Life science captives: time for a refresh?
Life sciences organisations have traditionally been among the most sophisticated users of risk financing vehicles. The industry embraced captives in a meaningful way just over 20 years ago, the last time the insurance market was truly hard and product liability capacity was reduced or stopped entirely.
While the principal driver of their interest was financing product liability risks efficiently, they often included other lines, such as property damage and business interruption (PDBI).
“Clients who use a captive insurer for the EU portion of their trials could increase the efficiency of turnaround for certificate issuance.”
Broadening the captive programme allowed companies to avail themselves of the diversification benefit and support a more enterprise-wide approach to risk management and financing.
Over the course of the soft market, life science sector risk managers have found capacity and appetite at a reasonable price for traditional property and general liability risks. Instead of replacing their captives with risk transfer options, they used their captives to coordinate and control how their self-insurance programme interfaced with the risk transfer market. They were looking to optimise the relationship from a total cost of risk perspective, while maintaining control over claims.
Now, we find ourselves back in a hardening market, with challenges across most lines of insurance including liability, PDBI and, in particular, directors and officers (D&O).
As the risk transfer market becomes increasingly challenging and uncertain, captives will again be examined as a resource to help navigate the rapidly changing insurance market environment. Similarly, organisations that do not own a captive or have not revisited their risk financing strategy for a while may want to explore how a captive can support their strategy.
How are captives currently used by the industry?
According to Aon’s Captive Benchmarking Survey, property and liability have consistently been the most commonly written covers by life science sector captive entities. While property risk can share similarities across multiple industries, liability exposures present a challenge that is quite specific to life sciences.
Given the sensitive nature of medical devices and pharmaceutical products, life science organisations are a litigation target. Several payments to settle litigations have exceeded $2 billion:
- In 2007 Merck & Co agreed to pay $4.85 billion to settle 27,000 lawsuits in relation to Vioxx
- In 2015 Takeda agreed to pay $2.4 billion to settle 9,000 Actos lawsuits
- Stryker paid over $2 billion to settle lawsuits in relation to hip implants since 2014.
These loss events have compounded the hardening market conditions for life science product liability risks. While med-device and pharma product liability wouldn’t be termed a ‘non-insurable risk’, commercial insurance market capacity and appetite for these risks is limited, especially for large US-based life science organisations.
Consequently, organisations that use a re/insurance captive often establish significant risk financing capacity. The objective is to create a financial buffer to the balance sheet, should there be a large loss event like those referenced above.
Where there is a captive in the company’s risk financing approach, there are other strategic benefits. For example, it strengthens the connections between risk management and other departments, such as legal, supply chain, treasury and, in many cases, human resources, helping them to actively manage the risk.
In addition, the participation of a captive in the programme can allow the risk manager to maintain control over claims and claims data. That is of particular strategic benefit in the life science sector. Not only does it facilitate confidentiality over market-sensitive product information, it means detailed claims information can be used for in-house risk modelling, trending and informed data-driven risk financing decision-making.
Property and business interruption
PDBI, typically a well-understood risk by captive owners and insurers alike, is now central to the current shifting of market conditions. The first driver for this was the 2017 hurricane season, with Harvey, Irma and Maria becoming three of the top 10 costliest insured loss catastrophes in history, totalling $90 billion combined. The California wildfires then followed in 2018 and, while claim estimates show this to be 36 percent down on 2017, the year represented a 26 percent increase in claims experience versus the 10-year average. This loss experience has resulted in drastic increases in rates, higher deductibles, shrinking capacity, and a narrowing of coverage.
Second, and perhaps more specifically to risk managers in the life science industry, there is an increased appetite for an effective non-physical business interruption risk financing solution. The increasing need for an effective business interruption cover is driven by the growing awareness for the complexity of the supply chain in the life science sector, and loss events that were not covered by the traditional PDBI policies.
The complexity of production and logistics was observed in the 2019 sartan recalls. Now, the COVID-19 situation has raised the issue again, increasing the risk of shortages of several essential drugs in Europe and the US.
In the past two renewal cycles we observed that risk managers consider revisiting programme structures in response to firming market conditions, but also shifting market demand. Strong captive balance sheets and well understood risks allow for greater risk retention, while policy wording flexibility affords a new opportunity to address the growing need for non-damage business interruption.
