Captives' value rising as tools for resilience
Global pandemic. Economic volatility. A new “normal” for organizations in every industry. 2020 has been a remarkable year for emerging risks, and one of the early lessons is the need to enhance resilience. Captive entities, which have long been a reliable tool for financing and mitigating risk, are proving their worth as equally valuable tools for making organizations more resilient.
As the rapid emergence of the coronavirus pandemic has shown, preparedness for interruptions from future risk events will be increasingly important. As severe as the impact of COVID-19 is, other risks continue to raise concerns, such as cyber risks and energy disruptions. The need for resilience in the face of emerging risks has perhaps never been greater.
Captives offer a number of significant benefits in making their owners more resilient, including:
- Pre-loss funding. The ability to finance future losses through a captive offers considerable efficiencies, not least being a ready source of capital to pay for unexpected losses. Rather than using other funds on hand, or tapping credit facilities, captive owners can utilize assets held by their captive. While organizations have used captives for decades to finance stable, predictable risks, captives are potentially even more valuable in financing new and unpredictable ones.
- Mitigating volatility. As risk-bearing entities, captives relieve pressure on their owners’ balance sheets by insuring exposures to financial volatility. In addition, captives under certain circumstances, with regulatory approval, may serve as a source of cash if their owners’ cash flow becomes constrained. For example, businesses across many industries experienced cash-flow problems when public authorities ordered lockdowns during the coronavirus pandemic. Surplus built up in a captive can be distributed back to the parent to provide cash-flow relief or be deployed for greater risk assumption.
- Writing broader coverages. Captives provide flexibility in underwriting novel and traditional coverages on broader terms. In addition, captives also enable their owners to optimize access to commercially available coverages. When market conditions change, captives are able to scale up to assume more risk, evening out the cost of risk transfer. A combination of risk mitigation, risk assumption and risk transfer often is the most effective way to manage many unpredictable and emerging risks, including cyber.
- Direct connection to a supporting network. Key assets and at times a necessity for captives is their connection to a broader environment of risk expertise and service providers ; a captive owner does not need to worry about “going it alone” and finds tremendous value in partnership with a strong fronting carrier. Captives also have the ability to directly access reinsurance markets, a large and global source of capital. Captives can plug into insurance partners’ expertise in underwriting diverse risks, handling complex claims, and complying with regulatory requirements in different geographies. Fronting services, for example, can enable a captive to cost-efficiently expand its writings to increased geographies, customers, suppliers and even third parties.