AM Best has observed an uptick in the use of existing captives in response to the hardening market conditions

AM Best has observed an uptick in the use of existing captives in response to the hardening market conditions, as owners seek optimal risk transfer solutions.

Several captives have increased retentions or limits on existing cover, as well as expanded into new lines of business as their parents have looked at increasing captive utilisation.

There has also been a change in strategy among some parent companies which used their captives selectively and sparingly in the soft market.

In the hardening market, captives have become central to the insurance buying process of some of those parents. In some cases, this has led to a reorganisation of departments in the parent company, to ensure the full integration of insurance and reinsurance purchasing decisions and captive management.

While the hardening market provides opportunities for captives to demonstrate their value, it also presents challenges, notes the rating agency.

Reinsurance capacity constraints

Captives, even those with good claims records, are therefore likely to face price increases for their reinsurance programmes in the 2023 renewals. Capacity, however, remains available. In a truly hard reinsurance market, such capacity may become much more limited.

AM Best notes that most captives have long-standing and strong relationships with their reinsurance partners, which helps mitigate the risk of capacity withdrawal.

The inflationary environment, combined with supply chain disruptions, is also presenting challenges for (re)insurers in terms of both claims and expenses. It can take some time for the impact of general inflation to be reflected in claims trends, but (re)insurers have started to report inflationary effects on claims costs in the second half of 2022.

In response, they are seeking premium increases to offset this, as well as reviewing deductibles to ensure that they will not retain more low-severity losses than anticipated when these deductibles were originally established.

Captives will also need to review deductibles and limits to ensure that they remain at the right level relative to updated asset values and estimate maximum loss amounts. The premiums that captives charge for their cover is expected to increase as well, considering the increased market reference price.

Finally, sanctions compliance also came to the fore in 2022 amid restrictions imposed on Russia and certain of its allies. Commercial insurers and captives alike have been quick to take action in response, cancelling contracts that fall within the scope of these sanctions.