How Captives Can Dampen the Risks of Wildfires

The phrase "growing like wildfire" is often used to describe faster-than-normal expansions. If anything is growing like wildfire today, it would be the use of the captive insurance approach to address climate-related risks, particularly wildfires.

Devastating fires in Canada, California, and Australia have captured public attention as they consumed vast areas of land. Europe and other regions are also experiencing fires on a previously unseen scale.

Two or three decades ago, it was relatively easy for insurers to determine pricing based on historical data. Unfortunately, the risk has changed inherently and unpredictably in recent years. Little wonder many insurers are walking away from writing coverage of these destructive disasters or pricing it well above what the marketplace is willing to pay. That creates an exciting opportunity for captives to cover a clearly defined insurance need.

Establishing a captive to address the challenges associated with wildfires begins with developing a thorough, accurate understanding of the risks your organization faces. Like commercial insurers, you can't really rely upon historical data because it fails to address the increased occurrence of fires.

You know everything about your facility and what it takes to run your business. Perhaps you're less concerned about direct damage to the facility and more worried about losing the power lines that feed your operations or about whether your employees would be able to get to work when the area is blanketed with smoke or when their own homes are unoccupiable or in danger of being destroyed. The better you can define the risks, the more effectively you can design your captive to address them. If some new risk emerges, folding it into the captive is relatively easy.

Suppose your company operates a facility in a relatively pristine area. A wildfire out west blankets your facility in thick, noxious smoke. You don't want your employees exposed, so you suspend production for several days. What kind of loss would that create? Beyond any immediate damage, what are the potential long-term effects of the fire's residues? Will they require professional remediation?

You can add another layer by considering how a distant wildfire might affect a critical supplier. Suppose your supplier is the one that must close because of wildfire smoke, so your operations are also temporarily interrupted. The growing complexity of the supply chain underscores the problem. What happens if a wildfire on the other side of the world keeps the cargo jet from landing there so it can pick up the components you need?

Effectively working with clients to create captives requires a holistic overview of multiple lines of business, working together with underwriters and actuaries to accurately model the risk. For example, experts will study the structure of buildings and attempt to identify the threats that could cause problems.

Captives can also be a powerful tool when addressing the human element. Beyond protecting your employees at work, you may be able to use funds from the captive to train them to deal with the threat of wildfires.

No matter which risks you choose to cover through your captive, your strategy will be more precise than what a commercial insurer could offer. A captive insurer is set up specifically for your company's unique needs, and a well-structured captive can accommodate the never-ending changes to those needs.

Because finding commercial insurance coverage for many of these risks is increasingly difficult or even impossible, companies may wonder if they'll run into similar roadblocks when obtaining reinsurance coverage for their captive. If a captive's owner and its consultants have clearly identified and addressed risks, and if the business plan is actuarily sound, reinsurers are eager to offer surprisingly affordable coverage.

As with all types of captive insurers, having access to the right data is critical to a program's success. By placing a previously uninsured risk like environmental impact liability into a captive, you'll begin to accumulate data and better understand the nature of your losses. During the first year, you might fund 100 percent of the risk. Then, based on what you've learned, in the second year, you can fund 80 percent through the captive and obtain market coverage for the remaining 20 percent, 60/40 in the third, and so forth. As you become more educated and pursue strategies to mitigate these new risks, your coverage should become more precise.

With the planet warming, expect the frequency and severity of wildfires to continue their upward trend and fires to become an issue in places that rarely experience them now. Because captives can provide the financial protection companies need while encouraging safer and better behaviors, expect to see them catch on like—well, wildfire.