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The benefits of captives for financial institutions

At a glance

  • Captive solutions are playing an increasingly important role in the risk-management strategies of financial institutions
  • The market continues to grow, and brokers now have a wealth of options to meet the complex needs of their customers
  • Zurich is a market-leader in captive insurance and reinsurance, with the necessary tools and expertise to serve the most sophisticated of risk profiles

In today’s global marketplace, financial institutions face a complex landscape. Companies may be international, but regulations remain local, and new risks are continually emerging.

Captive solutions have long offered benefits for those wishing to gain greater control over their risk-financing activities. Traditionally peaking during tough market conditions, captive formation and growth are now constantly rising.

While many large corporations already employ captive solutions, in one form or another, there’s still a wealth of opportunities out there for brokers. Zurich services more than 230 customer captives worldwide – including 40% of Europe’s largest banks – and remains at the forefront of developments in the captive sector by pioneering innovative solutions.

Demand for alternative risk financing

Globally diversified financial institutions face a number of risk-management considerations. Among these is a high demand for particular lines of business – such as professional indemnity and banker’s blanket bond – requiring high indemnity limits and significant policy customisation.

“The traditional appetite for these lines of business for large globally diversified financial institutions is limited,” says Luca Ravazzolo, Global Financial Institutions Lead at Zurich. “Tailor-made policies that successfully optimise local coverage often prove unattainable, with insurers frequently only willing to write higher excess layers, or policies with high retention levels.

“This need for greater flexibility and capacity has been a major driver for the uptake of captive solutions.”

Captives are widely recognised as generating incentives for better risk-management, helping to retain underwriting profits and having the potential to produce a number of micro-economic benefits – making captives attractive to financial institutions.

Growth of reinsurance models

Many countries stipulate that a locally-admitted carrier must issue insurance coverage. Therefore, a principal consideration for captive programme design is the local regulations where the issuing insurer will be domiciled.

If operating a direct insurance captive model (as opposed to a reinsurance captive model), a geographically diversified organisation will face the cost-intensive process of gaining licences to become a local carrier in each jurisdiction. Additionally, there are the continuing governance and compliance demands that come with direct insurance activity, such as reporting requirements, local taxation laws, and policy issuance and claims management rules.

The traditional appetite for these lines of business for large globally diversified financial institutions is limited”

Luca Ravazzolo, Global Financial Institutions Lead at Zurich

For this reason, non-admitted reinsurance models are gaining prominence among financial institutions. Customers can use Zurich’s established global network of local insurance carriers to their advantage. By having Zurich act as the direct insurer – a practice commonly referred to as ‘fronting’ – Zurich is able to provide tailored insurance coverage and the necessary premium, claims and other administrative frameworks.

In a ‘gross captive reinsurance cession’, the fronting insurer cedes up to 100% of risk to a customer’s captive reinsurer. This type of programme has the flexibility to meet capacity, pricing and coverage needs, while removing the challenges a direct insurance model can present.

Capturing emerging risks

Captives have long been used to insure gaps in cover, such as policy exclusions, but businesses can also use them for wider enterprise risk-management. Since a captive has the flexibility to determine its own capacity and appetite, this allows it to develop tailor-made covers that may not be suitably catered for in the commercial insurance market.

For example, providing effective coverage for supply chain risk may be challenging, yet it is a growing concern for many risk managers. Insuring this wider enterprise risk via a captive can offer many advantages.

Another growing area is cyber, which is a relatively new line of business for most insurers. Appetites, coverage and pricing can vary greatly in the marketplace. Despite this, only 1% of captive owners are funding cyber risks through their captives, according to research by Aon.

“Zurich has recently been working with two global banks to extend existing captive programmes to include cyber risks,” says Luca. “This has consisted of an intensive process of mapping and identifying the various risks, then analysing the most effective risk transfer options.”

New broker opportunities

The disparity between the perceived importance of enterprise risk-management, and the number of captives currently financing such risks, exposes a tremendous opportunity for brokers.

The capital requirements for businesses operating under regulatory capital frameworks, such as Solvency II, are determined by reference to the volatility of risks they are exposed to. Therefore, more diversified risk portfolios can generate capital credits, freeing up assets for investment.

Large corporations may have significant life risk exposures through their employee benefit portfolios, which are typically managed by human resource departments. But as captives have flexibility in terms of appetite and capacity, they can accommodate life risks as well as non-life – a trend Zurich is seeing more of.

This practice can also diversify a captive’s portfolio and leverage regulatory capital requirements to their advantage, as well as generating various administrative efficiencies.

Ensuring compliance

The multi-layer, multi-jurisdictional nature of many captive programmes presents various challenges from both an administrative and compliance perspective.

This is why Zurich has invested significantly in its award-winning Multinational Insurance Application (MIA) tool, which is offered free to customers and brokers and provides up-to-date tax and regulatory information covering more than 180 countries and 41 lines of business.

Room for smaller players

There is also much excitement around recent market developments aimed at supporting medium-sized companies who wish to access alternative risk financing. The advent of protected cell companies (PCCs) and ‘rent-a-captives’ signals the next stage of evolution, opening up the captive market to smaller companies.

Brokers are encouraged to contact their broker relationship manager at Zurich if they would like to further discuss captive solutions.

Image © Getty

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