Captives and Alternative Risk Transfer solutions add flexibility and control to International Programs

Recent years have seen powerful disruptive forces affect the global risk environment, including more volatile Nat Cat and weather-related losses driven by climate change and increased geopolitical tensions. As a result, many businesses are exploring their existing insurance programs. In particular, they’re looking at the value, flexibility and control offered by international programs when used in tandem with captive vehicles and other alternative risk transfer (ART) solutions.

Against the backdrop of the recent hard market, these evolving exposures have encouraged companies to refresh their thinking about insurance and take advantage of the benefits offered by international programs and alternative risk transfer solutions.

Captive (re)insurers can be structured and scaled in multiple ways and flexibility is one of the core benefits they bring to an international program.

It’s very common for companies to use a captive to enable local companies to have a smaller deductible than the parent wants at enterprise level.

Porter explains: “A multinational business might be comfortable with a USD 5m deductible on its property cover. But for some of its small local entities, that’s not something they can handle. Through the captive, smaller local entities can benefit from a USD 100,000 deductible. The USD 4.9m gap is covered initially by the captive (and hence economically by the parent), before cover above its USD 5m global deductible is triggered.”

In addition, captives can have a broader risk appetite than traditional carriers. This is particularly helpful if cover isn’t readily available on the open market and/or there are specific gaps in the policies available.

Sitting behind the policies in the international program, the captive ensures blanket coverage for the parent group.

Porter comments: “Whether it's a Nat Cat exposure or something like contingent business interruption, if all the policies on a program aren’t aligned, there’ll be gaps in coverage.

What the captive can do is fill these gaps by being a reinsurer of the fronting company for the entire policy. And that allows any of those losses that fall through the cracks to go to the captive and be covered at the level that’s been negotiated on a global basis.”

Captives can take on as much or as little risk as the parent wishes and many businesses flex their use to take advantage of soft markets and to shelter themselves from hard markets. In this way, captives help to create consistency in international business insurance, both in the level of cover provided and the price paid.

Andre Martin, Head of Alternative Risk Transfer APAC and Head Captive Centre of Excellence at Swiss Re Corporate Solutions, believes the ability to cover emerging risks, for which open markets aren’t yet fully developed, is particularly important.

He says: “Corporations are generating more and more revenue from intangible assets and the insurance market often needs physical damage to act as a trigger. In many situations, the commercial market for these intangible risks is underdeveloped and carriers often have limited appetite for them. A captive can act as a buffer and protect the business units that aren’t capitalised to absorb losses from these risks.  
 

Taking on such emerging risks in a captive demonstrates a company’s commitment to risk management and can strengthen its position when negotiating its overall re/insurance.

Captives sit at the heart of the alternative risk transfer solutions available within an international program, but there are also other options that can be highly effective.

Virtual captives enable companies to get many of the benefits of a captive, without having to set up and fund a legal entity. The contract behind a virtual captive (or partially funded solution) means the insurer settles losses and the parent company then pre- or post-fund a pre-agreed amount of the losses incurred via the insurance contract.

Martin explains: “A virtual captive is, effectively, a multi-year insurance agreement between a customer and an insurer. The agreement replaces the legal entity of a traditional captive but retains much of its self-insurance mechanisms.

As such a virtual captive can be a very effective alternative in conjunction with international programs, with the corporation enjoying the benefits but without the complexities of setting up a new legal entity.

Another solution that is seeing increased interest in conjunction with captives and international programs is parametric insurance. It has proven to be a very effective tool to fill the gaps of traditional reinsurance protection, in particular for pure financial losses that are not caused by a physical damage and therefore excluded from traditional international programs. Parametric insurance can provide global protection and fast payments outside of a customer's home country.

Going into more detail, Martin says: “Parametric insurance is an area in which captives are really waking up to the possibilities.

The captive can issue normal traditional policies to its business units and offer wider levels of cover than normal. The captive can take out a parametric reinsurance policy to protect itself from the losses incurred by this expanded cover. The instant payments from parametric policies mean the captive will have funds to then pay out on its indemnity policy losses, protecting its own cash flow in the process.”

The Alternative Risk Transfer and International Program teams at Swiss Re Corporate Solutions are among the most experienced in the market and their focus on transparency and support means they're always available to talk through ideas, discuss solutions in–depth, and suggest how they’ll work in practice.

Their experience means they can offer insight and specific strategies that have delivered benefits in similar situations. The team can also suggest options during the set-up phase to ensure all angles of a company’s particular challenges are addressed effectively.

Porter concludes: “I talk a lot about the tripartite relationship, because you’re always going to have the carrier, the broker and the customer. But when the customer has a captive, that adds another element because now you have the captive making the customer a risk-bearing member of the program team.

I think it really helps the risk manager get their message through to the rest of the organisation… and it allows us to have deeper conversations with the customer.

It changes the focus from traditional international program discussions, which are how fast can you issue, or how broad your coverage is… Instead, you’re focused on making sure the right coverage is in place and really putting the program together in the best way, tailored to individual customer needs.”