Published on 23 November 2023

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The Rise of Property Captives in the US

Published on 23 November 2023

As 2023 reaches its final quarter, catastrophe risks are pushing property insurance into a much harder market than anyone anticipated.

As 2023 reaches its final quarter, catastrophe risks are pushing property insurance into a much harder market than anyone anticipated. In fact, it is the most challenging market for three decades – a period that witnessed the fallout from Hurricane Andrew in 1992, the World Trade Center attack in 2001, and the 2005 windstorms.

The bucketing of perils into primary and secondary silos is becoming increasingly meaningless. Losses from convective storms, hail and tornados are combining with traditional cat risks to create an equally perfect storm for insurers.

Since 2017, the US has endured an average of 15 natural catastrophe events per year – compared to 10 in the previous decade and six prior to 2007. In 2023 YTD, the US has experienced 33% of the USD99 billion global natural catastrophe losses; yet with insured losses of USD68 bn, it accounts for nearly three-quarters of global insured losses, according to Gallagher Re’s Q3 2023 Natural Catastrophe Report.

Wes Robinson, national property president at RPS, commented that the recent reinsurance renewal period at the beginning of 2023 had a big impact on property rates at a time when direct insurers are already facing serious cost pressures.

"The average insurance carrier that deploys catastrophe business is looking at 30% to 80% increases in its reinsurance costs," Robinson says. "This increase would be tough to bear at the best of times, but with the recent pressure on underwriting results in the direct market, insurers have no choice but to pass these increases on to their insureds."

The Gallagher Re H1 2023 Natural Catastrophe Report highlighted severe convective storms in the US contributed to the second-costliest H1 on record.

Insurer Reaction

Insurers are moving away from policy blanket limits to more restrictive scheduled limits that reduce the ability for the insured to claim for loss events across multiple locations in one single claim. Some insurers have pulled cover entirely. To date, along with several smaller insurers, Progressive, State Farm, Allstate, Nationwide and Farmers Tokio Marine, AmGuard and Falls Lake Fire and Casualty Co have paused or restricted writing new business in the state. The news has led some commentators to question whether California has become the most uninsurable state in the US, with other states such as Florida, Texas, Colorado, Louisiana, and New York in hot pursuit.

The lack of capacity from incumbent markets has led to insureds retaining more risk by increasing deductibles, self-insuring, buying less catastrophe coverage and in some cases insuring at limits below replacement cost. However, there has also been increased interest in captives, which have the potential to provide broader, more affordable coverage tailored to an insured’s risk profile.

Captive Interest

Captive use has been growing in response to the hard market and the latest figures released by AM Best in August 2023 show captive surplus has grown by about USD 4 bn or 17% since 2018. Combined with stockholder dividends of about USD 5.3 bn, captives have saved their enterprises USD 9.4 bn over the past five years in money that could have gone to the traditional insurance market. The US captive market has grown significantly in recent years. US domiciles account for 52.4% of all global captives and North American offshore domiciles, including Bermuda and Cayman, account for 33.1%.

Type of Captive

 

Single Parent Captive:

A captive established by one company and incorporated into its risk management programme

 

Cell Captive:

Replicates the operations of a single parent captive but within an existing corporate legal structure (A Protected Cell Company). The existing structure allows organisations to share the administrative burden of a Limited Company without sharing insurance risks.

 

Group Captive:

Common in the US where the captive is owned by multiple organisations who share risk. Outside of the US the equivalent structure is referred to as a Mutual.

 

The control a captive offers is a huge draw; they allow owners to design tailored, comprehensive and responsive coverage, overcoming exclusions or restrictions that might apply in the commercial market. Property buyers with established single parent captives are expanding the utility of their captive insurance company by funding for additional coverage layers throughout their programs. Whereas prospective first-timers are conducting their due diligence, identifying the most strategic areas for captive integration within their insurance program and considering the start-up costs to establish a new captive. Alternatively, companies can rent cell captives, which are ideal for companies who are interested in implementing a captive strategy in a more expedited timeframe due to renewal trends or adverse market conditions. Overtime, cell captives can be transitioned into a single parent captive writing first part risk or transitioned into a cell portfolio company that can write third party risk and rent cells to other organizations.

