Retaining risk in a hardening market

Markets harden for a number of reasons but it’s fair to say that there are specific triggers for change. You need look no further than the Japan and New Zealand earthquakes, the Australian floods, United States hurricane and United Kingdom riots.

Coupled with uncertainties with the global economy, there will likely be substantial fluctuations in capacity and premium rates over the next three to five years. As the diagram below reflects, the previous insurance cycle went through a period of hardening from 2001, peaking in 2003. If recent events are indicative of future trends, it is expected that there will be substantial hardening of insurance premiums in coming years.

For very large enterprises, such premium volatility can be more challenging. Some manage this by setting up a captive insurance company – a company which provides insurance solely for their organisation. This enables them to retain risk at a comfortable level and also to smooth out the way risk premium is distributed, making costs more predictable.

A changing market = new efficiencies
Captives are designed to be an integral part of an organisation’s insurance placement as well as risk management program. Fundamentally, captives are licensed and regulated insurance companies owned by the insured, providing the most transparent governance mechanism and greatest access to the reinsurance market.

The average age of Australasian-owned captives are over ten years and have provided their owners stability through previous cycles. Over this time, many captives would have accumulated considerable underwriting capital and their owners would have grown in risk tolerance and/or evolving business needs since implementation of the vehicle.  Such uncertainties present an opportunity to re-evaluate the captives’ effectiveness.

For captives to maintain their effectiveness and strategic values however, their owners would be best served to review their capital and underwriting structures as well as operating processes.

Time for a health check?
From a governance perspective, it is prudent to undertake a periodic review of the captive to ensure its capital is well utilised and its operations align with the latest regulations and best practice.  A health check will serve to highlight opportunities and recommend action to achieve improvements.

Captives tend to vary in scale, maturity and complexity – therefore the depth of each assessment should be customised. 

The aim should be to provide a transparent process for the captives’ owners and stakeholders and would typically include:

• Revisiting the mission of the captive
• Updating insurance market conditions
• Reviewing appropriateness of risk retention level
• Considering additional risk classes
• Reviewing premium setting and reserving methodologies
• Benchmarking underwriting performance and profitability
• Stress testing for solvency position
• Reviewing use of accumulated capital
• Reviewing operations in terms of efficiency and compliance