Towards the tail end of 2019 the captive industry was already seeing growth amid a reduction in capacity and a hardening traditional insurance market. As we have continued through 2020 these market conditions have continued with captive structures thriving in the current economic environment.
“As the market has increasingly hardened, and as capacity has become more and more restricted, insureds are seeking out alternative risk solutions, leading many to the captive fronting space,” explained Mike Lister, Head of Complex Multinational in Canada for AIG.
In Canada specifically, captive feasibility studies have grown by 50% this year as compared to 2019. Likewise, Marsh Captive Management reports that it has seen a record 76 new captive insurance companies formed between January and July of this year, representing a 200% increase when compared to the same period in 2019.
Lister said this drive toward captive use is being accelerated by current events and market conditions. The current climate of economic uncertainty has brought many risks to the fore with the hospitality and transportation industries being particularly impacted, driving the shift towards alternative risk solutions.
“Coverage including property, energy, event cancellation, trade credit and certain financial lines are being heavily impacted by the current situation,” Lister explained. “Captive utilization is growing as a positive solution to help insureds address and mitigate their challenging risks.”
“There’s a lot of opportunity and a lot of capability within the captive space that can help insurers and insureds find optimal risk solutions,” he said. “That success and optimization starts with examining who you partner with. You need a fronting provider that understands not only captive solutions, but also the specific needs of your business.”
For those interested in captive solutions, here are some of the distinguishing qualities to look for in a fronting provider, and how those same qualities can enable captive partners to successfully navigate an ever-changing risk environment.
“This is one of the key strengths a fronting provider must have in order to truly add value in the current environment,” Lister said.
The ability to provide partners with what they need through flexibility and innovation is paramount to finding the right solution for the insured.
Both established and newly formed captives can benefit from this quality. The program design process should be innovative, searching to find new ideas and better solutions that would best fit an insured’s needs in an ever-changing global context.
Many captive fronted programs are multinational in nature, with different sets of risk in different locations spanning the globe. An experienced fronting provider will understand those diverse exposures and be able to implement valuable mid-term adjustments and program design solutions where needed.
“Utilizing global fronting experts who can help an insured effectively structure its placement to ensure effective risk retention while enabling a reduction in the risk transfer spend should be the baseline goal of any captive fronting partnership,” he said.
Innovation and flexibility are more than buzzwords for a fronting provider; they are essential qualities that enable excellent service delivery in the other key areas of a partnership.
One important way that innovation and flexibility are put to good use is through data and technology. The world is turning toward data collection as a solution to navigating increasingly complex risks, and captive service providers are expanding their offerings to meet those needs.
An effective fronting provider will work with the insured’s captive to promote greater risk governance, mitigation and innovation through creative solutions and risk management expertise. For example, by analyzing trends in historical claims data, the fronting provider can help the insured understand its risk portfolio to a greater degree and recommend possible key risk mitigation and loss prevention methods.
“Fronting providers should help insureds navigate historical data, analyze it and have a conversation around how to effectively structure the placement in terms of retention levels, global policy limits and applicable deductibles” Lister said.
Enhanced data collection is becoming ever more important, and good fronting providers continue to expand their access to integrated technology tools that provide captives with real-time data sharing and enable more effective risk governance.
“Having access to real-time data enables real-time decisions around risk management strategies,” said Lister. “Captives are very much a long-term solution, but if your data is a year old, or you don’t have access to current data, you may miss important information that could prove beneficial to the structure of your placement.”
Even with current economic conditions at play, the challenges and opportunities associated with globalization will remain for insureds and their captive subsidiaries for years to come.
“In a world with ever-shrinking economic borders, companies of all industries and sizes are recognizing the need to expand beyond their home markets to gain access to the greater consumer pool,” Lister explained.
The World Trade Organization reported that global trade is expected to fall between 13% and 32% this year alone. The United Nations Conference on Trade and Development found foreign direct investments are expected to fall between 30% and 40% in the same time.
“But with economic uncertainty comes opportunity for organizations to grow,” Lister added.
A fronting provider with deep knowledge and understanding of the multinational space can provide a significant benefit to captives in this current climate. As economic borders continue to shrink and captive programs expand, an extra layer of complexity is introduced due to variations in rules and regulations from country to country. An ideal fronting partner will be able to address those complexities and have the geographical reach to deliver policies in all jurisdictions of exposure, keeping organizations safe, compliant, and protected across borders.
“In this environment, it is essential to partner with a provider that has an expansive global network and the scope of knowledge, capabilities and products to provide both program structure flexibility and regulatory expertise,” he said.
“As your business expands and its exposures change, an experienced partner should move in lock-step with the needs of your organization.”
The fronting provider should be able to guide the captive step-by-step through the expansion process, asking the right questions and assisting in navigating any challenges that arise.
Lastly, it is imperative for insureds to work with fronting partners that understands the current complex and changing economic environment and that can help suggest and implement long-term solutions to meet short and long-term business needs.
“A captive is not a short-term solution,” Lister said. “For the sophisticated insured, a captive structure should be thought of as a long-term solution that is part of a comprehensive risk management strategy.”
With that in mind, insureds should seek a provider that offers a long-term partnership-based approach, particularly when dealing with the economic uncertainty of today.
“That should likely include an economic model that takes into consideration the credit exposure and cost of capital to the organization, because ultimately, when a service provider or a fronting insurer is fronting for a captive, the exposure lies in the credit risk for the fronted limit. Ultimately any risk written and ceded attracts capital. For a captive placement this comes down to unearned premium reserves, outstanding loss reserves and IBNR, so insureds should be prepared for a fronting provider to ensure that it will be able to cover its own cost of capital for the fronted limit and the residual credit risk after taking any qualifying collateral into consideration,” Lister added.
He said it’s important for a fronting insurer to calculate the cost of the credit exposure, the cost of capital and the cost of administering the placement.
“An insurer that accurately predicts the cost of its fronted placement year-over-year (subject to no material changes in exposure), while helping the insured to manage its insurance spend accordingly, is a strong indicator of long-term stability.”
These four qualities — innovation, data analysis, multinational understanding and longevity — strengthen a captive program’s ability to meet growing risk head on.
“During 2020, we have seen a perfect storm of a hardening market, reduced capacity and the current economic situation accelerating the utilization of captives and increasing the interest in alternative risk solutions,” Lister said.
“This is a trend that is likely to continue.”
For insureds that are looking to broaden their risk management efforts, captives might just be the place to start. A captive program is a long-term solution and step one is to undertake a captive feasibility study to determine whether a captive structure would be the right fit for your business. Step two is understanding the qualities of an optimal fronting provider. Step three is choosing the right partner.
“AIG has over 50 years’ experience and expertise in the captive fronting and captive management space with a comprehensive and transparent economic model and a flexible approach to program design,” Lister said.
The team at AIG works to deliver results through innovative solutions that drive effective risk management for insureds.
“Opportunities for captive expansion also bring additional risks and challenges from both a governance and compliance perspective,” Lister said. “When looking at expansion possibilities for existing captives, it becomes that much more important even for more seasoned captive users to partner with experienced, innovative and flexible service providers to help them navigate and react to this complex world and make sure they are optimizing their captive usage and meeting their ever-changing needs and preferences.”
To learn more, visit: www.aig.com/multinational.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with AIG. The editorial staff of Risk & Insurance had no role in its preparation.