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Aon Introduces Single-Parent Captive Cyber Insurance Program

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With cyberattack listed as one of their top risks, organizations are looking for ways to mitigate their risk in a market where cyber insurance rates are quickly rising. According to the Center for Strategic and International Studies, the annual cost of cyber crime and economic espionage to the world economy runs as high as 5 billion, or about 1% of global income.

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This does not include intangible damage to an organization, however. Companies are purchasing more insurance to cover the risk. In 2014, the report said, the insurance industry took in $2.5 billion in premiums on policies to protect companies from losses resulting from hacks.

As a result, captive insurers are being used more and more for coverage.

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Aon said it is addressing shortcomings in traditional cyber coverage with a cyber captive program with capacity of up to $400 million. Companies looking to form a captive would undergo a review to quantify their cyber exposures.

According to Peter Mullen, CEO of Aon Captive and Insurance Management, the program is designed to help clients understand their risk profile. “Once this is understood, they are is in a better position to make decisions about how much risk to retain in their captive and how much risk to transfer to the program,” Mullen said.
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 “The program allows captives to purchase coverage up to $400 million on a reinsurance or excess insurance basis.”

The cyber captive program will be domiciled in Bermuda and is available to single-parent captives. The basis for coverage will be “a very broad form which includes coverage for property damage and business interruption following a cyber event,” he added.

“Building a large tower of limits can be hampered by differing policy terms and conditions and dislocation of rates at different layers in a program,” Mullen said. “Additionally, many organizations facing cyber risks that can result in physical impacts, such as property damage and business interruption, agree that a more comprehensive approach to cyber risk is needed.

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Terrorism Incidents Down, Disruption Up in 2015

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A number of high-profile terrorism attacks worldwide have raised people’s fears this year, but the reality is that the number of attacks and deaths from such attacks actually decreased in 2015, according to Marsh’s 2016 Terrorism Risk Insurance Report.
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The report summarizes terrorism risk insurance trends, benchmarks terrorism insurance take-up rates and pricing, and offers risk management solutions for terrorism exposures.

The more current attacks, often perpetrated by a single individual or small group, are different from those carried out in the 1990s and 2000s when high profile locations were targeted. Individuals carrying out the more recent attacks may have no direct contact with a known terrorist organization, but could be drawn to them through writings and video, particularly on the internet, Marsh said.

These events can be very disruptive to operations in some companies. In the travel industry, for example:

  • About 10% of American travelers canceled booked trips due to the recent attacks in Egypt, France, Lebanon and Mali, which impacted $8.2 billion in travel spending, according to a survey by YouGov.
  • Booking losses for Air France were estimated to be €50 million ($56 million), the company said in a statement.
  • Airlines, hotel chains and travel websites experienced drops in their stock prices after this year’s airport bombing in Brussels.

In the United States, the Terrorism Risk Insurance Program Reauthorization Act of 2015 (TRIPRA) offers businesses a federal backstop against terrorism-related losses. While the overall take-up rate for TRIPRA coverage in the U.S. increased slightly in 2015, it has remained in the 60% range since 2009, Marsh said.

Managing terrorism risk requires a combination of strategies that protect people, property and finances. On the financial side, the choice is whether to retain or transfer the risk with insurance. But the changing pattern of terrorism risk has some companies asking if they are adequately insured for business interruption and related losses. They also wonder how to prepare for potential losses from cyber terrorism and other events.

Other key takeaways from the report include:

  • As small group and “lone wolf” terrorist attacks appear to be the changing face of terrorism, many organizations are assessing their coverage for indirect losses stemming from business interruption risks.
  • Following the 2015 passage of the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA), take-up rates in the US edged up for TRIPRA terrorism coverage embedded in property programs.
  • Among industry sectors, media organizations had the highest take-up rate for terrorism insurance in 2015.
  • Workers’ compensation markets for terrorism risks generally stabilized.
  • The number of Marsh-managed captives accessing TRIPRA increased by 17% from 2014 to 2015, but many captives that could offer a terrorism program do not.
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Captive Growth Increases Need for Insurance-Experienced Board

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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

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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.

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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.

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 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.

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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.”