Marsh Tracks Top Captive Trends

The number of captive insurers continues to increase globally, from 5,000 in 2006 to more than 7,000 in 2016. Once formed primarily by large companies, the captive market has opened up to mid-size and small businesses. The industry is also seeing a trend in companies forming more than one captive, using them for cyber, political risk and other exposures, according to a recent Marsh report, Captives at the Core: The Foundation of a Risk Financing Strategy.

Organizations are seeing disruptions in a number of areas and are relying more on their existing captives, Marsh said. Because of their flexibility, captives are also being used to respond to market cycles and organizational changes such as mergers and acquisitions.

While North America and Europe still dominate in numbers of captives, other regions have shown more interest in the past three years. In Latin America, captive formation increased 11% in 2016, the study found.

Within the United States, there is more competition among domiciles and some of the newer domiciles are experiencing growth. The top-growing U.S. domiciles in 2016 were Texas, Connecticut, Nevada, New Jersey, Tennessee, and New York. Domiciles outside the U.S. seeing the most growth include Sweden, Guernsey, Singapore, Malta, and the Cayman Islands.
As organizations’ exposures increase in number, complexity and severity, shareholder funds generated by captives are becoming more important. According to Marsh:

For many clients, captives are at the core of their risk management strategy, going beyond the financing of traditional property/casualty risks.

Specifically, we are seeing an increase in parent companies using captive shareholder funds to underwrite an influx of new and non-traditional risks, including cyber, supply chain, employee benefits, and terrorism, as well as to develop analytics associated with these risks and fund other risk management initiatives.

Risk management projects funded by captive shareholder funds in 2016 included initiatives to determine capital efficiency and optimal risk retention levels in the form of risk-finance optimization; quantify cyber business-interruption exposures; accelerate the closure of legacy claims; and improve workforce and fleet safety/loss control policies.

For example, Marsh-managed captives used to address cyber liability increased by 19% from 2015 to 2016. Since 2012, in fact, cyber liability programs in captives have skyrocketed 210%.
“We expect to see a continued increase, driven in part by companies that are already strong captive users and by those that may have difficulty insuring their professional liability risks,” Marsh said.

Captive Growth Increases Need for Insurance-Experienced Board

The current climate for captive insurers is gravitating toward encouraging captives—including single-parent, association and agent-owned—to appoint experienced, independent directors to their boards. Regulators (National Association of Insurance Commissioners and Bermuda Monetary Authority) and rating organizations (A.M. Best and Standard & Poor’s) have all come out in favor of the appointment of independent directors. They believe that independent directors add value by providing independent, experienced guidance to captive owners that is separate and distinct from a captive’s other advisers, including as managers, lawyers and accountants.

Their appointment could also help a company avoid a lawsuit. Independent directors do not have conflicts of interest, can provide experience that is different from others on the board and usually have a broad captive insurance perspective.

Another point worth considering is that some captive managers may have other interests, such as brokerages, reinsurance brokerages, actuarial, claims, asset investments. Some may even provide leads for a possible fee for premium financing. Furthermore, captive owners can mistakenly believe they get all the advice they need from their current advisers.

Independents on the Horizon

In the coming months, expect to see captive owners reaching out to independent directors, both because of their value-added consulting expertise and because regulators and possibly rating agencies will require it. This practice already exists in some overseas jurisdictions, and with Solvency II, it could become more important as it may ultimately apply here in the U.S.

What is often overlooked is the value-added experience independents offer. Here is a partial list of services normally expected of experienced independent directors:

  • Help in selecting the reinsurance interme­diary. They provide an independent per­spective separate from the reinsurance broker or risk manager.
  • Advise on acquisition opportunities of the captive, if any, such as buying a third-party administrator, a licensed admitted insur­ance company, or an investment in a new start-up retail brokerage firm. These sophis­ticated ideas are an expansion of most cap­tives’ business plans and need to be consid­ered carefully given the risks they present. Keep in mind, however, that the captive landscape from the 1970s is littered with the carcasses of captives that ventured ill-advised into such businesses.
  • Help in evaluating a reinsurance program’s structure and economics.
  • Attend and advise on the rating process with outside rating agencies, such as A.M. Best.
  • Attend meetings with insurance regulators, especially if there is a regulatory concern.

