2222222222

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.

Advertisement




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.

Advertisement




“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.

Advertisement




“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 [email protected]

More from Risk & Insurance

More from Risk & Insurance

Cyber Resilience

No, Seriously. You Need a Comprehensive Cyber Incident Response Plan Before It’s Too Late.

Awareness of cyber risk is increasing, but some companies may be neglecting to prepare adequate response plans that could save them millions. 
By: | June 1, 2018 • 7 min read

To minimize the financial and reputational damage from a cyber attack, it is absolutely critical that businesses have a cyber incident response plan.

“Sadly, not all yet do,” said David Legassick, head of life sciences, tech and cyber, CNA Hardy.

Advertisement




In the event of a breach, a company must be able to quickly identify and contain the problem, assess the level of impact, communicate internally and externally, recover where possible any lost data or functionality needed to resume business operations and act quickly to manage potential reputational risk.

This can only be achieved with help from the right external experts and the design and practice of a well-honed internal response.

The first step a company must take, said Legassick, is to understand its cyber exposures through asset identification, classification, risk assessment and protection measures, both technological and human.

According to Raf Sanchez, international breach response manager, Beazley, cyber-response plans should be flexible and applicable to a wide range of incidents, “not just a list of consecutive steps.”

They also should bring together key stakeholders and specify end goals.

Jason J. Hogg, CEO, Aon Cyber Solutions

With bad actors becoming increasingly sophisticated and often acting in groups, attack vectors can hit companies from multiple angles simultaneously, meaning a holistic approach is essential, agreed Jason J. Hogg, CEO, Aon Cyber Solutions.

“Collaboration is key — you have to take silos down and work in a cross-functional manner.”

This means assembling a response team including individuals from IT, legal, operations, risk management, HR, finance and the board — each of whom must be well drilled in their responsibilities in the event of a breach.

“You can’t pick your players on the day of the game,” said Hogg. “Response times are critical, so speed and timing are of the essence. You should also have a very clear communication plan to keep the CEO and board of directors informed of recommended courses of action and timing expectations.”

People on the incident response team must have sufficient technical skills and access to critical third parties to be able to make decisions and move to contain incidents fast. Knowledge of the company’s data and network topology is also key, said Legassick.

“Perhaps most important of all,” he added, “is to capture in detail how, when, where and why an incident occurred so there is a feedback loop that ensures each threat makes the cyber defense stronger.”

Cyber insurance can play a key role by providing a range of experts such as forensic analysts to help manage a cyber breach quickly and effectively (as well as PR and legal help). However, the learning process should begin before a breach occurs.

Practice Makes Perfect

“Any incident response plan is only as strong as the practice that goes into it,” explained Mike Peters, vice president, IT, RIMS — who also conducts stress testing through his firm Sentinel Cyber Defense Advisors.

Advertisement




Unless companies have an ethical hacker or certified information security officer on board who can conduct sophisticated simulated attacks, Peters recommended they hire third-party experts to test their networks for weaknesses, remediate these issues and retest again for vulnerabilities that haven’t been patched or have newly appeared.

“You need to plan for every type of threat that’s out there,” he added.

Hogg agreed that bringing third parties in to conduct tests brings “fresh thinking, best practice and cross-pollination of learnings from testing plans across a multitude of industries and enterprises.”

“Collaboration is key — you have to take silos down and work in a cross-functional manner.” — Jason J. Hogg, CEO, Aon Cyber Solutions

Legassick added that companies should test their plans at least annually, updating procedures whenever there is a significant change in business activity, technology or location.

“As companies expand, cyber security is not always front of mind, but new operations and territories all expose a company to new risks.”

For smaller companies that might not have the resources or the expertise to develop an internal cyber response plan from whole cloth, some carriers offer their own cyber risk resources online.

Evan Fenaroli, an underwriting product manager with the Philadelphia Insurance Companies (PHLY), said his company hosts an eRiskHub, which gives PHLY clients a place to start looking for cyber event response answers.

That includes access to a pool of attorneys who can guide company executives in creating a plan.

“It’s something at the highest level that needs to be a priority,” Fenaroli said. For those just getting started, Fenaroli provided a checklist for consideration:

  • Purchase cyber insurance, read the policy and understand its notice requirements.
  • Work with an attorney to develop a cyber event response plan that you can customize to your business.
  • Identify stakeholders within the company who will own the plan and its execution.
  • Find outside forensics experts that the company can call in an emergency.
  • Identify a public relations expert who can be called in the case of an event that could be leaked to the press or otherwise become newsworthy.

“When all of these things fall into place, the outcome is far better in that there isn’t a panic,” said Fenaroli, who, like others, recommends the plan be tested at least annually.

Cyber’s Physical Threat

With the digital and physical worlds converging due to the rise of the Internet of Things, Hogg reminded companies: “You can’t just test in the virtual world — testing physical end-point security is critical too.”

Advertisement




How that testing is communicated to underwriters should also be a key focus, said Rich DePiero, head of cyber, North America, Swiss Re Corporate Solutions.

Don’t just report on what went well; it’s far more believable for an underwriter to hear what didn’t go well, he said.

“If I hear a client say it is perfect and then I look at some of the results of the responses to breaches last year, there is a disconnect. Help us understand what you learned and what you worked out. You want things to fail during these incident response tests, because that is how we learn,” he explained.

“Bringing in these outside firms, detailing what they learned and defining roles and responsibilities in the event of an incident is really the best practice, and we are seeing more and more companies do that.”

Support from the Board

Good cyber protection is built around a combination of process, technology, learning and people. While not every cyber incident needs to be reported to the boardroom, senior management has a key role in creating a culture of planning and risk awareness.

David Legassick, head of life sciences, tech and cyber, CNA Hardy

“Cyber is a boardroom risk. If it is not taken seriously at boardroom level, you are more than likely to suffer a network breach,” Legassick said.

However, getting board buy-in or buy-in from the C-suite is not always easy.

“C-suite executives often put off testing crisis plans as they get in the way of the day job. The irony here is obvious given how disruptive an incident can be,” said Sanchez.

“The C-suite must demonstrate its support for incident response planning and that it expects staff at all levels of the organization to play their part in recovering from serious incidents.”

“What these people need from the board is support,” said Jill Salmon, New York-based vice president, head of cyber/tech/MPL, Berkshire Hathaway Specialty Insurance.

“I don’t know that the information security folks are looking for direction from the board as much as they are looking for support from a resources standpoint and a visibility standpoint.

“They’ve got to be aware of what they need and they need to have the money to be able to build it up to that level,” she said.

Without that support, according to Legassick, failure to empower and encourage the IT team to manage cyber threats holistically through integration with the rest of the organization, particularly risk managers, becomes a common mistake.

He also warned that “blame culture” can prevent staff from escalating problems to management in a timely manner.

Collaboration and Communication

Given that cyber incident response truly is a team effort, it is therefore essential that a culture of collaboration, preparation and practice is embedded from the top down.

Advertisement




One of the biggest tripping points for companies — and an area that has done the most damage from a reputational perspective — is in how quickly and effectively the company communicates to the public in the aftermath of a cyber event.

Salmon said of all the cyber incident response plans she has seen, the companies that have impressed her most are those that have written mock press releases and rehearsed how they are going to respond to the media in the aftermath of an event.

“We have seen so many companies trip up in that regard,” she said. “There have been examples of companies taking too long and then not explaining why it took them so long. It’s like any other crisis — the way that you are communicating it to the public is really important.” &

Antony Ireland is a London-based financial journalist. He can be reached at [email protected] Dan Reynolds is editor-in-chief of Risk & Insurance. He can be reached at [email protected]