Captives

New Ways to Use Surplus

There is a move toward captives’ strategic use of surplus to fund risk management-based projects, analytics, consulting and more.
By: | November 1, 2017 • 5 min read

Surplus produced by captives traditionally found a use in taking on additional limits, writing new lines of business or funding loss control. But as more captive owners start to write emerging risks such as cyber, supply chain and terrorism, there is a move toward using surplus to fund a variety of risk management-based projects and analytics associated with these risks.

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With most mature captives accruing surplus from multiple years of positive underwriting performance — most notably financial institutions, which stood at $40 billion in 2016, according to Marsh — that trend is only going to accelerate.

In the last year alone, surplus use extended to initiatives to determine capital efficiency and optimal risk retention levels in the form of risk finance optimization, quantify cyber business interruption exposures, accelerate the closure of legacy claims and improve workforce and fleet safety/loss control policies.

One major U.S. retailer, whose workers’ compensation program reported deteriorating loss experience at the same time the company was grappling with a large-scale acquisition, used its captive’s $50,000 surplus to fund additional external safety and loss prevention consulting in order to boost its internal resources.

Building on that, the surplus was used in subsequent years to fund additional risk consulting services.

“Surplus has become part of a much larger debate around data, customer information and how that can be used to maximum effect,” said Ward Ching, managing director, Aon Captive & Insurance Management.

“Clients are now asking strategy-related questions about business growth, product-service mix and market penetration, and captives are at the heart of that because they hold much of that data and the analytical capability to achieve a lot of those things.”

Central to Risk Management Strategy

Ellen Charnley, president, Marsh Captive Solutions, said companies increasingly put their captive at the heart of risk management and risk finance strategy, going beyond the financing of traditional property and casualty risks.

Ward Ching, managing director, Aon Captive & Insurance Management

“This means that the captive isn’t simply doing what it maybe historically did 10 years ago, just funding for the retentions and deductibles,” she said.

“Now it’s looking to potentially take on greater risk and to reduce the amount of commercial insurance risk transfer transaction, for example, in buying commercial insurance.

“Also, companies are looking potentially to structure deals whereby there’s much greater retention in the captive and buy higher level coverage to protect the captive through the reinsurance market. That structure is one a lot of companies, particularly the larger ones, are looking for as they get more comfortable in retaining risk, and in that respect, the role of the captive and the risk manager has been elevated.”

In terms of surplus use, Charnley said that captives are increasingly being used to fund analytical work focused on retentions.

“There’s more sophistication with respect to analytics and the captive’s role to play in that,” she said.

“The cost of that analytical project work is now being borne by captives using their potential profits and surplus they have developed over the years.”

Another example, said Charnley, was using a captive to fund an actuary who can understand, predict and quantify a company’s known risks. The surplus can also be used to fund analysis of the company’s existing book of claims in order to speed up claims closure and where necessary, to challenge claims adjustors, ultimately lowering the cost of risk in the long run, she said.

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“Predictable risk is always an area for companies to try and improve upon, so through loss control activities, for example, the cost of workplace environmental changes, to try to reduce workers’ compensation exposures and ultimately claims, can be borne by the captive,” she said.

“The captive, in turn, would benefit from a reduction in claims in addition to those of the parent.”

Sean Rider, managing director for consulting and development, Willis Towers Watson’s Global Captive Practice, said he has seen a trend toward using captives to fund more sophisticated analytics around risk finance optimization.

That includes the use of analytics to understand the optimization of their risk financing programs, he said.

“Captives for large global corporates are coming into their own as a repository for retained risk and a hub for executing risk financing programs that rely on the company’s balance sheet to manage the lion’s share of the organization’s risk portfolio,” he said.

Ellen Charnley, president, Marsh Captive Solutions

“To have a rational approach to running such a risk financing program, they need to have a robust analytical basis to their decision making.

“This is further supported by the re-emergence of the integrated marketplace in alternative risk transfer and the refocusing of large corporates in terms of optimizing their risk transfer/retention program.”

Jason Flaxbeard, senior managing director, Beecher Carlson’s Captive Services Practice, said some companies were centralizing their risk by using the surplus from their captive to finance their risk management team. Another use, he said, was paying for risk inspections and engineering visits for those captives that write property.

“We also have some clients who now want to use their surplus to take on enormous chunks of their own risk,” he said.

New Risks

Another area in which surplus is being deployed is in writing non-traditional emerging risks. Nancy Gray, managing director, Aon Global Risk Consulting, said cyber is one such area.