Independent directors are also asked to vote on many issues, including:

  • Should the captive change fronting companies?
  • Should the captive make a large dividend payment to the parent corporation, or should it return capital to its owners?
  • Should the captive write direct procure­ment policies for the parent corporation?
  • What law firm should handle uncollectible reinsurance?
  • Should the captive litigate or arbitrate certain claims?
  • Should it change asset investment managers?
  • Should the captive expand into other lines of business, such as writing third-party reinsurance business?
  • Should it move from an offshore domicile to a domestic domicile?
  • How can the captive reduce the cost of its reinsurance program?
  • How does a captive evaluate its various service providers?
  • What are the consequences of executing reinsurance or fronting agreements?

Captive Regulators Disappointed in New FHFA Rule

A final rule released by the Federal Housing Finance Agency (FHFA) amended its regulation on Federal Home Loan Bank (FHLB) membership to specify that captive insurance companies can no longer be used as a conduit to membership of the organization. Membership offers entities access to low-cost FHLB funding and other benefits. Because insurers may become FHLB members, along with credit unions and savings and loans, the Federal Home Loan Bank Act has been revised to specify that the term “insurance company” excludes captives.

Housing regulators have viewed captive insurers as a loophole used to access low-cost, government-backed financing. “Real-estate investment trusts that invest in mortgages are normally ineligible for home-loan-bank membership, but over the past few years have created captive insurers to gain indirect access to cheap federal funding,” The Wall Street Journal wrote.

As a result of captives being admitted as members, “25 are owned by entities that are not themselves eligible for membership.” The FHFA said it is “concerned that this practice will continue to grow and there is no reason to believe it will not grow to include entities other than REITs (Real Estate Investment Trusts), such as hedge funds, investment banks and finance companies, some of which have already inquired about establishing captives to gain access to the FHLB System.”

FHFA Director Melvin L. Watt said in a statement, “FHFA has the authority and the duty to implement the statutory membership provisions of the Federal Home Loan Bank Act and by adopting the proposal to exclude captives from the definition of insurance company we are making sure that institutions can’t frustrate the intent of Congress.” He added, “Congress has amended the Federal Home Loan Bank Act in the past to allow additional entities to become members of a Federal Home Loan Bank and it can certainly do so again if it wants some of these entities to be eligible for membership.”

Captive regulators of Vermont and Delaware expressed disappointment in the decision. David Provost, deputy commissioner of captive insurance of the Vermont Department of photo_provostFinancial Regulation, said, “Vermont’s response to the proposed rule was pretty straightforward: Don’t ban captives from FHLB membership just because they are captives. Captive insurance companies are regulated insurance companies, licensed for a particular purpose, and regulated in a manner commensurate with their risk,” he said.

Steve Kinion, director of the Bureau of Captive and Financial Insurance Products for the Delaware Insurance Department said, “The Delaware Insurance Department is disappointed that the Federal Housing FinancSteve Kinion (2)e Agency made the decision it made. In at least two comment letters, one in 2012 and the other in 2015, we have made attempts to work with the Federal Housing Finance Agency to help it understand captive insurers.” He added that what has been disappointing is that “our offers were never accepted. Delaware Insurance Commissioner Stewart continues to believe that captive insurers that are members of the FHLB system are well regulated and contribute to the FHLB’s mission of fostering housing in the United States.”

Kinion explained that that REITs have long sought membership in the Federal Home Loan Bank system, which was formed in 1932 to provide liquidity for the housing market. Because current law states that only certain types of institutions may become Home Loan Bank members, “captives have been a portal for membership. It’s unfortunate when well-regulated captive insurers are excluded from membership. I only wish that, before it issued its regulation, the FHFA would have allowed me the opportunity to show what Delaware does at the state level to regulate captive insurers.”

Delaware had been seeing increased interest in REITs. The domicile has one such captive and others were in the pipeline. One reason Delaware likes them is the revenue they bring in. “Our regional Home Loan Bank is in Pittsburgh and 10% of the profits generated have to be designated for affordable housing programs,” Kinion said. “In Delaware, there are a number of organizations that receive grants from the bank to promote affordable housing, and that benefits the state.”

The REITs captive program was fostered by Delaware Insurance Commissioner Karen Weldin Stewart. Her rationale was that, through the program she could “help with affordable housing in Delaware, which she can’t do directly as insurance commissioner,” Kinion said. “This was an indirect means of helping Delaware’s affordable housing programs.”

