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The COVID-19 Pandemic: Opportunities and Implications for Captive Insurance

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The COVID-19 Pandemic: Opportunities and Implications for Captive Insurance explores the challenges presented by today's business and economic upheaval, as well as the hardening insurance market, and what it means for the captive insurance industry.

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Captives: Navigating Continued Soft Market Conditions

Dollar Road Sign-SF
May 01, 2017

Two recent reports released by Willis Towers Watson and Willis Re confirm the soft market conditions that have plagued both the primary and reinsurance property-casualty insurance markets have continued into 2017. This article provides highlights from both reports and some of our own commentary concerning this prolonged period of weak pricing in the insurance markets.

Highlighting the importance of the issue to captives, this editor just returned from attending a captive board meeting. Part of the discussion at the meeting revolved around the recent loss of several good members (low loss ratios) to external commercial competitors. This is a problem all group captives, including risk retention groups, face when market conditions are soft. Can the captive price its products low enough, especially for good risks, to stop defections back to the traditional commercial insurance markets? Part of the Willis Towers Watson report looks at the changing dynamics out of Washington, DC, from the new administration and asks, "Will the transformation at hand turn this long, soft market?"

We begin our review with Willis Towers Watson's Marketplace Realities 2017: The Search for Growth Spring Update. It begins with an executive summary concerning soft market conditions and then looks at several scenarios, which may impact the status quo. The following quote is from the executive summary.

When interest rates are low and insurer investment incomes suffer, premiums have traditionally risen to compensate. Historically low interest rates, however, have not budged the current soft market. The cause? The fluidity of global capital. In search of ROI [return on investment], investors have turned toward insurance, flooding the marketplace with capacity and keeping prices down. Even as insurer losses have edged upanother traditional source of upward pressure on pricesthe marketplace has remained stable and buyers in most lines of insurance have benefited.

Captive.com commented on the impact of low interest rates on captives last year and suggested, based on comments from Federal Reserve Chair Janet L. Yellen, captives needed to be prepared to ride out this problem for a longer time frame than many hoped for (see "Captive Insurance and the Federal Reserve"). One scenario contemplated in the report is that moves by the new administration could help revive economic growth and lead to higher interest rates. This would cause investors to reallocate capital out of insurance into more traditional investment vehicles. And, for a while this past quarter, that scenario seemed to be occurring. The yield on the 10-year Treasury reached 2.62 percent back in March. But that faster growth optimism has waned of late, and the 10-year yield has fallen back to 2.29 percentnot nearly high enough to cause the rotation out of insurance contemplated in the Willis Towers Watson report.

As for market conditions, the Willis Towers Watson summary highlights "a benign market in stasis." Pricing changes as reported by commercial insurers to Willis were less than 1 percent in the first quarter of 2017. The following chart is from the report and shows its predictions for 23 classes of business.

Comparison of Willis Towers Watson Marketplace Realities Market Trends

 
Pricing Expectations
Marketplace Realities Issue
2017* Spring Update*   2017* 2016 Spring Update
Decreases  10  10  9
Increases  6  6  8
Mix or Flat  7  7  5

* International coverage added as a separate line for 2017.
Source: Willis Towers Watson Marketplace Realities 2017 Spring Update

For captives, two of their major lines of businessproperty and general liabilitywere facing downward pricing pressures while workers compensation was mixed depending on the state in question. Three other lines of business captives participate incommercial auto, cyber-liability, and employment practices liabilitysaw price increases; however, for most captives, these are not major drivers of premium volume and therefore do not materially impact overall revenue. The report contains detailed analysis for each of the 23 lines of business. Captive owners looking for a break in the clouds for pricing are not likely to find it here. All of this suggests that those who own or manage captives must really understand how they are pricing their books of business, especially in these conditions. Two previous articles in Captive.com may be beneficial in this regard: "Getting Captive Insurance Pricing Right" and  "Insurance Pricing—A Key Concept for Captive Board Members."

Looking at Reinsurance Market ReportYear-End 2016, from Willis Re, concerning the reinsurance markets, the news is not all that different from the primary markets. From a pricing standpoint, 2016 was a challenging year and 2017 looks to be developing in much the same way. The bright spot for captives, however, is an abundance of capacity in the reinsurance markets and the capacity can be accessed fairly inexpensively. 

Here are the salient highlights from the Willis Re report on reinsurance:

  • Reinsurers' equity increased to $344.1 billion at year-end 2016 representing growth of 4.4 percent over year-end 2015.
  • Return on equity (ROE) in 2016 declined to 8 percent from 9.3 percent in 2015, driven by natural catastrophe losses, which is also reflected in net income.
  • While equity increased, net income for the industry declined to $26.6 billion from $30.3 billion in 2015.
  • The combined ratio increased to 94.4 percent at year-end 2016 from 91.4 percent in 2015.
  • Alternative capital (or insurance-linked securities) continued to impact markets climbing to $75 billion in 2016.

Looking forward into 2017, Willis Re commented:

In the remainder of 2017 [reinsurers] face the continued challenge of substantial excess capacity which has been further exacerbated by a USD 14.4B increase in shareholders' equity at FY 2016.

Reported RoEs [returns on equity] decreased further due to the return to a normali[z]ed level of global insured Natural Catastrophe losses. However, the impact on profitability was modest due to continued reliance on substantial reserve releases in addition to the one-off support provided by significant realized investment gains. Profitability also benefited from a reduction in insured Man-made Catastrophe losses to USD 8B compared to USD 10B at FY 2015. (Swiss Re Sigma figures).

Looking ahead, RoEs may come under further pressure if reinsurers are unable to sustain the quantum of reserve releases from which they have benefited in recent periods.

In closing, both the primary and reinsurance markets for property-casualty insurance continue to be under stress. For captives, this is a double-edged sword, where they will continue to be buffeted by pricing within their own books of business while enjoying lower costs associated with purchasing reinsurance on their risks. We believe these conditions still have some life and are likely to continue for several more years. Even if things improve before our prediction, the likelihood of a prolonged hard market is slim.  With the entrance of capital market players into insurance, the days of sustained hard markets appear to be over. 

Therefore, captives wanting to survive need to make sure they are pricing their risks correctly but more importantly providing additional services and features to members that commercial insurers are not providing. Competition solely on price is not going to be a winning option.

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