BURLINGTON, Vermont — Captives have increasingly been used to cover property risks over the past five years as commercial insurance rates have spiked, providing alternative capacity and greater control of rates, a panel of experts said.
The vehicles can also be used with other alternative risk transfer programs such as structured insurance programs and parametric coverages, they said.
About 9% of total captive premium in Vermont is related to property risks, and the $2.63 billion in 2023 property premium written through captives in the domicile is 29% more than in 2022 and 100% more than in 2018, said Christine Brown, director of captive insurance in the state’s captive insurance division.
She was speaking during a session at the Vermont Captive Insurance Association’s annual conference last month.
“Even though we are hearing that the markets may be starting to stabilize a little bit, we’re still seeing that growth,” she said.
The hardening rate environment has driven property owners to consider captives, said Ray Rocchio, executive vice president at Keystone Risk Partners, a Media, Pennsylvania-based unit of Ryan Specialty LLC.
“The last four years of increasing rates and reduced capacity or increasing deductibles has really kind of put people in a position now where they’re just tired of the marketplace and traditional carriers and the pricing that’s going on, and so they’re looking for alternatives,” he said.
But captive owners should carefully review their catastrophe exposures before placing property risks in their captives, Mr. Rocchio said.
As part of that process, the risks need to be run through catastrophe models to assess exposures, but the models vary, he said.
“You really need to understand which model you’re using, what perils you’re looking at, and what version of the model you’re looking at,” Mr. Rocchio said.
For example, one modeling company may be strong in analyzing California earthquake risks, and another may be better for Northeast windstorms, he said.
In addition, while modeling companies have extensive experience analyzing some perils, they are “green” on others, Mr. Rocchio said.
“I’m not looking for them to tell me what the terrorism charge is or wildfires,” he said.
Once organizations understand the likelihood of being hit by a catastrophe, which can be comparatively low, they may be willing to take more of the risk in a captive, Mr. Rocchio said.
Structured programs can be developed through a captive to tailor coverage, access the excess and surplus lines market, and spread coverage over noncancellable multiyear terms, he said.
“Every program can be tailored to the client’s needs from either an exposure or financial cash flow perspective,” Mr. Rocchio said.
Property captives can also be used to access parametric coverage, said Derrick Easton, New York-based managing director, alternative risk transfer solutions, for Willis Towers Watson PLC.
Parametric insurance, which is based on agreed-upon coverage triggers such as wind speed, rainfall or temperature, has become more affordable compared with traditional coverage since the hard market began and can be used to cover previously uninsured exposures, he said.
“A property policy is great, but it doesn’t do everything. There are lots of gaps that it creates, whether that is just simply through deductibles, limits, supplements, exclusions. There are lots of ways that parts of a loss fall outside of that property policy,” Mr. Easton said.
In addition, claims disputes can delay payments for years, he said. Parametric programs pay out in days after coverage is triggered, and the funds can be used to cover any expenses a policyholder may incur, he said.
While parametric coverage is often bought directly, it can be used to reinsure a captive, he said.
“If you’ve been forced into taking massive deductibles because of the challenges in the property market, and you’re putting that into your captive, your captive could be facing a bankruptcy event. So, we’ve got clients who simply put this parametric capacity behind it,” Mr. Easton said.
As the captive grows, it can take on more of the potential catastrophe risk, he said.
Green exposures steer energy companies to captives
Concerns over climate change are driving more companies to embrace green technology, but the move is changing the nature of risks they must manage, sometimes increasing their exposures.
As commercial policyholders face significant climate-related risks, they are making greater use of captives, a panel of experts said.
Natural catastrophe losses remain elevated, with global insured losses exceeding $100 billion for the fourth consecutive year in 2023, said Daniel Raizman, Boston-
based global head of client engagement in Aon PLC’s climate risk advisory division.
And the trend has continued in 2024, with U.S. insured losses from severe convective storms alone hitting over $41 billion in the first half, he said during a session last month at the Vermont Captive Insurance Association’s annual conference.
Much of the catastrophe exposure growth is attributed to demographic changes, as more people move to coastal areas, but climate change is also likely contributing to the increase, Mr. Raizman said.
As climate change threats rise, companies are looking to alternative energy sources, but moving to green energy production can also increase risks, said Andrew Baillie, Haymarket, Virginia-based program director of global insurance for AES Corp., a global energy company.
For example, AES has a coal power station in Puerto Rico that Category 5 storms have hit three times without going offline, he said.
“Next time a Category 5 storm runs over a solar park in Puerto Rico, it’s not going to be the same answer,” Mr. Baillie said.
In addition, renewable energy sites can have very high values. For example, AES is building solar facilities with more than $1 billion worth of solar panels in concentrated areas and often the available commercial insurance coverage is a fraction of the panels’ value, he said.
“The protection gap is enormous between the value at risk and what you actually want to be able to protect,” Mr. Baillie said.
AES is making greater use of its Vermont-domiciled captives to cover the exposures, he said.
Climate change is also increasing exposures for the Lancaster County Solid Waste Management Authority in Lancaster, Pennsylvania, which operates two waste energy facilities and waste management facilities, said Chief Financial Officer Daniel Youngs.
LCSWMA set up a captive in 2021 in response to higher rates, reduced capacity and increased coverage exclusions, Mr. Youngs said.
“The captive has generated a vehicle that allows us to be differentiated,” he said. “It’s also allowed us to take on more risk and put more skin in the game.”
Captive owners cautioned to tread carefully with cyber risks
Cyber liability risks can be effectively covered through captive insurers, but organizations should scrutinize their potential exposures and the consequences of taking on such high-severity, low-frequency risks before placing them in a captive, a panel of experts said.
In addition, if organizations opt to self-insure, they should ensure they don’t lose access to ancillary services that insurers provide to cyber policyholders, they said.
Companies considering covering cyber risks via a captive should thoroughly examine their information technology infrastructure, said John O’Neil, Springfield, Massachusetts-based assistant vice president, corporate insurance risk manager, at Massachusetts Mutual Life Insurance Co.
“Sit across the desk from whoever is responsible for IT security in your company and ask them the hard questions,” he said during a session last month at the Vermont Captive Insurance Association’s annual conference.
One of the advantages of placing cyber risk in a captive is that companies can tailor their coverage, but if they are using excess insurers, the insurers need to be comfortable with the wording. If they are not, the captive owner must be aware of the exposures covered by the captive that the insurers will not follow, Mr. O’Neil said.
Captive owners should also ensure that they continue to have access to cybersecurity support, ransomware negotiators and other services that are often packaged with cyber coverage, said Kim Guerriero, Boston-based principal and consulting actuary at Milliman Inc.
“If you structure the policy in such a way, you don’t have to lose access. So, one of the ways to do that is through a large deductible policy,” she said.
Captive owners should also be prepared for potentially significant losses if they cover cyber risks, said Mike O’Malley, Dunstable, Massachusetts-based managing director at Strategic Risk Solutions Inc.
Cyber claims are unlikely to occur frequently, but when they do occur they can be large, he said.
When SRS advises captive owners on cyber risk, it runs a five-year stress test and shows them the actuarial results, he said.
“We walk through the concept of, ‘Are you ready to recapitalize the captive if you have a big event?’” he said.
Based in New York, Stephen Freeman is a Senior Editor at Trending Insurance News. Previously he has worked for Forbes and The Huffington Post. Steven is a graduate of Risk Management at the University of New York.