The alternative option

How captive insurance made a comeback during the hard market

By Bernice Han

At the height of the hard market a few years ago, interest in alternative insurance methods picked up among businesses with complex or hard-to-place risks.

Captive insurance – a non-traditional risk management tool that often flies under the radar – attracted companies wrestling with soaring premiums, huge excesses and other onerous terms.

While pricing has improved, interest in captive insurance has not waned, according to industry analysts and insiders. They say corporations that have used the method have retained it.

“We have to note we are coming off some record high increases in previous years and the absolute rate is still high compared with soft market years,” AM Best director of analytics Victoria Ohorodnyk tells Insurance News.

“The easing of market conditions does not necessarily mean demand for captive insurance will decline significantly. Many businesses that established captives during the hard market have realised the long-term benefits, including greater control over risk management, improved cash flow and potential tax efficiencies.”

Ms Ohorodnyk says the risk landscape has also changed in ways that “could sustain the momentum for captive insurance demand”.

There is growing geopolitical uncertainty and climate risk, and new perils have emerged – such as cyber and supply chain vulnerabilities – that “are difficult to insure through traditional carriers. Rates may also be volatile prospectively.

Captives allow businesses to tailor coverage and retain control over claims management in these evolving areas.”

There are various definitions of captive insurance. Put simply, it is a risk management and financing vehicle set up by a company to retain risk.

One key benefit is that any profits made by a captive are kept within the company.

Ms Ohorodnyk says captives are viewed as a long-term strategic risk management tool and not a short-term response to pricing cycles.

Marine Charbonnier, Asia-Pacific and Europe head of captives and facultative underwriting at global insurer Axa XL, sees “positive energy” in the Australian market after a recent visit to meet with her local team and distribution partners in Sydney and Melbourne.

“This is a market with a lot of challenges or large risks,” she tells Insurance News.

“It is a competitive market, so that means there are some captive options worked on by the brokers with the clients to have the best of the market. That’s why I see very positive energy here.

“We feel probably there will be more opportunities, especially within energy transition, so that requires a lot of attention and capacity, because it’s large investments.”

While declining to give specific figures, Ms Charbonnier says Axa XL’s captive business in Australia and the Asia-Pacific increased last year.

“So it’s very important to spend time here to listen to the market.”

Steven Bauman, Axa XL’s head of global programs and captive practice in North America, says more insureds are finding relief from property catastrophe risks, excess liability and emerging risks – the very exposures the captive market was built to serve more than 60 years ago and that rose again during the liability crisis in the 1980s.

“What was old is new again,” he says. “From the property risk side, interest in captive utilisation for catastrophic coverages is particularly increasing.

“The increased frequency and severity of weather events, combined with the higher premiums in firmer insurance markets, are enticing insureds to the captive market to offset some of the risk.”

Ms Ohorodnyk sees potential for captive insurance to grow in Australia.

“Rising insurance costs and evolving risk exposures could create future opportunities, particularly for large corporations in high-risk industries,” she says.

“Large corporations in industries with specialised risks such as mining, energy and infrastructure may increasingly look to captives for cost control and tailored coverage.

“Additionally, demand could also increase due to Australia’s significant exposure to natural catastrophe risks (bushfires, floods, cyclones), as captives could help businesses manage these risks more effectively, particularly when reinsurance costs are high.”

At present, Barristers’ Sickness & Accident and BHP Marine & General are the only two licensed captive insurers in Australia, according to the Australian Prudential Regulation Authority.

Brisbane broker Tony Venning, who runs risk advisory company Crucial Insurance, says he has received more enquiries from clients frustrated with traditional insurance during the hard pricing cycle.

However, significant barriers remain for those interested in setting up captives, he says. They must have the financial resources to establish a captive that can cover potential losses. They must also consider the costs of engaging financial experts such as brokers, accountants and lawyers to help with the set-up.

Due to the high capital cost involved, Mr Venning says, captives are not suitable for every business.

“We’ve seen an increase in clients and buyers posing questions about captives … how viable are they and how they work,” he tells Insurance News. “But what hasn’t changed is the barriers.

“Our main approach is that there are alternatives, but they always need to be considered against traditional insurance offerings.”

Protected cell companies, also known as sponsored cells, offer a way for smaller businesses to utilise the risk transfer mechanism. Such arrangements offer the benefits of a single parent captive without the need to create a separate legal insurance entity.

“From a broker’s perspective, it’s about trying to find the best solution for our clients,” Mr Venning says.

“If we can’t get some sensible pricing, we can’t get capacity at a reasonable rate out of the traditional insurance market and the client is instructing us to look at alternative approaches, then the captive solution, particularly through protected cell structures, can provide a viable alternative.”