13 October 2020EMEA analysis

Exposing supply chain risk and boosting captives: COVID-19’s impact on risk managers

​COVID-19 has put supply chain risk management under the spotlight, highlighting strengths but also, for many organisations, exposing weaknesses as well, according to Laurent Nihoul, general manager​ ​corporate risk and insurance for ArcelorMittal and a board member of the Federation of European Risk Management (FERMA).

“This is the first time in our lifetime that there has been such a global stoppage of activities, and it has placed a clear focus on supply chain,” Nihoul said.

“Lots of companies have suffered disruption, and it has been the perfect test of your supply chain risk management structure.

I expect captives to be on the rise because this kind of market pushes risk managers to find alternative solutions​ ​and captives are one of those.

“From a positive point of view, there are companies who realised their supply chain risk management process was really good, because they were able to respond efficiently, but for some it has been an opportunity to understand the limits of the risk management process and find ways to improve it.

“For ArcelorMittal it was quite smooth. Of course we had some impact here and there but globally it was not a big disruption at all.”

As the FERMA board member responsible for captives, Nihoul expects increased activities in this area as organisations respond to the hardening re/insurance market.

“I expect captives to be on the rise because this kind of market pushes risk managers to find alternative solutions​ ​and captives are one of those,” he said.

His views are supported by FERMA’s annual risk management survey, in which an increased number of respondents said they expected to make increased use of their captive, or to create one.

The specific use of the captive will depend on the risk profile of the organisation, Nihoul noted.

“Some will increase the retention on the bottom layers of the covers, others will remove some exposures that the market is overpricing​ ​a captive can fill a gap in your programme,” he said.

ArcelorMittal makes sophisticated use of its own captive, using it to fill gaps in the cover the company has in the insurance market and as a front row underwriting unit to access different reinsurance markets and create one single insurance product for its entities.

“We use it for financial optimisation​ ​that is the self-financing part of it: capturing underwriting profits, calculating the cost of risks and trying to minimise it, but we also use it in an operational way, optimising the flow of our insurance operation,” Nihoul explained.

“In an organisation such as ours we have many countries, hundreds of entities, and heavy industrial risk, so beyond the premiums and claims there is a process and a cash flow​ ​we use it to optimise this dual aspect.

“We have two main strategic principles: the first is that we use it in all insurance lines​ ​not all captive owners use their captive in all lines of busine​s​s.

“Second, we never use a captive without a risk transfer solution: we never take 100 percent of a risk in the captive​ ​we transfer to third party insurance companies.”

Nihoul would, naturally, like to see the re/insurance industry offer more appealing rates and terms and conditions, but he is concerned the problem is going to get worse before it gets better.

“We have the triple crunch at present: underwriting restrictions, capacity decrease and price increase, so it’s the most difficult market you could have,” he said.

“My concern with COVID-19 is that it will escalate. Last year the hardening market was a problem for insurance managers and within their organisations they had to explain why the price was going up, but now with COVID-19 what you have is almost all industries suffering heavily from the economic crisis, and in the January renewals we will see quality issues and higher prices in an environment where everyone is cutting costs.

“The impact is felt not just by the insurance managers but also by chief financial officers, and then it becomes a very significant problem, because why should they buy a product with lower quality and a high price when they have to reduce all their costs?

“On the other hand, I understand the dynamics in the insurance market and the fact the insurers have been making a loss and need to balance their profit and loss.

“The dynamic is understandable from a global perspective​ ​there are not enough premiums to pay the claims and they are reacting in a very quick and extreme way.”

Treatment of captives

Against this backdrop, FERMA is working to make the captive insurance route easier for companies, particularly with regard to regulations. It is in a dialogue with EIOPA on its review of the Solvency II directive, with the aim of encouraging a principle of proportionality for captives so that the way the regulations are applied recognises the differences in size and scope between captives and traditional insurers.

FERMA has also made suggestions and proposed guidelines to the OECD regarding its international Base Erosion and Profit Shifting (BEPS) framework. Among other things, this seeks to tackle the misuse of captives as a mechanism to dodge taxes by shifting profit into more favourable environments; FERMA is concerned that genuine use of captives should not be impeded.

“We are trying to improve the authorities’ understanding of what a captive is, why we use them and why they are efficient tools in the global self-financing structure of a company,” Nihoul said.

“You have to demonstrate to the authority that you are not artificially increasing or decreasing the price.

“We are happy for the regulators to target and remove any unfair transactions, but you should not hit the whole industry heavily with these rules and requirements. Our approach is to say we should have consistency in the guidelines and proportionality​ ​meaning that if a captive is used as a tax avoidance tool, we are the first to be happy to remove it from the market.

“But for all others, please have a proportional approach according to size, and apply it in a consistent way in all countries,” he concluded.