Captive Insurance: A Strategic Response to Market Dynamics

A.M. Best recently hosted a webinar titled "Captives: Solid Performance and Innovation Continues," exploring the current state of the captive insurance sector and alternative risk transfer (ART). Below are key takeaways from the webinar.

Continued Strong Performance of Captives

Dan Teclaw, director at A.M. Best, presented findings from A.M. Best's annual report on captives. He emphasized that captive insurance companies continue to outperform the commercial casualty market. The report examined various types of captives, including single-parent captives, group captives, and risk retention groups (RRGs). The analysis revealed that single-parent captives typically achieve lower combined ratios due to their efficient cost structures, while RRGs perform comparably to the broader market.

Mr. Teclaw shared the following key statistics.

• Underwriting Performance: The average combined ratio for single-parent captives was reported at 85 percent, significantly better than the 97.5 percent average for the commercial casualty composite. This low combined ratio is indicative of captives' ability to maintain profitability through disciplined underwriting and low expenses.
• Growth in Written Premiums: The hard market has driven growth in captive insurance company written premiums. Between 2019 and 2022, written premiums for the captive insurance composite increased by 27 percent.
• Loss Ratios: In 2023, single-parent captives experienced a 20-point increase in their loss ratio due to higher property losses. Despite this increase, their loss ratios remain well within the expected range.

These strong performances have translated into significant financial benefits for captive owners. Over recent years, captives have saved their owners an estimated $6.4 billion, according to Mr. Teclaw, which would have otherwise been allocated to the commercial market. Additionally, captives have distributed around $2 billion in dividends, further enhancing their value proposition.

Impact of the Hard Market on Captives

The discussion also touched on the enduring hard market conditions, which have significantly influenced the formation and utilization of captive insurance companies. Steve McElhiney, senior vice president and global director of reinsurance at Artex Risk Solutions, noted that the hard market, which began around 2018, has spurred increased captive insurance company formations and repurposing of existing captives. Particularly in the property insurance sector, where traditional insurers have retrenched, captives have become a crucial risk transfer solution, allowing companies to access reinsurance markets more effectively.

Mr. McElhiney highlighted that the awareness and acceptance of captives as a viable insurance solution have grown significantly, marking a departure from the situation a decade ago. He predicted that even as the hard market begins to stabilize, the interest in captives will persist. Supporting this trend, data shows a steady increase in new captive formations, with a 5–10 percent growth reported across leading domiciles.

Sector-Specific Insights: Energy and Beyond

Jo Mather, insurance director at Phillips 66, provided insights from the energy sector, which has experienced a dichotomy in market conditions. While the property insurance market within the energy sector has shown signs of stabilization, with potential rate reductions expected, the excess casualty market remains challenging. Ms. Mather noted that the hardening of the excess casualty market has driven energy companies to increasingly rely on captives to fill capacity gaps.

Ms. Mather also discussed the long-term evolution of captives within the energy industry. Captives, originally established to manage significant risks and retentions, have proven invaluable during the prolonged soft market and the subsequent transition to harder market conditions. This adaptability has allowed energy companies to maintain coverage and manage their risk profiles effectively, even as commercial markets have become more restrictive.

Challenges and Opportunities in Captive Utilization

The panelists explored the types of risks best suited for captive insurance, as well as those that pose challenges. Traditionally, captives have been used for classes such as workers compensation, property, excess casualty, and commercial auto. However, Mr. McElhiney pointed out that certain risks, like cyber and directors and officers (D&O) insurance, present more complexities when incorporated into captive insurance companies. The need for incident response services in cyber coverage and the regulatory challenges associated with D&O coverage are key factors that limit the use of captives in these areas.

On the innovative front, the pandemic has prompted companies to explore new uses for captives, particularly in managing employee medical programs and other benefits. Ms. Mather mentioned that incorporating employee benefits into captives, though challenging, has gained traction as companies seek to manage rising medical costs and other financial burdens.

The Future of Captive Insurance

Looking ahead, the panelists expressed optimism about the continued growth and evolution of the captive insurance sector. Mr. McElhiney forecasted ongoing penetration of captives across various industries, with increasing interest from midmarket and privately held companies. He also noted emerging opportunities in regions like Canada and Mexico, where captives are gaining attention as viable risk management tools.

Mr. Teclaw and Ms. Mather both emphasized the importance of data-driven decision-making when considering the establishment or expansion of captives. Ms. Mather advised companies to carefully evaluate their claims history and risk exposure before committing to a captive structure, ensuring that the decision is based on a solid foundation of data rather than market frustrations.