Are cyberattacks and ESG changing captive insurance?

Interest in self-insuring or having a captive insurance model historically has been cyclical, rising or dissipating based on the economic ebb and flow of insurance cost drivers. But that may be changing in today’s tough insurance market.

KPMG surveyed 100 insurance executives across all segments and found more than half expect a faster growth in the number of captive insurance entities in 2023 than in 2021 and 2022. Several factors, including inflation, are driving higher insurance premiums and interest in captives, which are wholly owned subsidiary insurers formed to provide insurance for their parent company or related entities. Cyberattacks and environmental, social and governance investing also transcend the traditional cycles for captives.

Cyberattacks over the past two years increased demand and premiums cost for cyber insurance by an average of 28% from the fourth quarter of 2021 to the first quarter of 2022, according to the Council of Insurance Agents & Brokers. Based on observations and conversations within the insurance landscape, cyberattacks have become more severe and this trend continues in 2023. As a result, even costlier adequate coverage may be more difficult to obtain. Although cyberattacks affect organizations across industries, when it comes to insurance, private equity has an advantage in their ability to bargain collectively because of their diverse portfolio.

ESG factors contribute to an increased focus on captives. A company’s ESG performance may impact the cost and availability of insurance for its business in general and for the directors’ and officers’ liability insurance. Management liability and the possibility of a shareholder lawsuit can make it difficult for a company to purchase insurance.

Advantages of captive insurance

Captives can offer the certainty of having insurance available during periods of higher premiums and unstable pricing. Companies essentially bet on themselves instead of paying a third-party premium. With captives, there is more flexibility in the policies companies can write and tailor to meet their needs. And while they take a risk in starting a captive, since there are operational costs, captives may be a better deployment of their capital.

Premiums paid to the captive offer three potential benefits: They can be tax deductions if the captive structure meets certain criteria, premiums can be invested before making payments on claims, and premiums build equity in years when any insured losses are less than expected.

Additionally, jurisdictions realize that enabling captives presents a great opportunity to attract more businesses. In terms of number of captives, Vermont is the largest U.S. domicile. Worldwide, Bermuda is the largest single jurisdiction, followed by the Cayman Islands.

As more companies revisit their captive programs, optimizing operations to make them fit for purpose can help reduce the amount of capital needed for captives. Organizations must carefully navigate risk, regulatory and tax considerations to achieve the optimal result. There are also several additional considerations and ramifications to evaluate.

1. Does the organization have the resources and expertise to set up the most optimal structure for their specific situation?
2. What are the potential cost savings compared to traditional insurance, and what are the trade-offs?
3. What risks should be placed on the captive?
4. What form of captive would be most advantageous for our business?
5. How will the captive be integrated into our overall risk management strategy?
6. What are the financial and regulatory requirements for setting up the captive?
7. How much capital does the parent company need to capitalize a new captive?
8. What coverages are struggling in the commercial market (premium increases, reduced limits, etc.)?

Ed Chanda is the national sector leader for insurance at KPMG U.S. He may be contacted at ed.chanda@innfeedback.com.

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