Captive market grapples with COVID-19, new opportunities for utilisation

That was the message from a panel of expert speakers in an Airmic Live broadcast on 22 June. Airmic's Richard Cutcher was joined by Ciaran Healy, of Aon, Jenny Coletta, Partner at EY, and Paul Corver, Group Head of M&A at R&Q, to discuss how captives have responded to the pandemic and how their future use will evolve as a result.

You can watch the full Captives in a Pandemic Airmic LIVE episode here.

The immediate questions facing existing captive owners at the outset of the crisis, according to Mr Healy, was whether the captive might be impacted from a capital solvency perspective, but the conversation quickly evolved into how the captive might support the group in the short term.

"Where a captive has excess funds, could it help with any short-term liquidity issues? Distributing excess funds back to the group, either through a intercompany loan or dividends in some cases," he said.

The other immediate consideration for captive owners was the travel restrictions that made holding full board meetings in the domicile location problematic, and in many cases impossible.

Ms Coletta explained why the new substances laws that many domiciles introduced from 1 January, 2019 and scrutiny from tax authorities at the group's headquarters made this a particular challenge.

"One of the key questions we've been getting since early April, is what do we do if we can't send our executives to the location to have a board meeting?" Ms Coletta said.

"Typically, there will be some local independent non-executive directors in the domicile who might need to have extra authorities delegated to them if UK directors can't travel and it becomes a sustained issue.

"Where groups are having to dial-in or host virtual board meetings, minuting at the outset noting that the reasons directors have not travelled is because of COVID-19. Having a long track record of having board meetings in that location is very helpful because you can point to it being an exceptional circumstance. Notifying company sectaries and group tax is very important as well."

With the market hardening prior to the pandemic, risk and insurance professionals were already beginning to turn to their captives to increase retentions, access greater capacity or write new risks, but those plans have been accelerated or expanded in light of the changing environment.

"As we moved out of the initial reaction phase and into recovery, a lot of captive owners started thinking is there a way we can use the captive for the issues we are seeing right now, or about to see? Most of our clients are starting to think how can the captive be positioned if there is a round two of the pandemic.

"I am fairly confident it will lead to a flurry of innovation and new applications of captives."

Writing increased layers or new risks requires capital, however, which may be in short supply at group level if the parent is under pressure from economic instability. One way to meet this requirement is by 'recycling' existing capital in the captive, which can be done by restructuring the captive and selling off legacy liabilities.

"Historic liabilities, potentially long tail employers liabilities or workers' compensation, will require capital to be held against them either by regulator requirement or potentially trapped in collateral that is supporting the obligation to the front company," said Mr Corver.

"If that capital can be released it can either be passed up to the parent as a distribution or used to support new business lines, either with capital or collateral. The ways of doing that would be through a loss portfolio transfer or reinsurance arrangement. The captive would negotiate with a run-off provider to place their historic risk into a reinsurance produce so that they bear all the risk going forward."

You can listen to the full Captives in a Pandemic episode, on the Airmic LIVE page here.