Using captives to quench the risks of wildfires
Alex Gedge, senior captive consultant at Hylant Global Captive Solutions, explains how captives can be used to manage wildfire and other risks.
We’ve long tossed the phrase “growing like wildfire” around to describe faster-than-normal expansions of any number of things. If anything is growing like wildfire today, it would be the use of the captive insurance approach to address climate-related risks. That’s especially true when it comes to risks associated with—you guessed it—wildfires.
Wildfires are as old as the Earth itself, but the combination of increased population density and extreme weather resulting from climate change has focused increased attention on them. Devastating fires in Canada, the US (specifically, California), and Australia have captured public attention as they consumed vast areas of land and many communities.
Europe and other regions are experiencing fires on a previously unseen scale. The causes can be attributed to various things, including lightning strikes and human acts, whether through outright arson or simple negligence.
The sheer number and the severity of wildfires have been increasing, making it difficult for insurers to find the balance of frequency and severity that makes reliable coverage possible. The risk has changed inherently and unpredictably in recent years for some of these catastrophic-level risks, making it difficult to model. Little wonder many carriers are walking away from writing coverage of these destructive disasters or increasing pricing.
The market’s reluctance to write coverage creates an exciting opportunity for captives to cover a clearly defined insurance need.
“Your captive exists solely to keep your business up and running.”
Knowing the problem
As with any type of risk, establishing a captive to address the challenges associated with wildfires begins with developing a thorough, accurate understanding of the risks your organisation faces. Like commercial insurers, you can’t rely upon historical data because it fails to address the increased occurrence of fires. When you built your facility, you had the correct coverage for the conditions at that time—but now, the increased likelihood of wildfires and how they might affect your facility and/or team demands a fresh look.
Your insight into your facility and the specific risks make a captive a practical option. You know everything about the facility and what it takes to run your business. Perhaps you’re less concerned about direct damage to the facility and more worried about losing the power lines that feed your operations, or about whether your employees would be able to get to work when the area is blanketed with smoke, or when their own homes are unoccupiable or in danger of being destroyed.
The better you can define the risks, the more effectively you can design your captive to address them.
Another advantage of the captive approach is that it allows the company to become nimbler about responding to new risks. If a new risk emerges, folding it into the captive is relatively easy. Adding the risk to a commercial insurance carrier’s policy is likely to be significantly more time-consuming.
Another set of risks related to wildfires involves what we might refer to as downstream issues. Large wildfires send massive clouds of smoke and particulate matter into the atmosphere, and winds send them thousands of miles away. The smoke may produce extraordinary sunsets, but its effect on people and other fauna is less desirable. Thick clouds of smoke can disrupt normal heating and cooling cycles, creating a knock-on of local weather issues.
Suppose your company operates a facility in a relatively pristine area. A wildfire breaks out to the west, blanketing your facility in thick, noxious smoke. You don’t want your employees exposed to health dangers, so you suspend production for several days. What kind of loss would that create?
Beyond any immediate damage, what are the potential long-term effects of the fire’s residues? Will they require professional remediation?
You can add another layer by considering how a distant wildfire might affect a critical supplier. Suppose your supplier is the one that must close because of wildfire smoke, so your operations are temporarily interrupted. The growing complexity of the supply chain underscores the problem. What happens if a wildfire on the other side of the world keeps the cargo jet from landing there so it can pick up the components you need?
Good modelling
Effectively working with clients to create captives requires a holistic overview of multiple lines of business and working together with underwriters and actuaries to accurately model the risk. For example, experts study the structure of buildings and attempt to identify the threats that could cause problems.
While we typically think of captives in terms of protecting business assets, they can also serve as a powerful tool when addressing the human element. Beyond protecting your employees at work, you may be able to use funds from the captive to train them to deal with the threat of wildfires. You can ensure they know where they can go for safe shelter or temporary housing, who they should call, and what they should have in place to respond quickly when the situation becomes dangerous.
Actuaries can identify factors such as geographic concentrations of employees who could be isolated from your facility because of a wildfire.
When you consider the importance of your employees and their wellbeing to keeping your business in good working order, addressing their needs through a captive can help you and them recover more rapidly.
No matter which risks you choose to cover through your captive, your strategy will be more precise than what a commercial carrier could offer. That’s because carriers are structured to focus on larger customer risks through averages that probably do not reflect the realities of your organisation. A captive insurer is set up specifically for your company’s unique needs, and a well-structured captive can accommodate the never-ending changes to those needs.
Suppose your company is based in California but one of your most important suppliers is in Southeast Asia in an area prone to typhoons. Flooding there could stop your flow of materials for weeks. What if you could structure financial protection for that kind of interruption into your captive?
Conversely, a wildfire at your California facility could keep you from meeting commitments you’ve made to customers. You might cover the financial consequences through your captive. The key difference between a traditional insurance carrier and your captive is that your captive exists solely to keep your business up and running.
Because finding commercial insurance coverage for many of these risks is increasingly difficult or even impossible, companies may wonder if they’ll run into similar roadblocks when obtaining reinsurance coverage for their captive. In our experience, reinsurers are eager to offer surprisingly affordable coverage if a captive’s owner and its consultants have clearly identified and addressed risks and if the business plan is actuarily sound.
There are other opportunities, such as the use of parametric strategies. Partnering with firms specialising in parametrics can assist with a captive whose key exposure is tied to the potential for flooding. The approach might involve combining sensors at specific sites to monitor rainfall and potential floodwaters and incentivising the sites to install effective flood defences and adopt interventions to limit the damage.
The right data
As with all types of captive insurers, having access to the right data is essential to a programme’s success. Companies that haven’t been compiling data related to climate issues can protect themselves while preparing for a captive through a process referred to as loss incubation.
By placing a previously uninsured risk such as environmental impact liability into a captive, you'll begin to accumulate data and better understand the nature of your losses. During the first year, you might fund 100 percent of the risk. Then, based on what you've learned, in the second year, you can fund 80 percent through the captive and obtain market coverage for the remaining 20 percent, 60:40 in the third, and so on. Your coverage should become more precise as you become more educated and pursue strategies to mitigate these new risks.
With the planet warming, expect the frequency and severity of wildfires to continue their upward trend, along with fires becoming an issue in places that rarely experience them now. By using a captive insurer as a vehicle for identifying and insuring the specific risks related to wildfires—or other climate-related issues—companies can provide the financial protection they need while encouraging safer and better behaviours.
We shouldn’t be surprised to see these captives catch on like, well, wildfire.
Alex Gedge is a senior captive consultant at Hylant Global Captive Solutions. She can be contacted at: Alexandra.Gedge@hylant.com
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