Provost said that while he supports REITs captives, the new rule will have a negligible impact on Vermont. “We have studiously avoided jumping on bandwagons of forming captives that have no apparent insurance purpose solely for some ancillary advantage,” he said. “We have allowed captives to apply for membership to the FHLB, and so far five have joined. They will have one year or five years to leave the FHLB system, depending on when they joined.”

Kinion noted, “I wish the FHFA would have at least talked to us, so they could have seen how we regulate captive insurance companies. If regulation is a concern, they should have at least taken a step to find out what we do at the state level. But that didn’t happen.”

10 Insurance Tips for Risk Managers

NEW ORLEANS—Most companies will at one time or another face coverage issues and lawsuits. In order to identify and avoid insurance-related issues and disputes before they arise, risk managers should take advantage of proven strategies for resolving difficult claims, advised Darin McMullen, attorney with Anderson Kill, P.C. at the RIMS 2015 Annual Conference & Exhibition here.

1. The purpose of insurance is to insure.

Don’t underestimate potential future problems and think of loss prevention and risk transfer rather than loss financing, he noted. Companies need to assess the types of risks they will face and make sure their program is tailored to meet these needs. Also important, he said, is making sure policies are designed to cover the losses the company will face on a day to day basis. For example, certain types of risks are seen in manufacturing and other risks are particular to an IT vendor. Risk managers need to examine any pitfalls or shortages that may exist in their current policies and seek legal opinions well in advance of renewal. They need to look at how exclusions might be interpreted as well, McMullen said.

Joshua Gold, also an attorney with Anderson Kill, added that risk managers’ jobs are more difficult than ever, with fragmentation in insurance programs existing, since many polices are purchased for a program. These may include directors and officers, product liability and cyber insurance. “There are products out there that try to assimilate them and make sure gaps in coverage are treated,” Gold said, adding that while the fine print in policies can be overwhelming, it can be key for proper coverage, especially when dealing with multiple lines, excess layers and towers of insurance.

2. Don’t limit insurance expertise to the risk management department.

All too often, “there are still going to be thorny claims and there still are going to be disputed claims, which are unavoidable,” McMullen said. He said that building expertise elsewhere within the company is critical to taking advantage of any and all available coverage. “We get the need for everybody to work together, but now, more than ever, this is important,” he said. Coverage should not just be delegated to risk or legal and collaboration is needed. For example, IT departments need to be included when planning for cyber coverage.

3. Lawyers and risk managers can be natural allies.

While there may be friction between departments in a company, legal generally recognizes the beneficial role risk managers play, McMullen said. He added that risk managers need to put any insurance-related communications in writing and assist in the analysis of policies and claims.

4. Insurance is an essential component of corporate resources and asset conservation plans.

Risk managers should purchase coverage with the intent of safeguarding the company’s own property and employees. They also need to recognize which mechanisms actually transfer risk and which do not.

5. Think insurance after a loss occurs.

This means looking to insurance coverage following all lawsuits, claim letters, product-related issues and financial losses. Risk professionals also need to analyze other sources of insurance that could possibly cover a claim.

6. Give notice of a claim or loss as soon as possible.

When faced with a claim or loss, McMullen advised risk managers not to hesitate to notify their broker, insurers and everyone in their tower of insurance as soon as possible.

7. When you make a claim, don’t accept “no” for an answer.

There is no downside to challenging an insurer’s denial of coverage. “You owe it to your company, you owe it to your organization to explore this and push back,” McMullen said, adding that determination and persistence often mean the difference between coverage and no coverage.

8. Find out where your company’s policies are.

Locate, collect and catalogue past insurance policies. Also acquire and keep policies of all entities related to your company.

9. Don’t panic if your insurer becomes insolvent.

If this is the case, McMullen advised risk professionals to file a proof of claim as a creditor and file a claim against the state guaranty fund in one or more possible jurisdictions. He recommended that they request the next layer of insurance companies to “drop down,” and also to consider litigation options.

10. Make sure your insurance team is conflict-free.

This means the team should be untainted–risk managers need to know where loyalty lies and if an attorney is representing both sides, McMullen said. “You want a conflict-free insurance team to take on the insurance company and to fight for the coverage that you are paying for,” he concluded.