From an underwriting perspective, a captive’s premium rate reflects a company’s unique exposures, whereas commercial market rates are based on company information and industry averages, typical exposures, and a margin for profit. In specific cases, captives can offer superior pricing predictability as they can be rated on the company’s specific loss history rather where data is credible than the overall market’s exposure. As a result, captive owners can benefit from more stable underwriting practices and less market volatility.

Securing the right level of capital to establish a viable captive is a crucial aspect within the risk versus reward paradigm: group captives’ minimum insurance spend sits at around USD250,000, for a cell captive, it would be USD500,000, while a single parent captive would require USD1 million. Nevertheless, captives seem to be built to last as they typically enjoy a 99% renewal rate – much higher than their traditional counterparts.

Traditionally, captives have been used for problematic but predictable risks such as workers comp, general liability and auto. Yet establishing a captive is now simpler than it once was. While property may be perceived as a more volatile risk, its short tail means no challenging legacy exposures. Claims and exposure can be well-understood thanks to the wealth of data available, allowing for well-informed decisions on risk appetite.

Captive Participation in Property Programs

Captives allow for a flexible approach and owners can use them to close gaps in their coverage by designing their own insurance policy especially as the property market continues to evolve. Companies are increasingly looking to captives to handle risks that may be difficult or impossible to place in the commercial insurance marketplace. Property owners’ captives can cover differences in conditions or limits. A captive can write a difference in conditions policy, also known as a “DIC policy” as a way to fund for the gaps in coverage within the commercial placement. As a result, a captive policy can be designed to dovetail in with the traditional policy, allowing coverage to be broadened and companies to fund for their specific risks.

Captives operate on par with commercial insurers and need to be run with underwriting principles at their foundation. Brokers and insurers are integral to captives in order to continually monitor and understand the value of risk retention versus risk transfer. The most effective captive strategy works alongside the utilization and the analysis of the commercial insurance market; risk transfer to the insurance market remains a central strategy for risks too large to retain. By retaining a portion of owned risk within the captive, the company reduces the overall capacity being purchased in the commercial market; gives insurers confidence in their willingness to manage or tolerate their own risk, and the captive also benefits from the underwriting and risk engineering expertise of the commercial insurers participating on their program.

While higher deductibles may mean cost savings on commercial property insurance premiums and may generate more interest from markets, the insured is inherently assuming more risk within their insurance program. It will be important for a company to conduct a cost-benefit analysis surrounding the risk they transfer to the marketplace and the risk they assume at the company level. For those companies choosing to take on more risk via deductibles or increased retentions, establishing a captive insurance company is a way for them to finance the risk in a more predictable and stable environment. Specific captive programs can include the following types of program structures:

• Deductible buydown policy: A property owner implements the policy via a captive to lower the amount of deductible they will have to pay if a claim is made. The policy may cover all risks or a specific peril like wildfire.


• Deductible reimbursement policy: The insured funds the deductible difference up front with a letter of credit and it sits in the captive where it may earn investment income on the funds.


• Fronting policy: A licensed, admitted insurer issues a policy on behalf of the captive without the intention of transferring any risk. These are usually used to comply with insurance regulations and require a front fee to the insurer which usually is a percentage of the premium.

Alesco can support businesses considering using captives and help them understand how to streamline their commercial insurance programs to sit alongside captive solutions. Our sister company Artex can advise and assist in the feasibility, formation and on-going management of captives, alongside other alternative risk management solutions. Both companies have developed market-leading expertise to help businesses find effective ways to manage their property risks when market conditions make it more difficult to do so via the more usual channels. Using captives may not be a viable solution for every business, but for some, it could prove invaluable for many years to come.