Bron Turner, Damion Henderson, KPMG
A number of factors have come together to increase the role self-insurance is playing in meeting corporate risk management needs, say Bron Turner and Damion Henderson of KPMG Bermuda.
A combination of the COVID-19 pandemic, the hard commercial insurance market and emerging risks has left risk managers struggling to find some types of coverage, either because of a lack of capacity, or sky-high prices. In this environment, increased interest in captives, from existing and prospective owners, is not surprising. A healthy number of captive formations around the world is just part of the picture.
“Until the dust settles in this market, business interruption could be a key area for captives to fill coverage gaps.”
From our discussions with clients, we see owners using their captives more strategically and increasing limits, retentions, and deductibles on existing lines. They are also adding new lines, including some types of coverage not traditionally provided by captives such as directors’ and officers’ (D&O) liability.
Points to remember when considering the role of self-insurance include:
• A captive should be considered as part of an overall corporate risk strategy, not viewed as a separate entity;
• Captives can provide flexible options for coverage of risks for which insurance is either unavailable or exorbitantly priced; and
• Any gaps in a company’s insurance coverage can be effectively plugged by a captive, with reinsurance used to manage risk tolerance (retention level).
COVID-19 has reminded businesses and insurers alike that a black swan event’s impact can be both pervasive and long-tailed. In the commercial market the response has been a tightening of terms and conditions for many types of coverage. Capacity has dried up. Captives are being used to address the resulting shortages.
Significant uncertainty looms over the market in the form of potential losses related to COVID-19 that may surface as a backlog of lawsuits reaches the courts. Expectations for a continuation of a hardening healthcare market in 2021 are partly driven by the cases against medical institutions and professionals from people who claim they contracted COVID-19 in hospital. The workers’ comp market faces similar uncertainty as employees who allege they were infected on the job go to court. Generally, claimants have so far found it difficult to prove their case, but the potential for severe losses remains.
Business interruption coverage has also hit the headlines. In the UK, insurers were ordered to pay out to tens of thousands of business interruption claimants by the Supreme Court in a case brought by the Financial Conduct Authority on behalf of policyholders. The ruling could have a ripple effect across other jurisdictions. Business interruption insurance is likely to become either more expensive, or come with more specific pandemic exclusions.
Until the dust settles in this market, business interruption could be a key area for captives to fill coverage gaps.
Because emerging risks, such as cyber and data breach, are relatively new and there is a lack of data, commercial insurers are reluctant to price coverage competitively and there is limited supply.
This may change as more data becomes available. Until then, many companies may find their best option is to self-insure, using a captive to access the reinsurance market to provide a level of coverage above retention.
In 2020, we supported a client in forming a captive in Bermuda to provide insurance coverage to the emerging Canadian cannabis sector, another risk lacking coverage from the commercial market. In the US, the SAFE Banking Act and the CLAIM Act, legislation going through Congress, is poised to remove federal hurdles for banks and insurers to service legitimate cannabis businesses.
However, commercial insurers will probably be reluctant to rush into this market, as cannabis is a heavily regulated industry lacking in loss data. The opportunity will be significant for captives to provide D&O and other types of coverage for a new US industry with prospects for generating tens of billions of dollars in annual revenues.
Over the past 18 months, we have seen a change in mindset among clients who have previously tended to leave their captive to provide the same coverage year after year. Captives are now adding new lines and increasing risk limits as they play a more strategic role in overall corporate risk programmes. The shift has been driven partly by COVID-19 and partly by rising commercial rates.
Companies who are the most proactive in conducting risk coverage gap analysis extract the most value from their captives. Those revisiting their captive insurance strategy are seeing better opportunities for deploying accumulated capital for underwriting rather than leaving it to generate meagre returns in the low interest rate environment.
The “rent-a-captive” option is proving popular with companies that do not pay enough premium to warrant the expense of establishing and operating their own captive. Most of the large captive managers have established structures that allow organisations to enjoy the benefits of a captive by effectively “renting” a segregated cell company.
This option offers speed to market, as it avoids the need to set up and license a new standalone captive.
With strong tailwinds from market conditions and the need for businesses to cover their own fast-evolving and sometimes unique risks, the self-insurance option is climbing higher up risk managers’ agenda, and we expect the growth in captives to continue.
Bron Turner is director of audit at KPMG Bermuda. He can be contacted at: firstname.lastname@example.org
Damion Henderson is managing director and sector lead for captives at KPMG Bermuda. He can be contacted at: email@example.com
KPMG, Bron Turner, Damion Henderson