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Captives

Captives Show Promise in Addressing Supply Chain Risk

Captives can serve as a primary-layer risk-transfer mechanism. They can also allow organizations to access reinsurance to cover difficult-to-insure losses.
By: | July 30, 2018 • 3 min read

A recent production shutdown of Ford’s flagship F-150 trucks following a fire at one of the auto manufacturer’s suppliers, is causing many companies to question how they manage and insure against supply chain risk. For a growing number of them, part of the answer is captives.

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With the growth of just-in-time manufacturing and global sourcing, supply chains are becoming more complex and vulnerable.

Meanwhile, dangers such as aging infrastructures, political instability, climate change, cyber threats, communications vulnerabilities and even reputational harm, threaten first-, second-, and even third-tier suppliers.

According to Nick Wildgoose, Zurich’s global supply chain product leader, investment in supply chain risk management has increased considerably since the global disruptions of 2011. Even so, he said, the level of disruption is still high, with 65 percent of corporations [reporting] a disruption in 2017.

Much of it is non-damage related, “so cyber, loss of talent, etc. It shows you need to take that holistic view of supply chain risk management.” Increasingly, that view includes captives, which not only serve as primary-layer risk-transfer mechanisms, but can also offer access reinsurance for difficult-to-insure losses.

Steve Bauman, Head of Global Programs and Captive Practice: Americas; XL Catlin

“We’ve seen it on a fronted basis, we’ve also seen on a direct basis,” said Michael Serricchio, managing director, Marsh Captive Solutions.

“It’s really no different than self-insurance, except you’re being more formal about it, you’re setting funds aside … you’re building up capital, whereby you can use that capital to hopefully avoid losses in the future. We have maybe five to 10 captives that are doing supply chain.”

Captives: Flexibility and Customized Solutions

Captives are flexible, said Brian W. Merkley, global director, corporate risk management, Huntsman Corporation, and well-suited for supply chain risk, which can vary greatly by industry and product and may not be adequately understood by the marketplace.

“Captives work even more efficiently when you have things that are outside the box,” said Steven R. Bauman, head of global programs and captive practice, North America, XL Catlin. “Certainly if there are gaps or deficiencies in that, that’s where the captive does very well.”

Captives can also be particularly useful to companies just beginning to address supply chain risk, said Wildgoose. “Captives can sit outside corporate budgets, so the captive can help provide budget for risk management,” he said. “It shouldn’t be the source of all the funding, but it can start like seed capital.”

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For some, an important benefit of captives is the access they can provide to alternative capital: “Especially now, with the blending of the insurers and the reinsurers and the capital markets, everybody wants … an opportunity to make money in this business on the back, and you see all these different sources of capital coming into the market,” said Gary Lynch, CEO and founder, The Risk Project, LLC.

“I’m not saying a captive is the solution, but a captive is a creative way of doing it and it allows you to think outside the boundaries of traditional coverages,” he said. “And potentially there are some tax benefits.”

For more mature captives, adding supply chain can be a natural next step.

“If the captive has been successful over the years, over the decades, and has the wherewithal to take more risk, that’s the perfect scenario,” said Bauman.

A Multifaceted Look

Still, said Merkley, there’s limited appetite for a dedicated supply-chain captive. “I’m hearing chatter about captives and their potential involvement in supply chain risks, but I am not really seeing anybody pull the trigger on any actual standalone supply chain risk policies,” he said.

The potential for overlap with contingent BI under a property policy is one reason why, said Serrichio. “You don’t want to have double insurance in the captive and in your property policy.”

Another is the potential for creating new gaps in coverage and how that aligns with all of the other policies in your program, said Merkley.

Bauman emphasized the need for caution. “It’s got to be a very measured and prudent use of a captive. So having a good partner in all this is important — folks that have seen it before and can assist with the pricing of it is also important.” &

Jon McGoran is a novelist and magazine editor based outside of Philadelphia. He can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Black Swans

Black Swans: Yes, It Can Happen Here

In this year's Black Swan coverage, we focus on two events: An Atlantic mega-tsunami which would wipe out the East Coast and a killer global pandemic.
By: | July 30, 2018 • 2 min read

One of the most difficult phrases to digest without becoming frustrated or judgmental is the oft-repeated, “I never thought that could happen here.”

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Most painfully, we hear it time and time again in the aftermath of the mass school shootings that terrorize this country. Shocked parents and neighbors, viewing the carnage, voice that they can’t believe this happened in their neighborhood.

Not to be mean, but why couldn’t it happen in your neighborhood?

So it is with Black Swans, a phrase describing unforeseen events, made famous by the former trader and acerbic critic of academia Nassim Nicholas Taleb.

We at Risk & Insurance® define these events in insurance terms by saying that they are highly infrequent, yet could cause massive damages. This year, for our annual Black Swan issue, we present two very different scenarios, both of which would leave mass devastation in their wake.

A Mega-Tsunami Is Coming; Can the East Coast Even Prepare?, written by staff writer Autumn Heisler, profiles an Atlantic mega-tsunami, which would wipe out lives and commerce along the East Coast.

On the topic of whether the volcanic island of La Palma, the most northwestern of the Canary Islands, could erupt, split and trigger an Atlantic mega-tsunami, scientists are divided.

Researchers Steven Ward, a geophysicist at UC Santa Cruz, and Simon Day of University College London, say such a thing could happen. Other scientists say Day and Ward are dead wrong; it’s an impossibility.

One of the counter-arguments is backed up by the statement that there has never been an Atlantic mega-tsunami. It’s never happened before and thus, could never happen here. See exhibit “A” above, re: mass school shootings.

Viral Fear: How a Global Pandemic Kills an Economy, written by associate editor Katie Dwyer, depicts a killer global pandemic the likes of which hasn’t been seen in a century.

Tens of millions of people died during the Spanish Flu outbreak of 1918.

Why it could happen again includes the fact that it’s happened before. The science on influenzas, which are constantly mutating, also supports just how dangerous a threat they pose to millions of people beyond the reach of antibiotics.

Should a mutating avian flu, for example, spread widely, we could see a 10 percent drop in GDP, mostly from non-physical business interruption.

As always here, the purpose is to do exactly what insurance modelers and underwriters do; no matter how massive the event, we create scenarios, quantify possible losses and discuss risk mitigation strategies. &

Dan Reynolds is editor-in-chief of Risk & Insurance. He can be reached at [email protected]