Future of insurance: Transfer, retain or finance?

Today, shifting market dynamics and the COVID-19 pandemic accelerates pressure on an already hardening market. The current situation and impending recession is creating huge amounts of uncertainty which is resulting in challenges for insurers, brokers and clients alike ,-with pricing going up and capacity being tightened.

It is unsurprising therefore, that many clients are re-looking at what risks they choose to transfer or retain, and whether self financing risks could be a cost-effective solution for them.

Generally, we see two types of clients that want to explore self-financing. The first cohort is made up of those companies that are – from an insurance perspective - generally considered to be difficult occupancies in the first place.

The second segment is those clients who are usually in a good position within the insurance marketplace but who believe the premiums currently charged by insurers do not appropriately reflect the risk that they have within their companies.

The financing options available

Regardless of why you are considering a self-finance approach, once you start thinking about retaining some of your risk there are broadly four options available.

• Increasing deductibles

The most obvious solution is to increase the deductibles in your insurance programme, retain the risk below that - and pay as you go.

However, the main downside with this approach is that you may have units within your group that are not cash rich or capitalised enough to also bear such an increased retention or deductible.

This means you could run into problems down the track, and that you have to manage the claims or losses that fall within that deductible yourself – which will require greater resources.

• Setting up a captive

The second option is to set up a captive, which have long been seen as a potential insurance solution for companies faced with a lack of capacity and high pricing due to a marketplace that may not adequately understand their risk or have sufficient appetite to underwrite it.

This approach is popular as a captive can provide additional capacity, controlling the type and level of risk the company retains versus what it chooses to transfer to the market. This is especially valuable in a hard market and can help to reduce cost, improve cashflow management and gain greater control over insurance.

Challenges to consider with captives are however thatthey are costly to set it up, costly to run and it’s not easy to exit again as there’s quite a lengthy process involving the regulator if you want to close it down.

• Set up a Protected Cell Company

If someone is put off by the costs involved with a captive solution, they might consider a Protected Cell Company as alternative. With a PCC, you enter ownership into an equity “cell” of an already established Cell Company with all its infrastructure.

By taking this approach, you can then benefit from the economies of scale of that infrastructure which should mean that you need less capital to inject and it costs less to run.

A consideration, however, is that you have to go to one of the established offshore Cell Companies, which means less ownership and direct control of the entity and dependence on the third party “core owner” for administration, management and governance.

Another problem is that this approach is still bearing considerable cost, you still need to inject some capital and you may still need to put up some collaterals for the “risk gap”.

• Setting up a virtual captive

To help solving some of the problems associated with the main self-financing approaches that currently exist, the concept of the Virtual Captive has been developed. A Virtual Captive allows you to gain much of the benefits of a captive without having to become the owner of a legal entity, eliminating the regulatory complexities of the traditional set up.

Instead, you emulate the financial mechanics of a captive (i.e. risk self-financing) on Swiss Re Corporate Solution’s balance sheet.

In practice, this is an insurance agreement between the client and us, covering a multi-year period and finances risks over time. As the insurer, we provide coverage through the agreement and handle all solvency aspects through our existing infrastructure. Unlike a traditional captive where remaining funds are paid through a dividend to the parent, in this case we pay any remaining funds through a Low Claims Bonus to the customer. Similarly, there can be an additional premium element in case things go worse than expected.

There are two main considerations before adopting the Virtual Captives approach. The first is that because you have entered into a multi-year agreement, the flexibility to change things is slightly less than you would get in a real captive. This is because you’re dependent on mutual agreement whereas if you have your own captive you can do whatever you want.

The second factor to be aware of is that because you are buying an insurance programme there is some risk transfer involved, so you are still dependent on the risk appetite of the insurer for that remaining risk. That means there are some risks where a Virtual Captive will not be an appropriate solution, such as pandemics at the moment.

However, we believe that a virtual captive will suit many corporates who have decided that the captive could be the right answer to their insurance needs, but who are also evaluating alternatives to avoid the time needed, the cost and complexities. It is also well-suited to those businesses that are worried about exiting a captive in the future or that need to close a time gap before setting up a new captive.

Thomas Keist is Global Captive Solutions Leader at Swiss Re Corporate Solutions