Going beyond traditional lines
As new challenges may require new answers, innovative risk managers constantly monitor and assess their risk profile and review their strategies for mitigating and financing the risks of their organisation. As innovation is in the DNA of the sector, many decision-makers are investigating options for using their captives beyond the traditional lines and strategically use these in negotiations with the markets.
The life science sector was hit heavily during the NotPetya ransomware attack in June 2017, resulting in material cyber-related losses. The event reiterated to risk managers the need to address this kind of risk. According to Aon’s 2019 Global Risk Management Survey, 59 percent of respondents from the life science industry have either purchased cyber insurance cover, or planned to purchase it in the next 12 months. A third of them have undertaken both a quantitative and qualitative cyber risk assessment.
As cyber risk and cyber insurance came onto the radar of risk managers over the past five years, we have observed corporates building up experience and insights into their cyber risks. They are taking an increasingly strategic approach towards managing and financing cyber risks.
Taking a more sophisticated approach to cyber insurance over time also means that more risk managers consider writing cyber insurance via their captive.
Of late, the life science sector has been associated with more securities class actions than any other industry sector. Consequently, in the past two renewals, D&O liability has been a significant and material pain point for life science sector risk managers. In fact, there has been an observed increase in the numbers of filed class actions, with a year-on-year increase of 20 percent in 2019 compared to 2018, and some very large settlements in recent years.
In response, D&O rates continue to rise. Per Aon’s Q3 2019 Quarterly D&O Pricing Index, indications were that price per million dollars of cover, regardless of entity sector, had increased by 69.7 percent compared to Q3 2018. Where deductibles of $1 million used to be commonplace, the same placements are now attracting deductibles ranging from $5 million up to $25 million in the life science sector. We observed an average rate increase for life science companies of 187 percent in 2019 compared to 2018.
As a result, life science risk managers are revisiting their risk financing strategy for D&O risks. This review includes the assessment of the limit and programme structure, as well as the analysis of risk financing options. While a captive is generally not suitable for writing side A cover, a few life science captive owners are investigating the potential of insuring sides B and C to manage the total cost of risk and respond to the rate increases being faced by the industry.
Clinical trial liability
Clinical trials are a key process in creating a product pipeline for innovative pharma and medical device companies.
The EU is introducing new legislation on how it authorises and regulates clinical trials across all EU member states, providing a unified system for sponsors and states, based on a single authorisation application process. This unified authorisation approach across all member states means that a failure in any one part of the application process means a failure of the whole application, union-wide.
As clinical trials insurance is a component of the application process, there is an opportunity to smoothen and streamline the insurance process. An EU-based direct-writing insurance captive allows the owner to manage and control the insurance management process throughout the EU, resulting in a reduction in delays in amendments to clinical trial certificates to meet with regulatory requirements.
Our data also show that clients who use a captive insurer for the EU portion of their trials could increase the efficiency of turnaround for certificate issuance versus commercial insurers, due to the bespoke nature of a captive’s in-house protocols. Considering the new regulation is time-bound, this speed could prove invaluable to a company’s research and development processes.
What next for captive owners?
What does all this mean for captive owners or those considering setting up a captive?
It means a few things. First, it means that a captive has a strategic and meaningful role to play in the company’s risk financing and risk management strategy. In recent years, captives have been under pressure with increased regulatory burdens and decreasing risk transfer pricing. However, we find that, in Europe in particular, captives have met the initial challenge of regulatory change and find themselves in a stronger position from a capital and governance perspective. This creates a foundation for sustainable growth.
Increased premium costs and tightening terms and conditions require corporates to examine alternative ways of risk financing and minimising total cost of risk. While the impact of COVID-19 is as yet unknown for many companies, it is likely to exacerbate challenges, rather than alleviate them. It is in this environment that a captive can drive efficiency as a strategic risk management tool.
Anne-Christine Fischer is global life science practice leader, global risk consulting at Aon. She can be contacted at: firstname.lastname@example.org
Simon Huttley is senior insurance manager at Aon Risk Solutions. He can be contacted at: email@example.com