Insurance with an ART-SY flair
Cell captive insurance structures are emerging as a popular tool to help insurance brokers and underwriting managers (UMAs) to get access to reinsurance markets and put in place alternative risk transfer (ART) solutions for their commercial and personal clients. “The pressure on reinsurance rates, hardening of global insurance markets and the loss events referred to during the opening of today’s webinar illustrate the need for bespoke [risk transfer] solutions, and for industry stakeholders to think out of the box,” said Mr Farad Kajee, CEO of Yard Insurance, during the recent InsureTalk33 event.
The ART in SA’s cell captives
The popular non-life insurance focused webinar played out against the backdrop of extensive flooding in parts of the Western Cape, where high winter rainfalls over 14-16 June 2023 caused extensive damage to provincial infrastructure. An early estimate from the Western Cape Government put losses in the agriculture sector at between ZAR750 million and ZAR1 billion. The growing popularity of cell captive insurance structures as ART mechanisms is evidenced by Yard Insurance, a registered insurer licensed cell captive insurer, growing from zero to 28 structures under management, and from zero to ZAR400 million in gross written premium (GWP) in under three years.
“Everyone in this audience will have come under pressure from their current underwriters, reinsurers or both from a rate perspective; from a limit perspective; or from a grid exclusion perspective … from last year to this, we are in a totally different insurance environment,” Kajee said. He added that reinsurers had sent a clear message during the 2022 Baden-Baden Reinsurance Meeting, namely that they were in the game to generate profits for their shareholders. “Global reinsurers have probably returned only 4% to shareholders over the past five years, which explains why we find ourselves where we are today in terms of the reinsurance landscape,” he said, before handing over to his colleague, Andrew Stockton, to share some background on the cell captive structure.
Complex risk transfer mechanisms
Many FAnews readers are active in the fields of insurance and / or risk advice; but few have intimate knowledge of the complex world of cell captive structures. In fact, insurance and legal experts are often left ‘grasping at straws’ when asked to explain these ART mechanisms. Andrew Stockton, who heads up Business Development at Yard Insurance, described a cell captive insurer as “a registered insurer licensed to provide cell captive structures that forms ring-fenced cells for other organisations, who are in turn referred to as either first- or third-party cell owners”. Each cell becomes a mini-insurer on behalf of a cell owner. The cell owner can be a UMA, in the case of selling insurance through brokers to businesses or individuals, or an individual commercial client.
Cell captive structures become popular when the cost of insurance becomes too high; when a large commercial client is uninsurable due to a lack of conventional insurance market appetite; and when claims ratios are so low that a large client sees few rewards from its existing insurance relationship. There are, however, significant differences between the first- and third-party cell captive structures that are worth unpacking further. A first-party cell captive is where a client, or commercial business wants to manage its own risk portfolio as if it were a mini-insurer. PS, this writer is unsure of the mini-insurer descriptor, but it is accurate, to some extent, in describing the cell captive arrangement.
A third-party cell captive was described as a structure that sells insurance to anyone in a target market; it issues policies in its name but is underwritten by a cell captive insurer. “A third-party cell provides insurance to everyday companies or people for any lines of insurance, be they commercial or personal lines,” Andrew said. One of the stand-out features of cell captive structures is that they give the cell owner direct access to the reinsurance market. “Once you have developed a policy for your captive structure you can then negotiate terms with a reinsurance company, and inside of that you can take either a quota share programme or an excess of loss programme or both, depending on what products you want in your cell and how much exposure you want to take on,” said Andrew. This freedom is balanced by tough regulatory requirements.
Ever heard of a CRESTA zone?
A third-party cell captive structure must be capitalised before you can write business in it. It must also maintain liquidity and solvency per the Solvency Assessment and Management (SAM) regulations and / or Solvency II. Need to know more? Just ask your local, friendly actuary about so-called Catastrophe Risk Evaluation and Standardising Target Accumulation modelling, or so-called CRESTA zones. “An actuarial analysis will be done to determine each cell’s minimum capital requirement based on the premiums expected; the indemnity limits you are going to run; and the deductibles,” Andrew said. “The statutory capital requirement is 125% of that amount, subject to a ZAR1 million regulatory minimum”. So, to all the non-mandated intermediaries and UMAs out there, a million ‘bucks’ is the initial cost of a ‘ticket to play’ in the third-party cell captive space.
According to Andrew, the first-party cell captive is simpler to motivate and understand. “If you have a client that is paying a lot of premium, and they are not big claimers, say with a loss ratio of below 10%, they end up paying away premium they could potentially be keeping in the business,” he said. The cell captive structure allows the cell owner, or your commercial client, to structure a policy with its own reinsurance programme, allowing for higher deductibles and excess of loss programmes. Yard Insurance shared a basic example of a commercial client ‘fully insured’ with a large conventional insurer compared to a self-insured first-party cell structure. The former arrangement involves ‘pooled risk controlled by an insurer’ and the latter ‘unbundled stand-alone risk controlled by the client’.
Cell captive versus contingency policy
In the fully insured solution, the insured pays an annual premium on the first day of the year, which is used up for insurance and reinsurance premiums; admin charges; commissions; and to cover projected claims and the traditional insurer’s underwriting margin. So, the entire premium is used up, and nothing comes back to the insured even if they have a zero-claim year. In the self-insured solution, the fixed or non-refundable cost is equal to the reinsurance premium only. “Any after-cost balance that remains in the ring-fenced solution earns interest at the investment rate, and is returned to the insured at the end of the period,” Andrew concluded. How this amount is returned to the insured varies depending on the structure: in a cell captive, through participation in dividends, or in a contingency policy, paid out as profits.
Writer’s thoughts:
There seems to be a compelling case for cell captive structures, especially for commercial clients that have excellent risk management credentials… Have you ever considered a first-party cell captive structure for a commercial client; and if yes, was the process as easy as today’s article suggests? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
