"Possessing a captive insurance company: A genuine strategic interest"

Cyber-crime, damages, reputation: The number of risks facing companies today has never been higher.
 
Among the tools available to risk managers to counter them, one stands out: the "captive insurance company". A captive insurance company consists of a reinsurance company established by an industrial or commercial group, with the specific objective of covering the risks to which its parent company is exposed. What are the benefits of this type of tool? Or the obstacles to take into account while implementing it? Yannick Zigmann, Managing Director of Risk & Reinsurance Solutions (2RS), number three in the captive insurance market in continental Europe, explains.

What is the usefulness of a captive insurance company?

In every business, there are a number of risks that represent a significant financial impact but cannot necessarily be transferred to the insurance market. This is the impetus for the idea to create a reinsurance company. Why talk about reinsurance? Because reinsurance is more flexible than insurance. It consists of outsourcing the administration of that subsidiary to a “captive manager” that will make available all the necessary tools for the operation of this company, whether administrative, accounting, or insurance-related technical issues.

Overview

2RS

Risk & Reinsurance Solutions (2RS) currently manages some fifty captive insurance companies in its portfolio, which makes it third in the market in continental Europe. In addition to its registered office in Luxembourg, 2RS has two subsidiaries located in Zurich and Malta, as well as a network that allows it to have a presence in the sector’s principal locations of operation. A partner of Siaci Saint Honoré, a French leader in industrial risk consulting, 2RS is part of the LCF Rothschild Group.

What risks does it allow to be insured?

There are three types. First, the risks insured or those for which the captive manager will verify whether it can do better than the market and determine a point at which it makes sense to take on some of the risks insured.
 
Then, there are the uninsured risks, for which there are products that can be considered in terms of client needs, not insurance cover without excess, but at a certain level. Take the case of credit risk: A company knows 80% of its customers well, and would like to insure only the remaining 20%. By setting up a captive insurance company, the business can self-insure against the real risk posed by its small customers, and purchase excess protection on the market at a rather low price.
 
Finally, there are uninsurable risks such as problems related to fraud or branding. To give a concrete example, we recently established a captive for a company operating in the logistics sector, which has to organise its warehouses based on the needs of its customers. The departure of one of them may involve a significant risk, particularly in terms of restructuring costs, for which there is simply no policy on the market. This is the kind of situation for which we build custom solutions, together with the risk manager or the company's CFO.

 

 
 

The immobilisation of a fleet of aircraft on the tarmac: an example of a particular risk that can be covered by a captive insurance company.

 

Who is this type of tool for?

To set up a captive, you need a revenue of at least 100 million francs, and for the company in question to make benefits. Because a company that is desperate will tend to buy the maximum amount of insurance and will not have the means to create their own operation. Our clients include mainly large family companies and mid-cap companies active in the energy, aviation, and railway sectors.

 

Reinsurance by captives is often perceived purely as a tax strategy. Is this assessment justified?

No. In addition, in the countries where we operate, namely Luxembourg, Switzerland, and Malta, the authorities do not see captives as fiscal optimisation solutions. It is a genuine risk management tool that allows the identification of the reserve that we will allocate to pay a claim, and with beneficial fiscal conditions. If you put a million aside over five years and then you suffer a loss, you can spend that million, whereas if you put the same amount in your accounts, with a 20% tax, you will only retain 80%. It’s true that there is a fiscal advantage, but it's related to technical insurance provision rules. It is also true that the subject of captives is also a bit of a secret, because it is a strategic tool that aims to settle claims and to protect the company's balance sheet. A company that has adopted such a vehicle does not necessarily want to communicate the weapons it uses to its competitors.

 

What are the benefits of the establishment of a captive?

The first advantage is to appear as a partner to the insurer. This allows you to work with this insurer over the long term, while influencing rates. But when you have a captive, the discussion you have with your insurer is not limited to prices, it also guarantees the option of choosing a partner based on the quality of its services. Another advantage is that you will benefit from risk management performance to make provisions and consequently finance the risk that you could not pay yourself before. Finally, the establishment of a captive also allows people in charge of risk management to have another counterweight within the company. Having a captive represents a real strategic interest. In some cases, it can even sustain the company's commercial development. For one of our clients operating in the retail sector, we devised a series of guarantees to sell to their customers. While it started as a risk management tool, it has now become one of their sales driving products.

 

And what are the disadvantages? The fact of having to immobilise funds?

No, because you will be able to partially manage these funds in the form of intra-group loans, there is some flexibility on this. So I do not know if there really are disadvantages, but it’s true that this is another form of risk management. This means changing habits. There is also the aspect related to the image of the captive, which is associated with financial secrets and tax havens. Take a French company like EDF, which had to create a captive, as did all of its competitors active in the nuclear sector, simply because that capability does not exist on the market. This caused a scandal when the media talked about its captive in Luxembourg, while in reality it was part of a sound risk management strategy.

 

What is the state of the captives market right now? How will it grow?

Between 2008 and 2012, we saw that the captives were growing at a slower pace, because with the financial crisis, parent companies needed more cash. But now the interest in them is making a comeback. For two years, we have seen three captives created per year, whereas before we had only one. My colleagues have seen nearly the same rate.  That’s a lot, because in the world of insurance, we play a role that’s a bit similar to an artisan.  So there is a real recovery in the creation of uninsured or uninsurable risks, with smaller companies as well.  

 

 
Yannick Zigmann
CEO - Risk & Reinsurance Solutions (2RS)
Article published in july 2016