If 2020 and 2021 showed us anything, it’s that the unexpected can and will happen — whether it’s a global pandemic, a cargo ship blocking one of the world’s busiest trade routes or a storm creating a widespread power outage. These unforeseen risks are difficult to predict and insure against, which made captive insurance, with its ability to write broad coverage and fill gaps in coverage, a useful tool.
Combined with the hardening of insurance markets, this is one of the reasons the pace of captive formations has increased. According to the 2021 Captive Benchmarking Survey from Aon, there has been sizeable growth in captive ownership. As business owners and leaders consider 2022, they should take into account these five trends when developing a robust risk-management strategy.
1. Key industries most likely to see growth in captives
Over the past two years, some industries in particular have been severely impacted by growing supply-chain risks and pressure. For manufacturers, disrupted operations had financial consequences due to supply-chain barriers, workforce availability and slowed demand. According to the 2022 Manufacturing Industry Outlook by Deloitte, manufacturing is expected to grow; however, the report cautions that ongoing risks lay ahead like labor shortages and supply-chain instability as leaders fend off disruption. Perhaps this is why, in the past, manufacturing has topped the list of the Global Risk Management Survey’s industries utilizing captive insurance. Like manufacturing, construction has also proved a key industry for captive utilization, ranking number two.
There are a number of threats that can devastate or bankrupt a construction business. Natural disasters or weather can impede completion of a project, a construction defect may lead to building failure, or there could be property damage, human injury or liability associated with negligence. There is also the threat of equipment damage, theft or a seasonal slow down. Covid-19 has introduced additional risks as companies grapple with supply-chain barriers and worker safety.
Lastly, the distribution industry and technology companies may see, and benefit from, increased use of captive insurance. Distribution companies face a myriad of risks leaving them vulnerable to losses and eventual bankruptcy, and according to a 2020 analysis by McKinsey & Company, warehousing and transportation for the distribution industry rank high in terms of taking longer than five years to see a return to normalcy. Accelerated technological advances also pose risks. In particular, robotics has opened businesses up to the potential for product liability claims and manufacturing defects from defendants seeking damages. This risk of technological-related lawsuits is a reason technology companies may see increased use of captives.
2. Captives proved beneficial in covering Covid-related losses
Covid-19 was an eye-opener for many businesses that thought their commercial insurance would cover losses in the event of a pandemic — only to find gaps or exclusions that led to claims being denied. The same was true for business-interruption insurance, which often fell short. With new variants hitting, and countries announcing new or extended travel rules, industries are still suffering.
For businesses with captive insurance, this financial strategy came to the rescue as they saw their Covid claims paid or were able to use their captive-insurance-company-accumulated wealth to weather the storms. For example, a physician practice in Alabama had to condense its operations to only emergency patients, going from 200 surgeries per week to fewer than 12. The basis of the claim was a dramatic reduction in revenue due to Covid-related state mandates. Having the claim paid allowed the practice to continue operations and offset the revenue loss.
3. A 2021 supreme court victory paves the road for captive insurance
The IRS has notoriously targeted captive arrangements and designated a majority of small captives as “transactions of interest,” including them on their annual “Dirty Dozen” list of abusive tax avoidance. However, during 2021, there were two major court victories for captives in a case against the IRS. CIC Services sued the IRS over its unlawful notice 2016-66. In 2021, the case went to the U.S. Supreme Court, where CIC Services triumphed unanimously against the IRS. In September, a U.S. District Court granted CIC Services an injunction against the IRS and notice 2016-66.
With the support of legal scholars and publicity from the case, implication in 2022 is that captive insurance can be increasingly seen as a strategy to benefit businesses without the threat of backlash from the IRS.
4. The hardening of the insurance market will continue with captives to the rescue
In the Global Economic and Insurance Market Outlook 2022 by Swiss Re, record premiums are predicted and expected to grow by 3.3%. Businesses can expect an increase in premiums due to increased claims activity, the continued pandemic and inflationary pressure. For employers offering employer-based health care, premiums are expected to increase 6.5% in 2022 according to an annual report published by PricewaterhouseCoopers.
One way to control premiums and collect the profit (after claims are paid) is through a captive insurance company. As rates continue to increase, it will further motivate businesses to pursue this route.
5. Companies will utilize their captives to cover cybercrime
As cybercrime continues to become more sophisticated, attacks are forecasted to increase. The Identity Theft Research Center (ITRC) says 2022 could be a record-breaking year for cybercrime. A cybersecurity breach can decimate a business and be costly. Thus, organizations will look for ways to prevent business disruption. A Market Segment Report from A.M. Best examining trends in the universe of best-rated captives noted that cyber risk has become a profitable line of coverage for captive insurance companies. The report cites cyber risk as one of the fastest-growing lines for captives that is generating “exceptional results” for the alternative-risk transfer vehicles.
The past two years have been tumultuous for the marketplace, and 2022 is expected to be no different. As inflation surges, consumer confidence will be impacted — in November the consumer price index (CPI) was up 6.8% from the previous year, the biggest 12-month jump in nearly 40 years. And according to Goldman Sachs, economic growth is forecasted to slow in 2022. With this in mind, and businesses now understanding the potential for unpredictable, widespread and severe events, risk management is critical. For businesses with captive insurance companies, or those considering it, taking into consideration expected trends can help define how the captive is best utilized to not only mitigate risk, but also control costs and ultimately boost profit.
Source: Entrepreneur
