Why smaller organizations are interested in creating captives

Interest in captives naturally increases as a hard market intensifies, but now even mid-market or smaller organizations are considering captives as an alternate way to transfer risk, panellists of a Canadian Underwriter webinar observed Monday.

“Traditionally, when you think of a captive, you think of the Fortune 500 companies that have big balance sheets that have the wherewithal to retain the risks,” Alonso Tello, vice president of captives and alternative risk at AXA XL Canada, said during the webinar Captivating Business: How Captives Can Work for You in the Hard Market. “We’re now seeing that the lower end of the spectrum from a size perspective buy into the concept as well.”

Tello added that smaller companies may be renting a cell from a sponsor. So, rather than owning their own captive, companies rent out space under another’s captive. Or they might group together with other insureds to share the risk as a whole.

It’s a sign of the times that the list of companies looking to self-insure has grown. Premiums are increasing along all lines of insurance and capacity is tightening, pushing clients to find alternatives to handle their insurance needs, explained Patrick Ferguson, captive sales executive and senior vice president at Marsh’s Captives Solutions Group.

“That typically dovetails nicely into captives,” he said. “So these clients are looking at captive insurance companies as potentially another solution as a way to self-insure part of the risk, mainly to deal with the fact that premium rates continue to increase as capacity is shrinking.”

Clockwise from top left: Moderator David Gambrill from Canadian Underwriter, Braedy Walker from HUB International Canada, Patrick Ferguson from Marsh’s Captives Solutions Group and Alonso Tello from AXA XL Canada.

Even clients with a good loss history and that manage their risks well are seeing their rates go up during the current hard market cycle in Canada’s commercial lines, as Tello observed. Such companies are looking to change the conversation they’re having with their insurer, including expressing an interest in taking on more risks and exploring captive options.

COVID-19 has exacerbated the hard market conditions, potentially prolonging the hard commercial market for an extended period,  said panellist Braedy Walker, assistant vice president of captives and analytics at HUB International Canada. He estimated the pandemic would prolong the hard market another handful of years, keeping interest rates down. Lower interest rates are one of a handful of factors prolonging the hard market, since insurers cannot rely on their investment returns to help offset their claims costs (and thus reduce premiums).

“What that lends itself to is the fact that captives are a long-term solution,” Walker said. “It’s a great way for companies now to take control of their risk management to weather the storm of increasing [premium] rates that they’re going to have over the next number of years.”

The pandemic has also brought the importance of cash flow to the forefront for clients. A  captive can help them maximize efforts in that area.

“Certainly, in an environment where premium rates are going up, [commercial clients are] looking at any type of way to self-insure and, frankly, improve cash flow,” Ferguson said. “In a lot of cases, you can set up a captive as a self-insurance vehicle, shave some premium costs, and then you have an ability — through either an intercompany loan or another vehicle — to return some cash back to the parent organization.”

Brokers should be aware that they may soon see more requests from clients about captive options, Tello advised.

“I think more and more companies will start to take the captive option more seriously as a long-term solution to help mitigate the volatility in the market that has happened from time to time.”

Feature image by iStock.com/ridvan_celik