“Going down this route allows companies to potentially increase their retentions and be more flexible in how they want to structure their insurance programs,” she said.

“Clients are now asking strategy-related questions about business growth, product-service mix and market penetration, and captives are at the heart of that.” — Ward Ching, managing director, Aon Captive & Insurance Management

“Increasingly, there is also an opportunity for companies to extend beyond their own P&C risks and take on their customers’ risks through their captive program.”

Courtney Claflin, executive director of captive programs at the University of California, who manages two captives, said the university is using the original captive to fund a grant program for risk management and safety needs.

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“We can play a role throughout the university system by creating a grant program to help individual departments or campuses that need funding for specific projects like campus security,” he said.

“The grant program allows them to write a grant proposal to the captive and then we can use the captive surplus to fund that grant.”

Ian Davis, the State of Vermont’s director of financial services, said companies are increasingly looking at new and innovative ways to deploy the surplus capital from their captive.

“The trend I see is that some captives have built up such a large amount of surplus, that they do studies to determine the appropriate use of and place for the capital in their organization,” he said.

Charnley added, “Surplus is another compelling value proposition that captives provide that perhaps otherwise would be lost in the parent company’s balance sheet. Having a separate pot of money that can be used in this way can be a tremendous benefit to a company.” &

Alex Wright is a U.K.-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at riskletters@lrp.com.

More from Risk & Insurance

More from Risk & Insurance

Insurtech

Kiss Your Annual Renewal Goodbye; On-Demand Insurance Challenges the Traditional Policy

Gig workers' unique insurance needs drive delivery of on-demand coverage.
By: | September 14, 2018 • 6 min read

The gig economy is growing. Nearly six million Americans, or 3.8 percent of the U.S. workforce, now have “contingent” work arrangements, with a further 10.6 million in categories such as independent contractors, on-call workers or temporary help agency staff and for-contract firms, often with well-known names such as Uber, Lyft and Airbnb.

Scott Walchek, founding chairman and CEO, Trōv

The number of Americans owning a drone is also increasing — one recent survey suggested as much as one in 12 of the population — sparking vigorous debate on how regulation should apply to where and when the devices operate.

Add to this other 21st century societal changes, such as consumers’ appetite for other electronic gadgets and the advent of autonomous vehicles. It’s clear that the cover offered by the annually renewable traditional insurance policy is often not fit for purpose. Helped by the sophistication of insurance technology, the response has been an expanding range of ‘on-demand’ covers.

The term ‘on-demand’ is open to various interpretations. For Scott Walchek, founding chairman and CEO of pioneering on-demand insurance platform Trōv, it’s about “giving people agency over the items they own and enabling them to turn on insurance cover whenever they want for whatever they want — often for just a single item.”

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“On-demand represents a whole new behavior and attitude towards insurance, which for years has very much been a case of ‘get it and forget it,’ ” said Walchek.

Trōv’s mobile app enables users to insure just a single item, such as a laptop, whenever they wish and to also select the period of cover required. When ready to buy insurance, they then snap a picture of the sales receipt or product code of the item they want covered.

Welcoming Trōv: A New On-Demand Arrival

While Walchek, who set up Trōv in 2012, stressed it’s a technology company and not an insurance company, it has attracted industry giants such as AXA and Munich Re as partners. Trōv began the U.S. roll-out of its on-demand personal property products this summer by launching in Arizona, having already established itself in Australia and the United Kingdom.

“Australia and the UK were great testing grounds, thanks to their single regulatory authorities,” said Walchek. “Trōv is already approved in 45 states, and we expect to complete the process in all by November.

“On-demand products have a particular appeal to millennials who love the idea of having control via their smart devices and have embraced the concept of an unbundling of experiences: 75 percent of our users are in the 18 to 35 age group.” – Scott Walchek, founding chairman and CEO, Trōv

“On-demand products have a particular appeal to millennials who love the idea of having control via their smart devices and have embraced the concept of an unbundling of experiences: 75 percent of our users are in the 18 to 35 age group,” he added.

“But a mass of tectonic societal shifts is also impacting older generations — on-demand cover fits the new ways in which they work, particularly the ‘untethered’ who aren’t always in the same workplace or using the same device. So we see on-demand going into societal lifestyle changes.”

Wooing Baby Boomers

In addition to its backing for Trōv, across the Atlantic, AXA has partnered with Insurtech start-up By Miles, launching a pay-as-you-go car insurance policy in the UK. The product is promoted as low-cost car insurance for drivers who travel no more than 140 miles per week, or 7,000 miles annually.

