Captive use grows – despite new regulatory regimes

30 September 2016

Written by Editorial team

UK risk managers are using their captives to help manage a broad range of risks including, where appropriate, those that are new and difficult to place in the open market.

Changing rules and regulations, from the introduction of regimes such as Solvency II to others with similar approaches, are adding costs to captives – mainly in the form of additional reporting and governance requirements. However, they do not appear to be changing the way in which captives are used or their popularity as a risk management tool.

In fact, it seems that captives are being used in increasingly sophisticated ways to deliver for UK organisations.

BT Group has a captive called Communicator, which has been based on the Isle of Man for 26 years. BT places a cross-class property damage and casualty programme in the Communicator.

The firm’s director of insurance and risk financing, Tracey Skinner, explained that it is used to take a significant amount of operational, working layer risk above relatively modest deductibles retained by lines of business. “We use the captive to fund the initial losses across all of our programmes and then we buy stop loss protection in the open market, so we are not exposed to too much risk from any one event or a series of events,” explained Ms Skinner.

BT seeks to transfer emerging and developing risks to the external insurance market where possible. When cover is not available, BT does consider its captives as an option for these tricky areas, particularly when the risk is predominantly an issue for a particular line of business rather than the whole group.

“Given our risk financing philosophy, if there is a new and developing risk that could have a significant impact on us, our view is that it should be placed in the external market. It remains there until we get some data on the risk and understand it,” Ms Skinner, who is an Airmic board member, explained.

Onerous

“If the external market won’t take the risk, then that is another discussion because we would be taking the risk anyway. If we could obtain a solution on a reinsurance programme above the captive for these risks that would be a good result for us, because at least then we have some risk transfer. If there is a significant risk to a line of business but to BT Group as a whole is less onerous, that is something for which we might form an incubator within the captive to see how it develops. We were having a discussion recently about non-traditional product recall risks and using the captive as a solution,” she added.

Lloyds Register has a Guernsey-based captive that is used extensively to reinsure its cross class programme, covering nine or ten different insurance lines, explained Clive Clarke, the company’s group insurance manager.

“We also use it for bespoke deductible infill policies and several other life policies. We don’t have a global arrangement on life cover but we have eight or nine countries where we buy the life cover and reinsure it into the captive. So there is a very strong mix of risk. We have set the risk tolerance level of the captive at a number we are quite happy with. In the past three or four years we haven’t come close to breaching it,” added Mr Clarke, who is Airmic’s current chairman.

Arcadia Group’s captive is also based in Guernsey. According to the group’s head of risk and compliance, Colin Campbell, it is also used for deductible infills. The captive is talking on more and more risks, including those that the open market doesn’t take or for which cover is unattractive.

“We are putting more cover through our captive, either doing deductible infills or putting covers that the insurance market isn’t offering or alternatively would offer but with restrictions and higher premium. So we are using the captive to provide more cover, recognising that it might only be for a temporary period. For example, we are using the captive to write four-, five-, six- or seven-year policies but recognising that it might just be a one-off premium and cover arrangement,” said Mr Campbell.

Although all of these captives fall out of reach of Solvency II, they are subject to regulatory regimes that are increasingly taking the lead from the European Union’s capital adequacy and risk reporting regime. The growing use of captives suggests such regimes are not affecting their viability of captives. However, UK risk manager agree with their peers across Europe that there has been an uptick in costs when it comes to new reporting requirements.

“Our captive is based in Guernsey, so Solvency II hasn’t had a direct impact but clearly Guernsey has had to come up with its own solvency regime. So we are incurring expense as a result of having to have a different approach to governance and risk, but we do not have more money in the captive’s bank as a result of these new solvency rules and regulations. So the financial implications are from the cost of governance and reporting – additional training for directors, new advisers and specialists, and more audit costs. This is because there is simply more to look at and more to consider. The Guernsey approach has been very pragmatic,” said Mr Campbell.

He believes this work has definitely delivered advantages for his firm and its captive, but questions whether there will be ongoing benefits from the new requirements.

Julia Graham, deputy CEO at Airmic, said many captives are living under new governance regimes that are to an extent following the principals of Solvency II, even if they do fall directly under its reach. She believes any additional reporting and capital requirements as a result are not stifling the desire and need for captives.

Little impact

“I think captives are still growing. More organisations are setting up captive businesses. I don’t think new regulations are having any real effect on the way and number of people that are using captives as a tool,” she said.

Ms Graham noted that over the years, captive users have become increasingly innovative and sophisticated. Captives have moved beyond simplistic refinancing tools and now increasingly help companies tackle difficult and emerging risks, she added.

“I think captives are having a bit of a resurgence in that people are using them, even if it’s not for risk transfer. People are using them for innovative solutions. More and more are using captives for employee benefits and to store and analyse data related to digital risks. So I actually think the purpose and reason for having captives is growing. I think people have become more mature users of captives and they still have a role to play, even in the soft market,” she said.

Gary Marshall, group risk manager at Polestar before it went into administration this summer, explained that his previous employer did not have a captive because it lacked the sufficient premium numbers, coverage lines or global footprint to merit setting up such a tool. “Those are the three elements that dictate whether a captive comes into play… so for us there were no real benefits of a captive,” he explained.

This article was originally published by Commercial Risk Europe, September 2016.

Download Find a related practitioner