Captives: widely misunderstood
Ellen Charnley, Marsh Captive Solutions
A Pandemic Risk Insurance Act (PRIA) modelled on the Terrorism Risk Insurance Act (TRIA) would trigger an increase in new captive formations, according to Ellen Charnley, president of Marsh Captive Solutions.
The COVID-19 pandemic has led to devastating losses around the world as businesses have shut down and many workers have been ordered to stay at home. Few businesses had taken out pandemic insurance before the crisis, but many more are expected to want it once the crisis is over.
However, providing comprehensive coverage for a risk as low frequency and high severity as COVID-19 at a rate that businesses can afford poses a considerable challenge.
For many, the answer is PRIA, which follows in the footsteps of TRIA, another measure that was conceived to help manage a risk that was too big for the re/insurance industry to handle alone.
Charnley said she supports the idea of PRIA as long as captives have access to it. “It would be a real shame if such a programme excluded captives, but so far it looks like it would follow the TRIA model and be open to captives,” she said.
If so, she believes businesses will be very keen to secure access to the programme.
“If a pandemic version of TRIA is created, a PRIA there will likely be an increase in the number of captive formations from companies specifically wanting to access that,” Charnley said.
The re/insurance market was already hardening before the COVID-19 crisis took hold, but the pandemic looks set to amplify the trend. Commercial insurers will be squeezed by losses to investment income, while the threat of governments forcing them to pay out on business interruption policies, despite policy exclusions, is casting a long shadow over the industry.
Charnley believes this too will encourage more businesses to think about captives.
“The coming market will see businesses retain more of their risk as they look to manage their commercial premium expense,” she said. “Once businesses start retaining more risk they will naturally start thinking about the potential benefits of risk financing with a captive.”
Marsh has already seen a marked increase in enquiries about new captive formations, as well as existing captive owners thinking about how they can make better use of their captives.
There are many answers to that question. Businesses can use their captive to write new lines of coverage if they identify coverage gaps in their commercial policies, as many now have in business interruption cover in particular. Charnley predicts an increase in the number of captives writing business interruption and pandemic risk.
Captives can also provide access to liquidity, most commonly via loans. While captives have been making loans to their parent companies for years, there has been a definite increase in such loans as other sources of corporate revenue have dried up.
Where captives have excess surplus, they can also pay dividends to their parent companies, grant premium holidays or accelerate claims payments. Captives can also buy assets from the parent, such as trade receivables or real estate, and hold them on its own balance sheet.
Charnley noted that Marsh Captive Solutions has helped clients extract $2.6 billion from their captives in the form of loans and dividends in the last month, as the COVID-19 crisis has deepened.
Some worry that captives that are launched in response to a specific crisis will not stand the test of time, and that owners will abandon them once the market starts to soften again. Charnley disagrees.
“It is rare to see captives being shut down, businesses tend to appreciate the benefits they bring, such as access to the reinsurance markets and evidence of insurance,” she said.
She admitted there could be an uptick in captive closures in coming months, reflecting a likely increase in bankruptcies among parent companies, or owners closing their captives to reduce expenses or gain quick access to liquidity.
However, she stressed Marsh has not seen any evidence of the trend so far. “Captive owners may look to reduce expenses or gain quick access to liquidity, but closing the captive may not release as much money as they hope, given the parent would still retain the captive’s liabilities,” she said.
Overall, she believes the number of captive closures will likely be outweighed by the number of formations.
Charnley also argued the captive community continues to be well served by brokers, despite industry consolidation reducing choice. Consolidation among brokers has had minimal impact on competition in the market and choice for captives, she said.
Marsh managed around 1,250 captive clients at the time of its merger, compared to approximately 100 for JLT. Similarly, while Aon has a large captive practice, Willis has a relatively small number of captive clients.
Charnley said: “The merger between Marsh and JLT has given the combined group’s clients access to the best from both groups. Each side has added new skills into the mix, and the captives group has structured teams accordingly, ensuring clients get the best possible service.”
JLT clients also benefited from the merger by gaining access to Marsh’s technology platform, which was considerably more advanced, she added.
Ellen Charnley, March Captive Solutions, Pandemic Risk Insurance Act, PRIA, TRIA, COVID-19