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Captives address emerging risks

Posted On: Sep. 1, 2023 12:00 AM CST

Ed Koral, Paul Carleton and Joseph Ziolkowski

BURLINGTON, Vt. Businesses are increasingly looking to captives to address emerging risks as commercial insurance market conditions remain difficult.

Demand is growing for innovative insurance programs for cannabis and cryptocurrency risks, among others, panelists said last month at the Vermont Captive Insurance Association’s 2023 annual conference.

“The search for capacity doesn’t end when your insurance broker says there’s no combination for you,” said Joseph Ziolkowski, co-founder and CEO of Relm Insurance Ltd., a Bermuda-based specialty insurer for emerging businesses.

“That’s the point at which the creative element should start kicking in,” he said.

Companies operating in emerging sectors such as digital assets and blockchain, cannabis and psychedelics face challenges getting insurance, Mr. Ziolkowski said.

“There needs to be a ton of collaboration with the operators of these businesses to put them in a position to reduce their dependence on the way insurance has functioned for the last 350 years,” he said.

New businesses face a classic “chicken and egg” problem where they need insurance to operate, but underwriters may not be able to provide coverage without knowing more about the probability and severity of a loss, said Ed Koral, New York-based director, strategic risk consulting, at Willis Towers Watson PLC, who moderated the session.

“Captives are frequently the answer, but part of designing that new product is deciding whether you have something that could be considered an insurable risk,” he said.

There are many examples of risks that people think may or may not be insurable, such as extended warranty, “and the Internal Revenue Service has gotten into the act of discussing that as well,” Mr. Koral said.

Large businesses with established captives are seeing opportunities to use them to solve problems, said Paul Carleton, executive vice president at Old Republic Risk Management Inc., a Brookfield, Wisconsin-based subsidiary of Old Republic International Corp.

Captives are being used to insure third-party exposures in business relationships “to maybe solve a business need and also generate the opportunity to bring third-party capital into their captive,” Mr. Carleton said.

For example, a retailer with a network of appliance installers that sometimes didn’t do a good job faced reputational risk when unhappy customers complained about their claims experience on social media, he said.

A general liability policy was crafted that rolled all the installations into their program with a third-party administrator of their choosing, and the risks were reinsured by the retailer’s captive, he said.

Stakes raised for risk managers in uncertain economy 

Risk managers and captive owners need to communicate the value of their captive insurance programs, especially in a hard market and difficult economy, experts say.

Risk managers should be prepared to defend the surplus a captive has built up in today’s economy when organizations may be looking to it as a means for cash flow, panelists said during a session last month at the Vermont Captive Insurance Association’s 2023 annual conference.

Rates for property and other lines of coverage are increasing in the hard market, said Karin Landry, managing partner, Spring Consulting Group LLC in Boston.

“We’ve seen increases of 30% up to 300% for certain lines of coverage,” Ms. Landry said.

An uncertain economy has heightened management’s focus on various things, including captives, and proving the value of a captive is coming to the forefront, she said.

“CFOs are always looking for ways to save money. Whenever you have a new CFO, everyone’s always worried about what’s in that piggy bank,” Ms. Landry said.

Organizations have competing priorities in today’s economic environment, which may lead to questions about whether captives are really adding value, she said.

“In the long run captives have shown their value, but these are the kinds of questions that we see clients dealing with on a day-to-day basis,” she said.

In a hard market, captives can be used as “a problem-solving tool” to combat rate increases and capacity reductions in lines such as cyber and property, said Michael Lubben, Chicago-based vice president of risk management and benefits at Henry Crown and Co./CCI.

By increasing retentions and putting in place a deductible buy-back, organizations may be able to draw greater competition among commercial insurers for their insurance program, Mr. Lubben said.

“A captive is a risk mitigation tool that companies are going to use to be able to get coverages or compete against coverages that you’d see in the market,” said Allan Autry, tax partner at Johnson Lambert LLP, in Raleigh, North Carolina, who moderated the panel.

Risk managers are often dealing with executives that need to approve the formation of a captive, Mr. Lubben said.

“They don’t know anything about captives, so the first step is to just provide that education and talk them through to this thing actually does exist and does work,” he said.

Having great communication with various parties, including insurance brokers, actuaries, the captive board and internal senior management, is critical to achieving a clear understanding of the value a captive can provide to the organization, Mr. Lubben said.

Long-term relationships with reinsurers key for captive owners

Captive owners need to build long-term relationships with reinsurers that can endure through hard and soft markets.

Captives that have diversified business relationships and write multiple risks will be more resilient in the long run and better positioned to leverage reinsurance coverage in a hard market, panelists said last month at the Vermont Captive Insurance Association’s 2023 annual conference.

“The more diversified the risk is in your captive long term, you’re going to be much better served, because you won’t have one loss blow up your captive,” said Steve Bauman, New York-based global programs and captives director, Americas, at Axa XL, a division of Axa SA.

“When the capacity is out there and abundant, you can go for that additional capacity and start to make other relationships that maybe you wouldn’t in a harder market,” he said.

Jeremy Johnson, Chicago-based vice president of global risk at Revantage Corporate Services, a Blackstone Inc. unit, said that after the January 1, 2023, treaty renewals, its broker advised it should expect a “double-double half.”

That meant its deductible limits and premium would double, and it could expect half the capacity, Mr. Johnson said.

By leveraging the reinsurance markets that it had engaged in previous years, it was able to discuss how to best optimize its risk management strategies and use the surplus generated over prior years and “maybe take a greater retention that would bring potentially more capacity to the table,” he said.

When relationships have been established over time, there’s a familiarity, Mr. Johnson said.

Reinsurers view a relationship-based, rather than a transactional-based, reinsurance process as a positive in the captive space, said Chris Ervey, Costa Mesa, California-based executive vice president at BMS Re, the reinsurance unit of London-based specialty insurance broker BMS Group Ltd.

“If you’re dealing with reinsurers that have been working with you over a period of years and they’ve had a profitable relationship, you have a much better chance to weather a bad year, to weather a change in the marketplace and maintain that relationship, especially in harder markets where rates are being pushed across the board,” Mr. Ervey said.

The session was moderated by Ryan Gadapee, shareholder, Primmer Piper Eggleston & Cramer PC, based in Burlington, Vermont.