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4 Captive Insurer Resolutions for 2018

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January 10, 2018

Captive.com recently came across the following article in the Economist: "The Origin of New Year's Resolutions." The story traces the history of New Year's resolutions back to the ancient Babylonians. This new year, as in many past, millions of people will resolve to accomplish a personal goal, make certain lifestyle changes, or eliminate bad habits. In that spirit, Captive.com has created a series of New Year's resolutions for captive insurers. While the narrative is intended to be somewhat amusing, please consider taking some of these suggestions to heart and potentially adopting them as resolutions for your captive insurer in 2018.

1. Survive in a Low-Interest-Rate Environment

Much has been said about the low yields on bonds and their implications for captive insurers. Today, most captives are well aware of the loss of interest income from their investment portfolios resulting from the low-interest-rate environment. While most have weathered this storm to date, holding out hope for an increase in inflation, and therefore in interest rates, is a countervailing argument. 

Greg Ip's January 3, 2018, Wall Street Journal article titled "A Hedge-Fund Titan Puts Away the Punch Bowl" concerns the prognostications of Ray Dalio, the founder of the hedge fund Bridgewater Associates, Inc. Mr. Dalio is known for his calls on the economy that have minted some very sizable investor returns in his funds. The article reported that, looking ahead, Mr. Dalio believes the United States will see "years of low interest rates …" and "… returns to a typical stock-bond portfolio over the next decade will be around zero after inflation and taxes."

While Mr. Dalio may be incorrect, clear-sighted captive managers and board members should consider how his prediction would impact their captive and consider the following.

  • Does your captive rely on income produced from the investment portfolio to mitigate premium increases?

  • Is investment income used to offset general and administrative expenses?

  • If investment income stays flat or declines, what changes would be necessary in order for the captive to continue to operate in a fiscally sound manner?

If Mr. Dalio is on target, preparation is a smart bet.

2. A Benign Catastrophe Loss Year

Just before the end of 2017, Captive.com published the article "2018 Reinsurance Outlook for Captives." At the time, we noted that reinsurance is an integral part of the risk management function for most captive insurers. The Swiss Re Institute's white paper "Global Insurance Review 2017 and Outlook 2018/19" stated as follows.

The multitude of large natural catastrophic (nat cat) events—Harvey, Irma, and Maria, earthquakes in Mexico, and wildfires in California—in the second half of the year have drained capital out of the re/insurance P&C sector. Price increases in loss-affected segments are already happening and could be substantial. The ultimate volume of losses is not yet known, but it will likely be large enough to cause price rises beyond the affected sectors/regions where profitability has already been under pressure due to low prices (such as in motor and some commercial lines). Given the amount of traditional and alternative capital losses, property reinsurance prices could rise significantly.

While reinsurance rates definitely firmed for January 1, 2018, renewals, rates did not increase as much as had been feared. Willis Re reported that global prices rose by 7.5 percent, while JLT noted an increase in property/cat rates of 4.8 percent. Prices were held in check by competition from the capital markets as new cat bond funds were launched and private equity managers helped support traditional reinsurers by purchasing equity either in the open market or through private placements.

As a result, captives with reinsurance facilities renewing on January 1, 2018, can breathe a sigh of relief. However, should 2018 turn out to be as bad or worse than 2017, reinsurance pricing is likely to become a lot more difficult as investors decide returns need to rise to compensate for the risks. Captives would be wise look at whether they can lock in rates for contracts in excess of 12 months as a hedge against rising rates. Discussions on whether your captive can access the capital markets are also warranted.

3. Understand the New Technology Landscape

The Captive Insurance Companies Association Conference in 2017 featured a presentation on the role of analytics in captive optimization, prompting the Captive.com news article titled "Big Data—What Captives Need To Understand." Technology developments that impact the entire insurance value chain continue to be announced. As a recent publication from Conning & Co. succinctly puts it, "A key target today is effective use of data with predictive analytics applications. The focal point for insurance technology has moved beyond processing transactions to generating insights."

Captives may understand this concept in terms of an arms race where they face distinct disadvantages. These include, but are not limited to, the following.

  • Insufficient internal data to effectively utilize predictive analytics

  • A lack of both monetary and human resources to participate in the process

  • A potential conflict of interest inherent in dealing with bigger service providers such as fronting insurers and reinsurers who are already pursuing this technology           

Ultimately, an effective clearinghouse for pooling and sharing data is needed that would ideally be organized by one or more of the captive insurance associations. However, at present, many captives believe their data provides a competitive advantage and are reluctant to share it with others. What better year than 2018 for captives to recognize the critical need to participate in this new data world?

4. Win the War for Talent

Acquiring and keeping quality talent is another theme, explored by Captive.com in articles such as "What Is Your Captive's Talent Acquisition Strategy?" and "Captive Insurance Talent War." However, 2017 brought this issue into sharper focus as multiple industries and companies started to report on their inability to attract and retain professionals. With an unemployment rate hovering around 4.1 percent and the ongoing retirement of the baby boomers, these trends are likely to only exacerbate the problem.

While many organizations have excellent internal human resources and have not experienced problems to date, the question is whether this condition will remain true in the future, and if so, at what cost to captives. Wage inflation has been extremely muted to date, but there are signs that this trend is waning. Captives should consider their current talent, from an expense standpoint, and their ability to retain this talent in the event wages start to increase rapidly. What other options are available to retain these professionals? Have these issues been discussed at the management and board levels?

These are just a sampling of possible captive insurer New Year's resolutions for consideration. Captive.com wishes all captives a happy and prosperous 2018 no matter which resolutions they decide to make—and hopefully keep.

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