Captives Are the Most Popular Method of Alternative Risk Financing

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April 30, 2019 |

A magnifying glass analyzes two cogs of a gear and reveals a red graph line with high and low markers ending in upward arrow

The 16th Annual Excellence in Risk Management report from Marsh and RIMS, the risk management society™, revealed that risk managers are operating in a data-rich environment that, when combined with growing alternative risk solutions, can result in more robust risk finance strategies and more resilient organizations.

However, a general lack of understanding of available alternative risk solutions and effective use of data and analytics hinder many risk professionals from harnessing the opportunities, according to the report, which revealed that 53 percent of C-suite and 30 percent of risk managers said they need to learn more about alternative risk transfer (ART) solutions.

The report found that 31 percent of organizations use or have used alternative risk transfer solutions, and, in the minds of some risk managers, ART solutions hold promise as creative and cost-effective solutions where "captives are often an integral part of an ART program, regularly used as a stepping stone toward other solutions."

After captives (78 percent), the next most popular forms of risk finance used by organizations were structured risk programs (33 percent), risk retention groups (27 percent), and integrated risk programs (26 percent), according to the report, which found that 52 percent of survey respondents who utilize a captive expect to expand its use into other areas in the future. 

While captives are the most well-known form of ART, the report noted that the key "difference between a captive and ART solutions—such as parametric coverage, [catastrophe bonds], or integrated risk programs—is that a captive uses a company's own capital, not a third party's."

The report also said that "the biggest key driver for forming a captive is to act as a formal funding vehicle to insure risk that is being self-assumed by the parent company." Captives also allow flexibility in accessing alternative risk capital, whose use, according to the report, grew by 9.2 percent in 2018.

Accessing alternative risk solutions can be difficult without utilizing an insurance vehicle, the report said. Often, companies use special purpose captives to access investors, allowing them to purchase tailored risk solutions such as catastrophe bonds and integrated insurance products.

Financing hard-to-insure exposures was the top benefit of alternative risk solutions cited by survey respondents (38 percent). The report revealed that captives are increasingly used for emerging risks such as wildfires, asbestos, and cyber liability. Captives also allow organizations to "diversify their risk finance portfolio."

Further, the report found that 69 percent of respondents that have looked into ART solutions plan on using them within 2 years. Marsh and RIMS believe that "if increasing numbers of organizations use their captives to access nontraditional risk capital, it could in turn help bring more ART solutions into the mainstream."

About half of C-suite respondents revealed that they lack understanding around how ART products work, compared with 18 percent of risk professional respondents. Accordingly, risk professionals said their greatest obstacle is explaining the benefits of ART solutions to others in their organization.

While the report cited cost as the main obstacle to using ART, it emphasized that "comparing the financial costs between ART products and traditional ones fails to recognize the full value of ART solutions. While the cost of the product is important, decisions to use ART solutions are often driven by the protection afforded to the organization."

The report also found that larger organizations are more likely to use ART solutions than smaller organizations due to the strength of their balance sheets and overall risk retention appetite. The report said that only 25 percent of respondents from organizations with $1 billion or less in revenue use, have used, or expect to use ART within the next 2 years. This compares to respondents from organizations with more than $5 billion in revenue, where 61 percent said that they use, have used, or expect to use ART within the next 2 years. 

While larger companies are more likely to use ART, smaller companies expressed a desire for more information. The report observed that "as alternative markets evolve, it's possible their products will become more relevant to smaller organizations."

The report also found that most risk professionals (47 percent) rank improving the use of data and analytics as their top priority for improving risk management capabilities. Data-driven modeling is critical, as companies need to compare traditional insurance against alternative solutions to clearly understand the value each provides, the report noted.

"By effectively marshaling data and risk modeling tools, organizations can better understand changes in their risk profiles and risk-bearing capacity, allowing them to access the opportunities presented by the growing levels of capital available for risk finance," said Brian Elowe, North American chief client officer with Marsh.

Of interest is that risk professionals and C-suite respondents differ on how they think their organization would best benefit from improved use of data and analytics. Risk professionals cited informing decisions on specific risks, while C-suite respondents cited informing the overall business strategy.

The Excellence report, Strategic Risk Finance in the Era of Big Data, is based on more than 600 responses to an online survey and a series of focus groups with leading risk executives in January and February 2019.

April 30, 2019