What five challenges do companies face transitioning to captives?

Only 5% to 6% of global captives are headquartered in the region.

With over a quarter of the world’s commercial insurance market rooted in captives, this traditionally niche market is garnering significant attention and investments.
This is not to say, however, that these are easy pickings. Swiss Re Corporate Solutions has outlined five challenges to maintaining captive insurance.

Captive insurance represents 25% of commercially sold insurance and thus appears in nearly every Fortune 500 firm, EY said in their 2024 Global Insurance Outlook report. In 2022, global premiums written through captives amounted to $176b.

Specifically, only 5% to 6% of the 6,000 captives globally have parents headquartered in the Asia Pacific (APAC) region, in stark contrast to the 86% share from Europe and the United States, Swiss Re Corporate Solutions said in an insight.

Given that 40% of Fortune 500 companies are headquartered in Asia, the region is considerably underrepresented in the captive insurance market, indicating significant potential for growth.

“The captive insurance market has certainly seen impressive growth over the past few years. And whilst the APAC region is still underweight both in terms of captives being domiciled in the region, as well as captives with parents headquartered in the region, we have seen also some development here,” Andre Martin, head of Innovative Risk Solutions for APAC at Swiss Re Corporate Solutions, told Insurance Asia.

In such an environment, traditional insurance premiums rise, prompting risk managers to seek more control over their insurance programmes. By establishing a captive, companies can retain a greater portion of their risk, reducing their dependence on conventional insurance providers and mitigating the impact of premium volatility.

“Out of the 7,000 captives across the world, only 6% have parents from the APAC region, which is certainly less than global GDP figures would suggest. Now looking at the drivers behind this increased interest, traditionally one of the main catalysts for corporations to think about captives is obviously the hard market, which forces risk managers to rethink their retention strategies and to take more control over their insurance programmes, rather than being pure price-takers,” Martin said.

Whilst the hard market is not the sole catalyst, the insurance landscape is undergoing profound disruption due to climate change – signalling a shift from physical to intangible assets, economic uncertainties, and geopolitical tensions.

These factors compel risk managers to reassess and future-proof their insurance strategies.

Traditional vs captives

Traditional insurers have had to adapt to the rise of captives, which now divert hundreds of billions of dollars in premiums annually. Whilst this shift represents a challenge, it also opens new opportunities for collaboration.

“With corporations taking more control over their insurance programmes and retaining more risk, captives have become an active player in the reinsurance market,” Martin told the magazine.

“So some of the risk transfer has shifted from the insurance level into the reinsurance market. And whilst more premium will be retained by the captive and diverted from the traditional insurance market, there is still a lot of added value that commercial insurers can provide, both in terms of risk transfer solutions and services,” he added.

Economically, captives enable companies to retain underwriting profits and investment gains in-house, rather than passing these benefits to third-party insurers. This retention can lead to significant cost savings and enhanced financial performance.

“Another argument that is becoming increasingly important is the ability to use the captive as an incubator and fund non-insurable risks. In a corporate world that is moving from an asset-heavy to asset-light, new risks are emerging for which the commercial market has little or no appetite (eg. Cyber, NDBI, supply chain or reputational risks),” Martin said.

“Here a captive can pool and warehouse these emerging risks, or act as a transformer, retaining the risk on group level and thereby shielding the BUs who are not capitalised to assume exposure,” he explained further.

Also, captives promote a culture of loss control and prevention through internal incentive schemes, ultimately improving the overall risk quality of the organisation. 

The centralised management of exposures, premiums, and losses provides a comprehensive view of the company’s risk landscape, facilitating more informed decision-making across the business.

Challenges

The APAC region, despite its economic significance, remains underrepresented in the global captive insurance market. 

“Apart from a general market maturity or ‘education gap,’ I think one contributing factor is that our region is very diverse, leading to a fragmented regulatory environment,” Martin said.

One reason is the fragmented regulatory environment across the region’s diverse jurisdictions. Unlike the more harmonised regulatory frameworks in Europe and North America, APAC presents a complex landscape for captive formation and operation.

“But having said that, the region is changing and adapting: the key hubs like Singapore, Labuan and Hong Kong are increasingly active in attracting captives into the region by adjusting their regulatory frameworks, making captive formations easier and cheaper and allowing for more structural flexibility,” said Martin.

Whilst captives offer numerous benefits, industry players must bear in mind the following challenges:

1.       Capital Requirements: Initial capital injections are necessary, diverting funds from other business investments.

2.       Risk of Claims: Adverse claims can erode capital, despite reinsurance programmes designed to mitigate these impacts.

3.       Operational Costs: Running a captive incurs administrative, legal, auditing, and licensing expenses.

4.       Regulatory Burden: Varying regulatory frameworks increase the complexity and cost of compliance.

5.       Exit Strategies: Corporations must plan for possible exit strategies, which can be costly and complex.

Captivating industries

Captive insurance is finding traction across various industry sectors, from energy and pharmaceuticals to food and beverage and manufacturing. Industries with unique exposures or capacity needs — such as product liability for new medications or natural catastrophe coverage — particularly benefit from the tailored solutions that captives provide.

“Having said that, there are occupancies that have specific exposures or capacity requirements where the commercial insurance market is lacking to provide adequate solutions. Examples would be product liability for new medications, emerging risks like supply chain or reputational risk, or simply a capacity crunch in NatCat cover,” Martin explained.

Looking ahead, the captive market is expected to continue its positive trajectory, with increasing activity and visibility in the reinsurance market.

“Apart from the classic captive fronting and captive protection solutions mentioned, we see quite some interest in alternatives to the classic single parent captive, and one of them is our Virtual Captive concept [...] It is an alternative for those companies that have decided that a captive would be the best solution for their insurance needs, but for a range of reasons do not want or cannot set up a captive. Essentially the company is using the insurer's balance sheet as their captive,” Martin said.

Captives are likely to play a more significant role in managing emerging risks, such as cyber threats and human capital protection.

It will also become more active in the reinsurance market, leveraging parametric solutions and alternative capacity sources.

“One trend we also see is that captives are not only used to cover physical assets, but also to protect their human capital by funding and retaining Employee Benefit schemes in-house,” Martin told Insurance Asia.

“Last but not least, depending on the domicile and regulatory framework, captives can also expand their mandate to become a profit centre by underwriting third-party business, thereby creating an additional revenue stream. Usually, such third-party business is EB or extended warranties for suppliers or customers, in line with overall business strategies,” he added.