Captives grow as property, cyber rates rise

The increased interest in captive formations and greater use of existing captive insurers seen in 2022 will likely continue through 2023, experts say. 

Owners are using captives more as commercial insurance rates for lines such as property and cyber liability have soared over the past two years and insurers have pulled back available limits. 

Increasingly, owners are using captives to fill in gaps in higher layers of programs rather than just using the vehicles to fund deductibles and lower layers of coverage, captive managers say.

The total number of captives worldwide increased by about 2% last year to 6,191. Of the largest U.S. domiciles, all but one of the Top 10 reported a net increase in captives. In Europe, Asia-Pacific and North American offshore domiciles results were mixed (see charts).

“It’s been very busy in terms of captive utilization as well as new formations, so we are still licensing captives like crazy,” said Nancy Gray, regional managing director-Americas at Aon PLC in Burlington, Vermont.

Captive growth has continued to be robust, and the growth has been across industries, risks covered and domiciles, said Jason Palmer, head of U.S. captive management at Willis Towers Watson PLC in Burlington.

“It’s really across the board, rather than it being specific to one sector of the business,” he said.

The trend is likely to continue, said Peter Kranz, senior vice president at Alliant Services Inc. in Burlington.

“The insurance market is fundamentally changing, with traditional markets backing further away from risk,” he said, resulting in premium credits for captives retaining that risk.

Sharply rising property rates have led to more companies using captives.

In some cases, policyholders are using captives to obtain coverage that is difficult to find in the commercial market, Ms. Gray said. For example, one policyholder formed a captive to cover wildfire risk and obtained a rating for the captive so it could fulfill its debt covenants.

“That’s an example of unique ways a captive can help address different risks within an organization,” she said.

Owners are using captives to fund rising property deductibles and covering layers in excess towers, where capacity is restricted or too expensive, across a broad range of property risks, Mr. Palmer said.

“It’s the entirety of the marketplace rather than being specifically for windstorm or flood or other types of property risk,” he said.

Owners are using captives to take a quota share cover or a layer higher up a program, said Anne Marie Towle, Carmel, Indiana-based CEO global captive solutions at Hylant Group Inc. 

“People are taking on more risk and utilizing their surplus, if it’s an existing captive, or, if they’re setting up a new one, deploying capital in a more meaningful manner, because otherwise some of these layers might be cost prohibitive,” Ms. Towle said.

Cyber

Cyber liability is another area where owners are adding risks to their captives in response to hikes in commercial rates.

Marsh saw a more than 50% increase in cyber premiums placed in captives over the past two years, said Ellen Charnley, president of Marsh Captive Solutions in Las Vegas.

Captives are being used to fund cyber deductibles, establish policy language for primary coverage that insurers follow in excess layers, to fill out capacity in excess layers of programs through quota share arrangements, and at the top of towers to complete limits that parent companies are seeking, Mr. Palmer said. 

“We are seeing it all over the placement and you don’t often see that with captive lines of coverage,” he said.

Organizations that need to use a large panel of cyber insurers can use a captive to fill in coverage excluded by some of the insurers, such as ransomware losses, Mr. Kranz said.

“For example, you throw your captive in, and the captive writes the full coverage and just cedes back to the market everything but ransomware,” he said.

Liability 

In 2022, captive owners also added more casualty risks, where rate increases were often more moderate, but coverage remained comparatively expensive, to reduce their total cost of risk by retaining more, Ms. Gray of Aon said. 

More owners are using captives to cover auto liability risks as the commercial auto insurance market remains challenging for buyers, Ms. Charnley said. In addition, Marsh set up several risk retention groups over the past year to address auto liability risks, she said.

Other areas of captive premium growth include life insurance, voluntary benefits and medical stop loss coverage, where the reinsurance market has been difficult, Ms. Charnley said.

Captives are also being used to cover supply chain risks, such as by offering coverage to vendors and suppliers or by taking on higher layers of supply chain-related risks, Ms. Towle said. 

Some captive managers said that owners are also looking to use existing or new captives to cover directors and officers liability risks.

Some states have laws barring companies from retaining the risk, but last year Delaware changed its corporate law to allow Delaware corporations to buy Side A D&O cover from captives. More than 50% of publicly traded companies are incorporated in Delaware. 

D&O rates have come down significantly since the law came into force, deterring many owners from moving out of the commercial market, several managers said.

But there has been interest in covering D&O, others said.

The change in the Delaware law sparked significant interest, said Mr. Kranz of Alliant. Some company directors, though, remain wary of moving from paying a premium to a D&O insurer to using a company-owned captive. Keeping the risk could potentially open them up to further claims from shareholders if a significant loss occurs, he said.

“It’s a great change in the law and there are potential benefits from it, but I think there was a rush to it and then a pause to understand the ramifications,” he said.

Marsh set up a protected cell facility in Delaware for companies that wanted to use a captive structure to cover D&O risks at “arm’s length” from the directors and officers covered, which has generated interest from owners, Ms. Charnley said.

“We’ve had people set up cells, but it takes time because it’s a huge decision because they have to be fully funded,” Ms. Charnley said.

Onshore/offshore

The years-long trend of more companies establishing captives in domestic U.S. domiciles, which have proliferated over the past two decades, continues.

In particular, companies are increasingly forming captives in their home states to minimize the potential for being charged self-procurement premium taxes, Mr. Palmer said. Some states impose those taxes on nonadmitted insurance coverage.

U.S. companies that don’t have international operations have little reason to select an offshore domicile because the costs of dealing with international jurisdictions are often higher, Ms. Towle said.

But while some offshore domiciles are reporting lower numbers of captives, some are still seeing substantial premium growth because of the business they are writing. For example, Marsh is seeing significant premium growth in offshore domiciles with life insurance captives, such as Bermuda, Ms. Charnley said. 

“The premium volume indicates what people are doing with their captives, and it indicates the strength of the market,” she said.