Captives owners are increasingly evaluating the possibility of expanding their existing self-insurance programmes to include non-traditional lines of insurance, says Claire Hutchinson of Advantage Insurance.
Emerging risks can often be underestimated or simply misunderstood due to their intangible and potentially unquantifiable characteristics. As loss occurrences associated with emerging risks could have a materially detrimental impact on the financial position and financial performance of a business it is essential that a robust feasibility study is conducted when considering the expansion of a captive insurer’s existing insurance programme to cover emerging risks.
An optimal outcome can be achieved by harnessing a new or existing captive, through partnership with insurance professionals
One of the primary challenges posed by emerging risks for captives owners is the process of accurately quantifying risk to appropriately underwrite coverage and determine provisions for outstanding loss reserves.
Quantitative analysis of emerging risks can be complicated due to limited historical data upon which to base assumptions. Emerging risks are constantly evolving, which implies that experts must try to assign an informed value to an elusive, moving target.
The structure of a captive can assist in the quantification process. In comparison to traditional insurance providers, a captive provides a platform to develop tailor-made coverage, through performance of thorough risk assessment analyses that address the specific concerns and needs of the business rather than offering an off-the-shelf package.
This gives captives owners the opportunity to develop specific loss data and history to support underwriting and actuarial models. The data will set out previously unclear details required to define the appropriate coverage and as such, form the foundation of future policies.
Emerging lines of coverage
Emerging risks for which captives may be able to provide solutions include cyber risk, terrorism risk and environmental liability.
Cyber risk is any risk associated with financial loss, disruption or damage to the reputation of an organisation from failure, unauthorised or erroneous use of its information systems.
Results of the American Property Casualty Insurance Association Enterprise Risk Management Committee’s 2019 Emerging Risks Survey indicated that 80 percent of participants believed cybersecurity and data breach to be on their list of the top five emerging risks; highlighting this as an area of focus for most business owners.
Initial cyber liability coverage issued by captives focused on first party risk with an emphasis on data breaches. Coverage has since been extended to include reputational damage, business interruption coverage and third-party risk for physical damage and bodily injury privacy/ liability.
The development of cyber liability coverage over the past few years has highlighted the need to treat cyber risk as a risk in its own right rather than an extension of an existing policy.
Cyber liability coverage is being seen to be popular among business owners. It is interesting to note that year-on-year increases in coverage can be attributed to an increase in the premiums written by captives with existing cyber coverage rather than an increase in the number of captives adopting cyber liability as a line of coverage. This implies that many businesses remain exposed to cyber risks.
It is possible that businesses that remain exposed to cyber risk without adequate liability coverage have assessed cyber risk in isolation and have assigned the responsibility of managing cyber risk solely to the IT department. A more appropriate approach may be to assess cyber risk as an inherent risk that permeates the entire business environment.
Terrorism risk stems from any act that imposes a threat to human life, property or infrastructure in violation of the law with the primary intention of intimidating or coercing a population or authoritative body.
The risk of potential terrorist attacks, and likely exposure due to workplace location, have led to an increase in popularity of the use of captives to cover risks associated with an attack. Similar to cyber risk, one of the main concerns regarding terrorism is the risk of business interruption and loss of revenue from delays in operational supply.
Specific coverage for acts of terrorism can include first and third-party coverage for property, workers’ compensation, general liability and cyber liability. The landscape for terrorism coverage has evolved with sited acts of terrorism. The coverage ranges from a focus on property damage in the event of mass casualties to non-damage business interruption and active shooter coverage.
In response to terrorism coverage requirements, some countries have established terrorism loss-sharing programmes such as the Terrorism Risk Insurance Program Reauthorization Act of 2015 (TRIPRA) in the US. This programme facilitates coverage of terrorism risk through a more transparent and stable system which covers losses for qualifying “acts of terrorism” according to the TRIPRA that are above the minimum triggering threshold.
The risk of environmental liability arises from physical exposure to natural elements in the ordinary course of business operations.
The prevalence and magnitude of climate change and manmade environmental disasters continue to pose an evolving risk with a considerable degree of concern for some business owners. A business with exposure to environmental risks seek solutions that promote coverage with sustainable corporate governance in mind as well as minimising business interruption.
Natural disasters ranging from wildfires, hurricanes and floods have seen an increase in frequency and the effect of a single event can be catastrophic. Businesses are operating in an integrated global environment where a natural disaster on one side of the world could directly impact the operations of one or several of the business supply chains located elsewhere, thereby resulting in disruption of the day-to-day activities of the business.
Role of the Cayman Islands
As a jurisdiction, the Cayman Islands has seen continued growth over several years, establishing itself as one of the leading captive insurance domiciles globally. In recent reports, the Cayman Islands Monetary Authority (CIMA) has indicated that there has been an increase in the diversity of submissions made in relation to emerging risks. This interest in the Cayman Islands for new coverage has been welcomed and encouraged by government and regulatory authorities.
The Cayman Islands has been, and is, committed to maintaining a flexible, yet robust, regulatory framework, with the support of insurance professionals. The positive response from global markets, in terms of growth, can be attributed to the implementation of such a framework.
The jurisdiction has acknowledged the role emerging risks play in the future of the insurance industry and recognises the relevance of remaining at the forefront of innovation. To this end, the regulatory bodies have committed to the monitoring of development areas and the retention of industry experts to advise on areas of emerging risks.
These efforts will ensure that sophisticated processes and risk-based analyses are in place to review all new applications that are submitted to the jurisdiction by captive owners.
When addressing emerging risks and how to structure coverage within a captive, one option is for existing captives to extend coverage to include such policies for emerging risks. The structure results in risk-bundling which increases diversification within the captive and provides a capital injection to fund operations. However, the structure implies that emerging risk coverage is ancillary to existing lines of coverage.
Given the global and wide-reaching implications that emerging risks present, there is merit in considering a second alternative in which the risks are covered in a standalone captive. A separate structure will ensure that all pertinent and specific risk criteria can be addressed in the captive. A cost:benefit analysis will thus need to be performed on an individual basis to assess which option is best suited to the needs of the business.
If these emerging risks are relevant to a business, what is the process for establishing appropriate coverage? The CIMA regulations for Approval and Notification of Changes: Class B, C and D Insurers and Portfolio Insurance Companies, with specific reference to the addition of new lines of business/ new class of risk, provide a practical starting point to initiating coverage for emerging risks. Key considerations include:
- Line(s) of business/risks to be written including levels of retention, cessions/limits and aggregates by line of business;
- Fronting/ceding arrangement and security requirements;
- Reinsurance arrangements;
- Actuarial reports on premium funding and reserving, including confidence level, discount rate, and/or rating methodology;
- Additional capital required, including full explanation of the rationale for the chosen level of support proposed and the proposed method of capitalisation; and
- Pro-forma financial projections.
Emerging risks in the current business landscape may appear overwhelming when one large loss event can materially and adversely affect an entire organisation.
A captive can provide a sustainable solution to business-specific emerging risk needs.
An optimal outcome can be achieved by harnessing a new or existing captive, through partnership with insurance professionals, to adopt a proactive approach in understanding the overall business environment, identifying precise areas of direct or indirect risk exposure and the quantification of risks in underwriting and actuarial models.
Claire Hutchinson is an account manager at Advantage Insurance. She can be contacted at: email@example.com
Claire Hutchinson, Advantage Insurance