Captives in EMEA and North America: Adapting to Grey Swan Risks in a Hard Market

8 July 2021

Vincent Barrett, Regional Managing Director for Aon’s Captive and Insurance Management business in EMEA, and Nancy Gray, Regional Managing Director for Aon’s Captive and Insurance Management business in the Americas, share their perspective on the way clients in these regions responded to the pandemic in hard market conditions, and what this means for captive strategies going forward.

The last 18 months have proved formative for enterprise risk management (ERM) strategies around the world, with lessons from the pandemic as well as wider pricing changes in insurance sharpening the focus in EMEA and North America on effective and cost-efficient risk transfer strategies.

Before we delve into the details of these trends, it’s worth holding a mirror up to reflect on how insurance buyers in the EMEA and North American regions responded to the global pandemic from a risk management perspective.

Overall, a high number (82%) of respondents across global industries did not include pandemic among the top 10 risks in their organisations’ risk registers prior to COVID-19, according to the results of Aon’s global COVID-19 Risk Management and Insurance Survey¹

There was slightly more of a sense of unpreparedness in EMEA than North America - the survey showed that 73% of respondents in EMEA reported that they did not have a pandemic plan in place, against 69% of respondents in North America. The global benchmark was 69%.

Interestingly, 36% of EMEA respondents to the survey did not think the pandemic would accelerate a review of their ERM process, while North America had the lowest number of respondents indicating that they would review ERM processes (25%).

This ties in with what we are seeing on the ground in both regions in respect of a disconnect, where there is a need to fully recognise and appreciate the link between enterprise risk management and resiliency. Much more could be done to learn lessons from the pandemic response and apply them to future scenario plans.

Risk pricing: captives are becoming more relevant

Above and beyond future planning for ‘grey swan’ events like pandemics, corporate insurance buyers in EMEA and North America have also faced the new normal of hard pricing in many lines.

The prolonged soft market that existed until around two years ago meant that it made more sense from an affordability standpoint for companies to use the commercial insurance market for most risks, with captives used to manage additional capacity that was not available in the market.

Hard market conditions have changed that perspective and are sharpening companies’ focus on the value and cost of their insurance programmes.

In North America, for instance, certain property market risks such as wildfire coverage are either very expensive or there is simply no capacity, prompting clients to explore captive retention strategies for their property programs or using the captive to access additional capacity in the reinsurance market to fill gaps in coverage.

Exclusions are also playing an increasing role in driving demand for captives. Insurance buyers thinking about how best to structure insurance programmes are now looking to factor in aspects around pandemic risk, but are finding specific claims related to pandemic impacts - for instance business interruption - are now being excluded.

This is comparable to the insurance industry’s reaction post 9/11, which saw almost blanket terrorism exclusions added to policies in its wake.

These dynamics are placing more focus on the strategic benefits of captive insurance programmes - both as a means of filling gaps in insurance coverage where insurance has become unaffordable, as well as a way of ensuring there is an appropriate back-stop in the event of another global grey swan event where traditional coverage for such an event, for instance pandemics, is increasingly being excluded.

Responding to evolving trends

There is a consensus that EMEA and North America could do more to better integrate corporate risk and insurance activities in the future. Companies in both regions are horizon-scanning to determine what the future risk landscape looks like.

In terms of ERM planning going forward, the Aon survey revealed that geopolitical tension ranked higher in the US than on average globally, reflecting ongoing trade disputes with China as well as domestic political unrest. Similarly, US companies ranked major cyber events higher up on the list of risks, with a higher volume of breaches and related costs than in other regions.

North American organisations were more attuned to the possible impacts of a major cyber event, rating it their third most significant concern/future shock, which is higher than in other regions.

Meanwhile, organisations in EMEA indicated that the new use of technology was their top priority when asked how they would maintain or increase their revenue.

Companies in EMEA, however, were more concerned about climate change as a major shock when compared to other regions, which may be a function of concern over the impact on their supply chains and increased corporate scrutiny from consumers and investors.

Planning for Grey Swans

Pandemic risk was ranked as one of the least important risks in Aon’s 2019 Global Risk Management Survey (coming in at 60 out of 69 risks). We think it’s clear now that pandemic risk should rank in the top 10 – and the 2021 results which will be published later on this year should tell a different story.

With ongoing hard market conditions combined with tightening coverage available in the commercial market, however, organisations may find it difficult to purchase the level of cover they need for risks like pandemics in a way that is cost-efficient.

There are several benefits to having captive control over programmes for grey swan events, not least the control over the data used to assess the risk - enabling companies to really get to grips with the risk from their unique perspective, and to have this data at their fingertips should they wish to take the risk to the commercial market in the future. Having this data when negotiating with insurers is an advantage to ensure they get industry-leading/competitive cover for industry-leading/competitive price when compared to a company that does not hold sufficient data.

Captives also allow companies to centralise control over an insurance programme across a global business - and this can be particularly efficient when assessing the risk of extraordinary low frequency, high severity global events such as the COVID-19 pandemic. A captive allows companies to centrally control not only purchasing but also to absorb different limits and conditions across various operating locations.

In addition, the option to deploy captives has the benefit of providing a company with leverage against which to encourage an insurer to sharpen their terms and conditions for commercially placing the risk, as they know their potential client can retain the risk themselves if the wordings and terms and conditions in the policy do not satisfy the insured.

Horizon scanning

Looking ahead to the grey swan risks on the horizon, it seems that for many possibilities - and in particular risks like climate change - there is an increasing focus on risk reduction and risk improvement behaviours.

Aligning these behaviours to a desired outcome is key to measuring risk reduction. Captives provide a business with a mechanism to align interests - sharing the risk and the potential losses associated with that risk achieves this in a transparent, controlled and regulated way.

As such, risk managers should consider exploring a captive insurance programme as a way to more efficiently and effectively transfer these types of ‘grey swan’ risks over the long-term.

To read the full findings from Aon’s COVID-19 Risk Management and Insurance Survey, click here.