Captive Insurance Strategies for Addressing Property Risk Challenges

A Vermont Captive Insurance Association (VCIA) conference session included panelists Christine Brown (State of Vermont Department of Financial Regulation), Derrick Easton (WTW), Ray Rocchio (Keystone Risk Partners), and Ed Koral (WTW) discussing the growing importance and strategic management of property risk within the captive insurance space. 

Introduction: Property Risk in Vermont's Captive Insurance Market 

According to Christine Brown, Vermont's captive insurers reported gross written premiums (GWP) totaling $30.6 billion in 2023, with property risk accounting for approximately 9 percent. Property risk continues to play a significant role in the captive sector, consistently ranking among the top five lines of business by GWP. 

Ms. Brown highlighted the growth in property premiums over the past five years. In 2019, property premiums in Vermont captives totaled $1.29 billion, increasing to $2.63 billion by 2023—more than doubling in that period. Likewise, the number of captives and cells providing property coverage grew from 160 in 2019 to 230 in 2023. 

Factors Driving the Adoption of Captives for Property Risk 

The session highlighted key factors driving the increase in property risk coverage through captive insurance companies. 

• Rising Costs. The escalating costs associated with property insurance, driven by inflation and increased property values, have pushed companies to seek alternative risk management strategies. Traditional insurance markets have struggled with limited capacity, leading to higher premiums and more stringent coverage terms.
• Increased Losses. The frequency and severity of property losses, particularly those linked to natural catastrophes, have also contributed to the shift. Industries such as manufacturing, energy, real estate, agriculture, and retail, which are highly susceptible to property risks, have increasingly turned to captives to better manage their exposures.
• Limited Capacity in Traditional Markets. The constrained capacity in traditional insurance markets has led many organizations to explore captives as a viable solution for retaining risk while maintaining control over their insurance programs. This trend is particularly evident in industries with large property portfolios that require significant coverage.

Innovative Property Risk Solutions in Captives 

The panel explored property risk management strategies within captives, emphasizing the role of catastrophe (CAT) modeling in assessing and managing these risks. They noted, however, that CAT modeling can yield variable results, complicating the accurate valuation of property exposures, and referenced George Box's quote, "All models are wrong, some are useful."

The panel also stressed the importance of precisely defining insurable risks within a captive framework, highlighting historical challenges such as inadequate property schedules and the unpredictable nature of property risks, which can fluctuate significantly due to factors like natural disasters and market conditions. 

The panelists explored the use of fronting and structured solutions as strategies for captive insurers to address property risk challenges. Fronting allows captives to minimize predatory pricing, meet contractual obligations, and eliminate frictional costs associated with frequent claims while also offering form flexibility through excess and surplus (E&S) lines. However, organizations should carefully consider the associated costs, including fronting fees and additional collateral requirements. 

The panel explained how structured solutions help manage property risk in industries with large property exposures and high-value asset portfolios, such as real estate investment trusts, builders risk, habitational, and food processing companies. Structured solutions, suitable for entities with a minimum annual premium of $1.5 million, offer several advantages, including the ability to lock in rates for up to three years without the risk of cancellation and the avoidance of insurance to value (ITV) forced adjustments. This is especially beneficial for industries with significant asset portfolios, as avoiding forced ITV adjustments helps prevent unexpected premium increases or disruptive policy changes that could affect financial planning. Structured solutions also provide flexibility in asset valuation throughout the policy term, while the option to incorporate independent claims adjusters and aggregated limits enables more efficient risk management. Additionally, up to 70 percent of premiums may be returned based on loss performance, according to the panel. 

The Role of Parametric Risk Transfer in Complementing Traditional Property Coverage 

The panelists said that parametric risk transfer is an increasingly important component of comprehensive property risk management. Parametric solutions can be used in a captive to complement traditional coverage, addressing basis risk—the misalignment between the actual loss and the policy response. Unlike traditional property insurance, which may leave gaps due to deductibles, sub-limits, and exclusions, parametric risk transfer provides coverage based on predefined triggers, such as specific weather conditions, seismic activity, or other measurable indices like wind speed, rainfall levels, or even cyberattack severity, depending on the policy's design. 

The panel noted that parametric solutions can cover a wide range of perils, from traditional risks like hurricanes and earthquakes to emerging risks such as cyberattacks and pandemics. They provided an example of a California-based company with significant total insured values (TIV) spread across multiple locations. This parametric program, which used peak ground acceleration (PGA) data from the US geological survey, had a flexible payout structure calibrated to the resilience of the company's properties and surrounding areas. In parametric risk transfer, PGA is often used as a trigger for earthquake-related losses. For instance, if the PGA at a specific location exceeds a predefined threshold, the policyholder receives a payout regardless of the actual damage to their property. 

The approach allowed for faster settlements and broader coverage, making parametric risk transfer an appealing option for mitigating property losses that exceed traditional policy limits.  

The panelists also noted the importance of calibrating parametric solutions to align with the specific loss scenarios faced by the insured. This involves understanding the underlying data and models and ensuring that they reflect the real-world impact of potential property losses.