30 November 2020EMEA analysis

AM Best predicts an increase in European captive formations

AM Best has predicted an increase in the formation of captives in Europe, in response to challenging economic conditions and the rising cost of insurance.

In a market segment report titled Europe’s Captive Segment Poised for Growth Amid Hardening Insurance Conditions, AM Best noted Guernsey, Luxembourg and the Isle of Man all saw a reduction in their number of registered captives during 2019. In each jurisdiction – Europe’s three largest domiciles for captive insurance companies – the number of licences surrendered exceeded the number issued, AM Best noted.

This trend is set to reverse in 2020 and 2021, AM Best predicted, as hard market conditions make captives more attractive as a risk retention tool.

Since the beginning of the year, commercial insurers and reinsurers have commonly reported double-digit percentage increases in rates, and a tightening of terms and conditions, AM Best noted, with casualty lines particularly affected.

“Amid tougher renewal discussions, AM Best has observed an uptick in the use of existing captives, as owners seek optimal risk transfer solutions,” the rating agency said. “A number of captives have increased retentions or limits on existing cover, while in some instances they have expanded into new lines of business as their parents have looked at increasing captive utilisation.”

AM Best argued that the performance of captives in Europe throughout the COVID-19 pandemic has corroborated its view that the European captives that it rates have strong capital buffers that provide resilience against severe market shocks.

AM Best-rated European captives have not reported significant underwriting losses related to the COVID-19 pandemic, it said. While some have reported lower premiums as a result of the pandemic, this has also typically been accompanied by a reduction in claims activity, it noted.

Meanwhile, AM Best also noted that an increasing number of captives owners have integrated ESG factors in their operations, which has had an indirect effect on captives.

Many captives hold “a large part of their investments in inter-company loans, with the underlying assets invested by their parents,” the rating agency said.

“A change in a captive parent’s operations, notably in an effort to manage transition risk in industries such as oil and gas, can have a knock-on effect on their insurance needs,” AM Best said. “Ultimately, this would require a captive to adapt accordingly.”

AM Best advised captives to assess ESG exposures as part of their risk management activities to better understand the potential impact on their business. “A failure to do so can present significant risks, be they financial or reputational. Cyber risk and environmental liability are just some of the new areas of coverage for captives, and as such will require a fresh consideration of ESG factors for operators,” it added.

Captives are also harnessing digitalisation to make it easier and more cost-effective to write third-party business which it noted strengthens their relationships with key partners and secures diversification advantages for the captive.

“Big data and actuarial developments are also supporting captives with the underwriting of new products, whether for the benefit of their parents or third parties,” AM Best added.

AM Best argued the European Insurance and Occupational Pensions Authority’s (EIOPA) refusal to relax regulatory requirements on captives under Solvency II on the basis of proportionality will ultimately prove beneficial for captives by offering security to their stakeholders.