.
Captives are strategic risk management tools
Single parent and group captive board meetings are a perfect platform for senior managers to discuss uncertainty that matters to their organisations, suppliers, customers, employees, shareholders and other stakeholders. A captive insurance company, when used as a strategic risk management tool, will develop creative solutions for evolving risk management issues.
A strategic captive insurance company enables its parent(s) to:
- Centralise risk management, because the captive is a magnet for data needed to identify/assess and manage risk, and to develop improved operational processes from lessons learned;
- Improve risk identification and assessment looking forward to future disruptive events, because of a multidisciplinary and diverse captive insurance company board;
- Improve decision-making to meet their strategic and operational objectives, because of improved understanding of risk, its likelihood and impact;
- Comply with regulatory and contractual insurance requirements;
- Access to risk capacity from the global reinsurance and capital markets;
- Control and design claims management, risk control, and coverage relevant to the needs of the member insureds and their stakeholders;
- Improve understanding of claims and risk management data which enhances the management of risk and the overall efficacy of the operation (we cannot manage what we cannot measure); and
- Develop evidenced-based risk control measures to reduce uncertainty and improve stakeholder value.
Now is the time for organisations to form group captives employing ERM and ESG thinking to improve organisational resilience and stakeholder value before the next global event. My Captive Insurance Companies Association (CICA) board colleague, Courtney Claflin, demonstrated the essential role single parent captives play in driving risk management in his Captive International article “How captives help universities” published in October 2019. Group captives can bring these same data-driven risk management solutions to those organisations in the spirit of contributing to the greater good.
I fully support the US COVID-19 Business and Employee Continuity and Recovery Fund being proposed by policyholder groups and major insurance trade associations to fund business recovery. The challenge going forward, however, is for captive insurance programmes to stimulate our creativity, enabling the design of business disruption, recovery, and resilience solutions to increase preparedness. This will help reduce the overall economic loss caused by a changing climate and pandemics.
Such forward-moving programmes will reduce reliance on governments, which often act hurriedly to develop a response during the crisis. Improved public-private partnerships are needed to address these evolving global risks. Group captives can partner with commercial re/insurers to develop customised risk financing programmes to fit the group’s needs beyond traditional insurable risks.
Examples of such partnership outcomes include:
- Business operations and supply chain difference in conditions coverage for cyber and pandemic related exposures;
- EBITDA recovery coverage to fund the costs of responding to a crisis and enable specific mission-critical functions to continue;
- Global employee health and safety risk management coverage and risk control programmes;
- Voluntary employee benefits to meet personal risk management issues;
- Global directors’ and officers’ liability coverage;
- Mitigation of climate change impact to organisational strategy;
- Mitigation of reputational impact; and
- Improved cyber ransomware, business disruption, and breach response.
The group captive insurance programme will improve risk identification and assessment by focusing on future uncertainties that matter to the group. This initiative will benefit from the group members’ combined historical knowledge of its operations and industry. The group understanding of its unique set of risks and their interdependency with national and global trends will improve risk identification/assessment and enable the group the focus on the uncertainty that matters.
Finally, single parent captives can offer dividends and provide loan-backs to ensure their parents have the capital needed to fund emergency response and recovery. It is more complicated for group captives to distribute excess policyholder surplus to aid member insured recovery from a catastrophic event.
Captive insurance programmes require a diversity of thinking on their boards, management, and vendors. A captive can break down communication barriers between risk owner silos because insured member senior managers are meeting as a captive board to talk about risk. To enable this conversation, diversity of thinking, as well as the diversity of information coming from all organisational risk owners, will broaden and deepen the risk management vision and captive benefit.
Reducing economic impact
Is it possible that captive insurance companies could become the world’s risk managers? It is undoubtedly time for risk managers to understand that everything has changed. We have been talking about pandemics for years, but few were prepared for the current healthcare and economic impact from COVID-19.
Addressing catastrophic risks must be a partnership. The federal government should fund needed duplication in healthcare capacity, providing enough beds, equipment, and personal protective equipment for healthcare providers to manage the healthcare crisis. State and local governments need to act more quickly to enforce mitigation behavior, such as the CDC prescribed in 1918 and 2020.
Considering the enormous damage done to our healthcare infrastructure and economy by COVID-19, growth in group captives may tip the balance in organisational ability to drive improved loss prevention and mitigation, reducing the overall economic damage caused by a catastrophic event.
Michael Zuckerman is an associate professor at Temple University’s Fox School of Business, in the department of risk, insurance and healthcare management. He can be contacted at: firstname.lastname@example.org
Michael Zuckerman, Temple University, Fox School of Business, COVID-19, Risk management, Business and Employee Continuity and Recovery Fund