Insurance News

Insurers lose out as firms do it for themselves

Posted on: October 3, 2011

LONDON (Reuters) – Insurers struggling with flat prices and paltry investment returns face an added headache as companies spooked by slowing economic growth and plunging financial markets increasingly opt to self-insure, diverting revenue from the industry.

Self-insurance, where a company buys protection from a specially-created subsidiary, or “captive,” is commonly associated with giant oil firms facing such potentially huge risks that no insurer can cover them at a reasonable price.

Also used as a cheaper alternative to regular insurance in many other sectors, captives are growing strongly, fueled by worries about insurers’ vulnerability to a potential second global financial crisis, as well as mounting pressure to cut costs, industry executives say.

“In many cases, the companies that are self-insuring are as big as the insurance companies they are placing the insurance with,” said David Ezekiel, chairman of insurance broker Marsh’s (MMC.N: Quote, Profile, Research) captive management division.

“From a credit standpoint, they trust their own balance sheets more than their insurers’.”

The main appeal of self-insurance is that it is usually cheaper, as captives have lower overheads than their commercial counterparts, and have no incentive to maximize profits.

They also offer companies transparency over their insurance costs, allowing them to predict accurately how a claim will affect future premiums. Many firms see this as a vital advantage at a time the outlook is clouded by a flagging economy and choppy financial markets.

“The general instability of everything economic at this point has driven the increase in interest in captives,” said Steve Chirico, an analyst at credit rating agency AM Best.

“There’s so much flux, and the companies are wondering what they can control.”


Hard numbers on the self-insurance sector are scarce, as captives are mostly based in low-tax offshore centres which rarely publish data on the companies they host.

According to industry publication Business Insurance, there were 5,617 captives worldwide at the end of 2010, up from 5,525 a year earlier.

But the best measure of growth in the sector is the volume of risk being transferred from the commercial market to established captives, insurance executives say, with anecdotal evidence pointing to big increases.

Companies are in particular turning to captives to cover emerging but increasingly onerous corporate risks such as employee pension liabilities and environmental pollution, after concluding that insuring them commercially is too expensive.

“We are seeing a trend of companies transferring risks such as personal accident, long-term disability and pension benefits within a captive,” said Malcolm Cutts-Watson, chairman of insurance broker Willis’s captives practice.

“This type of risk was traditionally purchased from the commercial insurance market.”

According to AM Best’s Chirico, no less than a third of the commercial insurance market has been diverted to the captive sector over the last 25 years, while Ezekiel of Marsh estimates the premiums foregone by mainstream insurers at “well into the billions.”

However, the blow to the insurance industry is cushioned by a steady flow of revenue back to the commercial market as captive insurers buy reinsurance to limit their risk exposure.

Growth in the captive market is also at the mercy of price fluctuations in the commercial insurance sector, with low prices on balance making companies less likely to self-insure.

One factor in the sector’s current growth is that companies are anticipating an upturn in insurance prices as the industry seeks to recoup record claims from the Japanese earthquake and other natural disasters in the first half of 2011.

“Now is a good time to be thinking about setting up captives and respond to a potential hard market before it happens, to close the stable door before the horse bolts.” said Charles Winter of reinsurance broker Aon Benfield.

(Reporting by Sarah Mortimer and Myles Neligan; Editing by Elaine Hardcastle)

© Thomson Reuters 2011. All rights reserved.

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