The future of captives as a profit centre: Part 1

08-12-2017

The future of captives as a profit centre: Part 1

baona / istockphoto.com

Innovative risk transfer will influence the future of the captive as a business model, as Marcus Schmalbach of BlockART Institute explains.

The origins of today’s industrial insurance market can be found in 14th century London, when traders founded a Buyers Club to insure against the then-prevailing existence-threatening risks, such as fire, mutiny, maritime accidents and piracy, using a collective.

marcus1.jpg

Buyers Club 1.0

Fast-forward to the 21st century and the development of this Buyers Club has led to the billions of industrial insurance offers available on today’s market. This was an entire industry from the beginning, consisting of brokers, insurers, and reinsurers. Combined with this are legal and tax parameters that make the market difficult for outsiders to understand, and make it seem very complex.

The implementation of intermediaries and additional market participants has led to long and complex coverage processes, high administrative costs and an increase in the insurance premium. While in the beginning this was 100% equal to the loss reserve, today this amount represents only 40 to 60% (depending on the insurance line and form) of the total premium to be paid. But what is the rest of this sum used for? For the financing of the brokers, insurers, and reinsurers—with the addition of insurance tax.

marcus2.jpg

Premium components

If this were the only weakness in the industry, it would certainly be forgivable. However, the industrial insurance market is a reactionary industry. Real product innovations are sought in vain. Standard insurance is offered, such as fire, business interruption, liability, etc. However, these can by no means be viewed as existence-threatening risks nowadays, and the basic idea of the Buyers Club is no longer taken into account.

Innovation failures, new technologies, business model disruption or recruitment problems are just a small selection of risks which can lead 21st century companies into bankruptcy. If you look for insurance coverage on the classic industrial insurance market, you are looking in vain—the providers have no solutions for this. Why?

Creating such solutions would involve costs for innovation, calculated risks, and a moral risk on the part of the customer. As mentioned before elsewhere it sounds paradoxical, but insurers are afraid to take risks—the saying “the cobbler’s children are always the worst shod” is true. However, a market survey conducted by our institute revealed that industrial companies are realising a change in the risks to their existence—especially in the context of globalisation and digitisation—and see a need to hedge against these risks. The crucial question, however, is how? One approach is alternative risk transfer (ART), under which the captive is also outlined as a solution.

marcus3.jpg

Risk map

Especially on the cost side, a captive delivers excellent savings potential, especially regarding costs, and an industrial company can have a slice of the premium pie. However, the problem remains being able to insure against new existential risks—especially if this concerns a reinsurance captive.

“Whoever wants to shape the future must understand the past,” is an old piece of wisdom from innovation management. So we return to the origins of the article, and equally to those of the industrial insurance market. Why did the Buyers Club develop in the way that it did? Due to market size and increasing complexity, we will take a look back at its evolution.

Everything in the industrial insurance market is determined by the brand, money and data. The abovementioned market participants contain all these parameters and use them to define their right to life. But is this still current? No!

Fortune has brand awareness and the confidence it brings to captive owners and insurers alike. Plenty of money—in the form of capital reserves—is also available. Data? The corporations of the world have more knowledge about their industry and their supply chain than insurers and brokers do. So why shouldn’t captives expand their activities, rather than just insuring their own market risks for their own companies?

Why aren’t captives perceived as profit centres (as various corporate companies already do), which should hedge against risks threatening their existence—both for their own company and for other companies? Currently, captives can only insure market risks, as they depend on the wording of insurers and reinsurers. What if this were no longer the case, and the captives could set up their own coverage concepts that would meet the requirements of both the parent company and the supply chain members? Blockchain technology undoubtedly offers the technical possibilities for this offer.

The question of how to do this is answered in our following article Buyers Club 2.0: the future of corporate risk hedging.


Marcus Schmalbach is a lecturer in business administration at a university of applied sciences in Southern Germany and a PhD in the field of captive insurance companies at the University of Gloucestershire, UK. He is head of BlockART Institute which is doing research in the field of blockchain and alternative risk transfer. He can be contacted at: schmalbach@ryskex.com

Marcus Schmalbach, BlockART Institute, Captives, Blockchain, Global

Captive International