Hard Market, Industry Disruptions Create Captive Opportunities

With a traditional insurance market that appears likely to continue hardening, and that market facing disruption from events like the COVID-19 pandemic and potential new competitors, there are opportunities for captive insurance companies.

Hard insurance markets are characterized by high demand for insurance and a reduced supply, said Chris Mandel, senior vice president and director at the Sedgwick Institute. During hard markets, insurers often impose strict underwriting standards and issue a limited number of policies while premiums are high.

Speaking as part of a new Captive Insurance Companies Association (CICA) webinar, Mr. Mandel noted that a hard market in 1985–86 was associated with a tort liability crisis. While there were minor blips in the market over the next 15 years, the September 11, 2001, terrorist attacks led to another hard market.

"These things and the way the markets go are driven by economic events and other events," Mr. Mandel said during the webinar titled "Captive Strategies for Hardening Markets," part of CICA's 2020 "Building on the Best" webinar series.

Considering the impact the COVID-19 pandemic might have on market conditions, Mr. Mandel said, "What will really matter the most is how long this particular crisis event lasts." Other factors such as government and central bank stimulus efforts also will likely affect the pandemic's impact on the insurance market. "I think that has very significant and, to some degree, unpredictable implications for all markets, not just insurance," Mr. Mandel said.

The pandemic may affect the insurance market in other ways.

"I'm expecting to see some technology changes in terms of communications, and I'm expecting to see that reflected in the whole issue of work at home," said Ward Ching, managing director at Aon Global Risk Consulting.

"What is the workers compensation impact of working at home?" Mr. Ching asked. "If you've got a government that's saying you must work at home, your employer is saying work at home, you are, in fact, performing your duties at home." That raises the question: If an employee suffered an injury while working from home, would it be covered under workers compensation?

"I think there's definitely going to be an impact there for sure," Mr. Mandel said. "It's kind of a double-edged sword because, on the one hand, I think many of us are grappling with the question of the compensability of those that contracted the coronavirus and where they might have contracted it." Whether the disease was contracted in the course and scope of employment is going to be hard to prove, Mr. Mandel said, though he suspects statutory law courts will lean in favor of the employee who contracted the coronavirus.

"So, you've got that and then you've got the completely different issue of what about work at home," he said. "Under what circumstances do you define 'course' and 'scope' under those circumstances?"

Mr. Mandel said he thinks that for the average worker COVID-19 and working from home changes the paradigm for the workers compensation exposure, what it might mean for claim volume, and what it might mean for the contraction of other diseases that wouldn't have been considered occupational in the past.

Another webinar panelist, Peter Rosiere, vice president risk management at Sodexo, said he's seeing the impact of a hardening market, as well as the impact of the pandemic.

"We're seeing the restriction in capacity. We're seeing increased retentions," he said. "We're also seeing significant reduction in our exposure base because of the operational impact of the virus. So, hopefully, the two offset each other a little bit, but in general, the rate was going to be going up on all our lines of coverage."

Hardening markets provide opportunities for captive insurance companies, Mr. Mandel noted. "Market rates become drivers for alternative risk transfer options, which, of course, captives are at the heart of," he said. "The ideal is a long-term focus, and it should be tied to a long-term risk financing strategy that's ideally aligned with an overall risk strategy. And I don't know that a lot of folks think that way."

Effective use of captive insurance companies can also influence relationships with traditional market insurers during tough market conditions, Mr. Mandel suggested.

"When captives perform well and they're profitable, the market notices that and the market response shifts, I think, to become more flexible," he said. Things become more flexible and negotiable with primary insurers and reinsurers, and there may be efforts by those traditional markets to win back some of that business that has gone into captives.

A company considering using a captive to address a hard market must view the move as a marathon rather than a sprint, Mr. Rosiere said. "You don't do captives for a short-term fix. There's too much money, too much admin," he said. "It's just too big of a deal to do for just a 1-year type of solution.

"Structure, domicile, and operate with a hard market mentality at all times, and then take advantage of softening," he said. "The challenge with operating in this particular way is there are so few people who have been through hard markets." Current market conditions "are going to be a learning experience for a lot of people,' Mr. Rosiere said.

As organizations weigh their risk transfer/risk retention decisions, Mr. Ching suggested a method he referred to as "NextGen Risk Finance." "We're suggesting this is an evolution of the enterprise risk management framework that really encourages organizations to think differently about finance, treasury, the use of risk portfolios, and more importantly, the use of analytics and leverage," he said.

Driving the technique is the increased amount of data. "We can see things in the risk management data that we really couldn't see 5 years ago," Mr. Ching said. Armed with that data, it's now possible to connect risk information to company performance information to help inform strategy and financial performance.

It's also possible to approach risk as a portfolio of exposures across areas like hazard risks, operational risks, market risks, and human capital risks, Mr. Ching said, rather than considering each individually. Thinking about risk as a portfolio of exposures can help mitigate the impact of volatility in any one exposure, much as a portfolio of stocks helps mitigate exposure to the volatility of any individual stock, he said.

"The question is, is your risk profile in the organization matched with your mitigation strategy?" Mr. Ching said, adding that most organizations tend to overdefend their trivial risks and underdefend the large risks. "With the data, we can now see where the alignment takes place and how much a volatility impact misalignment might actually cause," he said.

Data can be used to determine a "strike price" at which efficient trade between risk retention and risk transfer takes place, Mr. Ching said. That allows an organization to make a better decision about which risks and how much risk should be covered in the captive insurance company, and to have better discussions with traditional insurers.

More information about CICA's "Building on the Best" webinar series can be found on the CICA website.