SRS bullish for captives formations
Increased scrutiny of small captives contributed to a decline in captive numbers in the years between 2015 and 2020, according to a report by Strategic Risk Solutions (SRS). The hard market is causing a reverse in that trend, however.
Its paper on the state of the captive market records a 3.7% annual growth rate in captives worldwide from 2006 to 2015, with numbers increasing from 4,951 to 6,851. The following five years saw a 2.5% decline to 6,027 in 2020. In 2021, however, this reversed again. Regulators in the domiciles it operates in saw captive numbers increase 2.9%. Formations were up by more than a quarter (26.2%), while closures were down almost a third (31.2%).
Taking captives and cells together, the increase was 5.5%, it estimates.
“Most sectors of the captive insurance industry experienced favourable growth conditions during 2021. Only small captives and captives requiring ERISA approval faced headwinds,” the report notes.
Increasing premiums in commercial insurance are driving growth, it suggests.
“The hardening of the commercial property & casualty insurance market has seen a resurgence in the traditional use of captives, taking a layer of their parent organisation’s property & casualty risk,” the authors write.
Not all lines are equally suited to captives, however, it warns.
“The strongest demand for captives is being seen in the lines that are most distressed, although some of these lines tend not to be the best suited to captive use. Low frequency, high severity coverages such as umbrella liability and cyber liability require relatively high capitalisation to protect against volatility. Directors & officers coverages also face structural challenges around Side A coverage. For existing captives with higher levels of retained surplus, taking higher limits in the captive and providing coverage in low frequency, high severity lines has allowed the captive to put under-utilised capital to work.”
Group captive activity has also been closely correlated with premium rates in the commercial market. Risk retention groups (RRGs), meanwhile, saw a particular turn-around in 2021, with 26 formed in the year and only four closed – the highest level of formation and the largest net increase in RRG numbers since 2007.
Finally, cells and series are growing fast, with captives cells up 10.9% in 2021. Excluding Bermuda and Cayman, most of the activity was concentrated in four US domiciles: North Carolina, Vermont, Tennessee, and Delaware.
“With the popularity of the cell structure and increased interest in captive programs, we are seeing insurance companies and brokers setting up their own cell facilities as a service to their clients,” the report states.
Only small captives have continued to see a squeeze.
“The IRS is still heavily focused on this sector with concerns over the potential abuse of the election. Over the past few years, IRS action has included small captives being placed on the dirty dozen list, increased reporting requirements through form 8886, blanket IRS settlement offers and the pursuit of cases through the courts,” the report authors note.
Even here, though, the decline in numbers is slowing.
“This has resulted in a clean-up of the small captive market with closures and a lot fewer formations. Remaining small captives tend to have a good fact pattern supporting the election. In 2021, we began to see the end of this cleaning up period with fewer closures.”
Overall, the report is optimistic for the future, with trends expected to continue in 2022.
“This should lead to an increase in captive and cell numbers in the coming year and greater utilisation of captives. We do expect that there will be some flattening of premium rates by the end of the year, but this should not slow captive use,” it concludes.