3 Issues That Potentially Threaten Captive Insurers

Three Exclamation Marks

July 08, 2019 |

Three Exclamation Marks

Captive insurer boards should be vigilant about surveying the environment to identify threats. Early identification and discussion around such matters can help a captive board determine whether future study and/or action is advisable or if the board will add the item to a watch list to be monitored. Following are three current issues with potential implications for captive insurers and a discussion of why it is important for captive insurance company boards of directors to be watchful about surveying the environment to identify threats.

Talent Acquisition

An April 2, 2019, Business Insurance article titled "Lockton, Alliant Battle over Brokers Reflects Wider War for Talent" describes the situation where Lockton Cos., LLC, charged Alliant Insurance Services, Inc., with hiring away 26 employees, and a similar number of clients, from Lockton's Denver branch. Judy Greenwald, the author of the Business Insurance article, suggests the underlying cause for the lawsuit is the brewing war for talent where broker skills are in short supply.

We have previously written about "the coming war for talent." Many captive insurers thought they would be immune from this problem; however, emerging information suggests nothing could be further from the truth. For instance, the website GreatInsuranceJobs.com, in The 2019 Insurance Industry Employment and Hiring Outlook Survey, states, "The insurance industry has [an] all-time record number of workers. 2.7 million now work in this industry, and this survey see[s] no signs of this slowing down. With an unemployment rate at 2 percent in the industry and 3.9 percent in the USA, finding skilled talent to fill openings is challenging companies and will only get tighter in 2019." A heading on the website summarizes the report as follows: "Record Insurance Industry Employment and Impending Retirements [Are] Creating Serious Issues for Employers."

The questions for a captive insurance company board are "What is your talent acquisition strategy, and how will you set your company apart from the thousands of other insurers actively looking to retain the same people in which you are interested?"

Cyber Insurance

Cyber insurance is the second of the three potential risks. A quick Google search of the phrase "why your captive should write cyber insurance" turns up a series of articles on the topic. However, a recent A.M. Best report titled Market Segment Report: Cyber Insurers Are Profitable Today, but Wary of Tomorrow's Risks should be required reading for all captive insurers. In the section of the report titled "Concerns and New Risks Continue To Emerge," A.M. Best states the following: "Cyber risk is unavoidable.… Cyber business interruption/continual business interruption is difficult to underwrite, even as demand for this coverage grows…. Although underpricing by new market entrants is an industry concern, a systemic event remains the top threat to cyber insurers' solvency."

Captive board members should be asking themselves the following: "Do we really understand our risk profile if we are writing cyber coverage? Is our product priced properly, and have we limited our exposure to both increased frequency and severity arising from this coverage? If not, do we have sufficient capital to handle the systemic event to which A.M. Best alludes? If not, what should we do?"

Interest Rates

The third and final issue concerns interest rates. By now, we believe many captive insurers have presumed the threat of continued low interest rates and low investment portfolio yields is a thing of the past. Yet, after the recent Federal Reserve Open Market Committee meeting, there is no assurance this is a correct assumption. On June 13, 2019, Kiplinger published an economic forecast piece written by David Payne and titled "Short-Term Rates Falling in Anticipation of Fed Rate Cut."

The opening synopsis shows why captive insurers should pay closer attention to this phenomenon:

Short-term interest rates are headed down because of expectations that the Federal Reserve will cut the federal funds rate next month. The Fed probably will lower the rate, at either its July 31 or September 18 meeting. The central bank wants to counteract the slowdown in manufacturing caused by the trade war.

The Fed could also cut rates in 2020 if an expected economic slowdown threatens to snowball. [Gross domestic product] growth should slow from 2.5 percent this year to about 1.8 percent next year, but could drop more if a US-China trade deal doesn't happen, or some other negative economic shock occurs.

While the likelihood of a half-point interest rate cut in July or September was significantly reduced as a result of the recent jobs report, a quarter rate reduction remains a possibility. For captive insurance companies, which recently saw their book yields turn up again after a sustained period of falling yields, this is not welcome news. While our crystal ball may not be accurate, especially in short-term interest rate environments, see more on future interest rate levels.

This article focuses on three specific issues, but there is a host of others that warrant examination and discussion by captive boards. If your board is not having such discussions on an ongoing basis, perhaps you should ask why.

July 08, 2019