The risk management community is considering the threats posed by new and emerging risks. One potential solution being discussed is deploying captive underwriting capacity.

Captives are currently often employed to supplement insurance which may have inadequacies, thus covering existing gaps in insurability. Using captives for emerging risk is therefore a natural evolution, although various challenges present themselves.

In this Insight we will lay out:

• What advantages can be captured by underwriting expansion?
• What risks might be considered, and what are the decision criteria?
• A process for design and implementation

Motivations

Firstly, why consider diversification to cover a broader range of perils outside of core conventional covers, which for Professional Service Firms tend to be Professional Liability and Cyber?

As threats evolve the Enterprise Risk Management response needs to be considered. Risk financing is part of that.

• There may be a limited commercial insurance market for new and emerging risks, but an insurance proposition can be designed.
  
  
• Adding additional risks to an established captive creates an increased spread of risk and may thereby deliver diversification and capital benefits.
  
  
• Consideration of new underwriting should stimulate an exercise in risk identification and assessment.
  
  

Other motivations for increased captive use may include:

• Provision of comprehensive cover to supplement commercial cover or fill gaps. Reinsurance can be purchased to reduce the net risk retained and a form of Difference in Conditions underwriting results.
  
  
• As a front for back-to-back commercial capacity to promote consistency of purchase or cover. Commercial cover and pricing are replicated. Local fronting may be required.
  
  
• Utilize advantages of a global risk pool. Best used perhaps for long term and more predictable risks, employee benefits is one example. The captive becomes the pooling mechanism.
  
  

Having identified candidate risks, tests can be applied to shape decisions around whether to proceed, and the shape of any cover. The captive financial structure, ownership and purpose are all key factors as to what is desirable and feasible.

Implementation Steps

Step 1 – Risk Identification

Risks can be identified by accessing one’s own data and external resources such as surveys. A roundtable or risk workshop can be used to identify the key new and emerging risks facing the organization, and the degree to which risk financing can be designed. Canvassing entities insured by the captive for their views is clearly valuable.

Risks may be identified where insurance cover exists in the market but has gaps or deficiencies. One such category might be a wide range of business interruption risks.

Thus, two broad categories emerge:

• Risks that have insurable characteristics but are not conventionally insurable.
  
  
• Risks where gaps and deficiencies exist in insurance covers.
  
  

Step 2 – Design Process

Borrowing from design thinking techniques, three key questions follow:

• Desirability - Is there sufficient need or demand for the cover?
  
  
• Feasibility - Can the coverage be articulated, defined in policy language, and priced?
  
  
• Viability - Would the designed cover respond to the risks faced, and be sustainable and adaptable to changing conditions?
  
  

Step 3 – Underwriting Strategy

Risks and the scope of policy cover are thus identified for consideration, along with the triggers.

Underwriting questions then emerge, such as:

• How to price? Is there historical data, or can data be accessed?
  
  
• In the absence of sufficient data, how can one proceed?
  • Create scenarios to assess frequency and severity. Possibly feed the scenario results into a model. Consider average and adverse outcomes.
    
  • Access any suitable external data to support the model. Consider the aggregation potential.
    
    
• Is commercial support desirable/available? Is there coverage or pricing guidance to build on? Specialist insurance markets exist to support creative approaches.
  
  
• Should cover be on a named perils or “all risks” basis? Take reputation risk as an example: it could be defined as arising from specific defined sources, or from any event that generates negative publicity and financial loss (parametric approach).
  
  
• What net risk should be retained? Would the captive write the risk, seek to transfer where desirable, or merely front for commercial insurance if available?
  

Building to Maturity

A strategy that begins with underwriting gaps in current covers or uninsured emerging risk exposures can then incorporate other objectives such as hedging future market movements in cover or price.

Further expansion may evolve based on the experience, demand and risk appetite.

These steps build a foundation. There is still much work to be done but a strategy and the framework for a project plan have been established. Key considerations will build through the process depending on the extent of new underwriting and the ability to retain net risk.