“Due to the growing need for these products, companies such as Marmalade — cover for learner drivers — and Cuvva — cover for part-time drivers — have also increased in popularity, and we expect to see more enter the market in the near future,” said AXA UK’s head of telematics, Katy Simpson.

Simpson confirmed that the new products’ initial appeal is to younger motorists, who are more regular users of new technology, while older drivers are warier about sharing too much personal information. However, she expects this to change as on-demand products become more prevalent.

“Looking at mileage-based insurance, such as By Miles specifically, it’s actually older generations who are most likely to save money, as the use of their vehicles tends to decline. Our job is therefore to not only create more customer-centric products but also highlight their benefits to everyone.”

Another Insurtech ready to partner with long-established names is New York-based Slice Labs, which in the UK is working with Legal & General to enter the homeshare insurance market, recently announcing that XL Catlin will use its insurance cloud services platform to create the world’s first on-demand cyber insurance solution.

“For our cyber product, we were looking for a partner on the fintech side, which dovetailed perfectly with what Slice was trying to do,” said John Coletti, head of XL Catlin’s cyber insurance team.

“The premise of selling cyber insurance to small businesses needs a platform such as that provided by Slice — we can get to customers in a discrete, seamless manner, and the partnership offers potential to open up other products.”

Slice Labs’ CEO Tim Attia added: “You can roll up on-demand cover in many different areas, ranging from contract workers to vacation rentals.

“The next leap forward will be provided by the new economy, which will create a range of new risks for on-demand insurance to respond to. McKinsey forecasts that by 2025, ecosystems will account for 30 percent of global premium revenue.

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“When you’re a start-up, you can innovate and question long-held assumptions, but you don’t have the scale that an insurer can provide,” said Attia. “Our platform works well in getting new products out to the market and is scalable.”

Slice Labs is now reviewing the emerging markets, which aren’t hampered by “old, outdated infrastructures,” and plans to test the water via a hackathon in southeast Asia.

Collaboration Vs Competition

Insurtech-insurer collaborations suggest that the industry noted the banking sector’s experience, which names the tech disruptors before deciding partnerships, made greater sense commercially.

“It’s an interesting correlation,” said Slice’s managing director for marketing, Emily Kosick.

“I believe the trend worth calling out is that the window for insurers to innovate is much shorter, thanks to the banking sector’s efforts to offer omni-channel banking, incorporating mobile devices and, more recently, intelligent assistants like Alexa for personal banking.

“Banks have bought into the value of these technology partnerships but had the benefit of consumer expectations changing slowly with them. This compares to insurers who are in an ever-increasing on-demand world where the risk is high for laggards to be left behind.”

As with fintechs in banking, Insurtechs initially focused on the retail segment, with 75 percent of business in personal lines and the remainder in the commercial segment.

“Banks have bought into the value of these technology partnerships but had the benefit of consumer expectations changing slowly with them. This compares to insurers who are in an ever-increasing on-demand world where the risk is high for laggards to be left behind.” — Emily Kosick, managing director, marketing, Slice

Those proportions may be set to change, with innovations such as digital commercial insurance brokerage Embroker’s recent launch of the first digital D&O liability insurance policy, designed for venture capital-backed tech start-ups and reinsured by Munich Re.

Embroker said coverage that formerly took weeks to obtain is now available instantly.

“We focus on three main issues in developing new digital business — what is the customer’s pain point, what is the expense ratio and does it lend itself to algorithmic underwriting?” said CEO Matt Miller. “Workers’ compensation is another obvious class of insurance that can benefit from this approach.”

Jason Griswold, co-founder and chief operating officer of Insurtech REIN, highlighted further opportunities: “I’d add a third category to personal and business lines and that’s business-to-business-to-consumer. It’s there we see the biggest opportunities for partnering with major ecosystems generating large numbers of insureds and also big volumes of data.”

For now, insurers are accommodating Insurtech disruption. Will that change?

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“Insurtechs have focused on products that regulators can understand easily and for which there is clear existing legislation, with consumer protection and insurer solvency the two issues of paramount importance,” noted Shawn Hanson, litigation partner at law firm Akin Gump.

“In time, we could see the disruptors partner with reinsurers rather than primary carriers. Another possibility is the likes of Amazon, Alphabet, Facebook and Apple, with their massive balance sheets, deciding to link up with a reinsurer,” he said.

“You can imagine one of them finding a good Insurtech and buying it, much as Amazon’s purchase of Whole Foods gave it entry into the retail sector.” &

Graham Buck is a UK-based writer and has contributed to Risk & Insurance® since 1998. He can be reached at riskletters.com.