From uncertainty to confidence: The path to better risk management

First established in 1962, the concept of captives has been around for over 100 years, coming into prominence in the 1980s, when they were often used as tax-efficiency vehicles. However, over the past 30 years, there has been significant growth in the captive market, with captive insurance becoming a popular method of risk retention among corporations, with approximately 90 percent of Fortune 500 companies owning captive subsidiaries. And, with the development of group captives, it is now a much more accessible model for mid-size companies. 

With this increase in popularity in mind, there are multiple reasons behind the captive boom that can open up opportunities for the parent company to retain risk in an innovative and more economical way:

• Balance sheet protection
• Avoid potentially unnecessary premium transfer
• Ability to be selective about which exposures they want to keep versus transfer to the broader marketplace
• Create capacity to leverage the market during a hard market

However, while alternative risk transfer solutions offer substantial advantages to firms seeking to mitigate the impact of unexpected losses on their financial statements and uncertainty in their cash flows, there are also difficulties that come with setting up a captive.

Despite their growing popularity, captives also present serious hurdles to overcome for organisations looking for other means of risk retention. The most common are:

Regulatory challenges

The captive operates like any commercial insurance company and is subject to state regulatory requirements, including reporting, capital and reserve requirements.

Board-level alignment

Adopting a suitable board of directors for your captive can be challenging, given the increasing demand for good governance and independence from regulators and tax authorities. However, when composed of appropriate individuals from the insured and expert independents, it plays an essential role by holding the captive’s operation to account, providing independent oversight and specialist insight.

Taxation

When setting up a captive, it is important to remember that any profitability can incur taxes when trying to extract the money back into the business.

With these opportunities and challenges in mind, it is essential to remember that captives are part of the journey rather than the destination when considering risk retention opportunities. The journey begins with good data. By improving your knowledge and understanding of your data, you can improve your confidence when taking risk transfer decisions and reduce the uncertainty around your data by moving from an insurance-based mentality to a risk management-based one. With better data and more control over your balance sheet, what benefits could that bring?

Ultimately, the thinking behind creating captives is underpinned by the drive to protect your balance sheet. However, another overlooked factor is the need for more understanding of your exposures due to an absence of supporting data, which leaves organisations feeling they have little to no choice over which option to take regarding risk management. But what if that wasn’t the case? 

As technology continues to drive innovation in the market, data management platforms like Insurwave can offer all insurance entities within the ecosystem access to the same shared view of their insurance data in real-time. With the ability to access the data points you need in detail, you can gain access to the necessary data that will allow you to measure your exposures accurately. As a result, you would have far better capacity to make informed decisions when deciding whether to retain those exposures and make financial provisions for them through your balance sheet.

The combination of risk management and data analytics is a powerful one. With this combination, you can retain and manage your risk with confidence and, as a result, be more selective about what risk you transfer and deal with in-house. Returning to the journey analogy, you now better understand your exposure data. What more can you do with that information?

A transition from uncertainty to confidence defines the journey to better data management. The more risk and exposure you retain on your balance sheet, the less you are able to demonstrate the positive effect of de-risking through risk transfer. This could mean borrowing becomes more expensive or, in the event of a large loss, the share price is impacted. 

The benefit is that there are consistent savings through the reduction in premium spend. For example, catastrophe cover could be the only risk transfer requirement. Using data to practise better-informed risk management and loss mitigation means that you don't have to buy as much insurance and transfer your risk because you understand and are confident about the risk you are taking on.

By prioritising data, you can begin your journey towards the ultimate goal of a real-time risk transfer programme where you can view where your business is and take better-informed risk management decisions from it and have a far greater impact on the cost of your insurance for your business.