Why financial institutions are using captives to insure key risks

By Adriana Scherzinger and Alex Muralles | Zurich North America

Growth of captives has been one of the top trends in commercial insurance and risk management lately, and financial institutions (e.g., banks, asset managers, insurance companies) have been one of the earliest and most advanced users of single-parent captives.

Over the past few years, the hard market and reduced (re)insurance capacity for some coverages prompted many businesses to seek alternatives, and captives proved to be an ideal solution for many. For most captive formations in 2023 and 2024, business owners and risk managers have assessed their risk profile and determined a captive will integrate well with their commercial insurance covers.

Beyond the typical reasons to form captives, why do financial institutions in particular turn to captives? We asked three well-known leaders in the U.S. captive market — one from the largest captive domicile in the world, another from a top captive manager, and the third from one of the largest financial institution captives that Zurich North America provides fronting services for — to share their perspective on that question. They include:

• Ian Ascher, Executive Director of Global Risk Management for JLL. This diverse real estate investment management firm has a captive that dates to the 1990s and has expanded significantly in recent years.
• Sandy Bigglestone, Deputy Commissioner of Captive Insurance for the Vermont Department of Financial Regulation. Vermont recently overtook Bermuda and the Cayman Islands as the top captive domicile in the world.
• Michael Serricchio, Managing Director and Americas Consulting Leader for Marsh Captive Solutions. It’s estimated that one in four captives globally is managed by Marsh Captive Solutions.

Together, their insights shed light on how captives can be strategically valuable to businesses in the financial sector and beyond. Before we get to those, a couple basics:

A captive is a regulated (re)insurance company that a business sets up to provide (re)insurance to its parent organization and sometimes other affiliates. The captive is wholly owned and controlled by the entity or entities it insures. Single-parent captives, also known as pure captives, insure a single parent’s risks.

Now, onto the Q&A.

Q: Are financial institutions one of the largest users of captives, and why?

Serricchio: At Marsh, financial institutions are the top industry segment represented in our captive management portfolio, representing over 50% of premiums we manage. Growth for this segment exceeded 30% last year. And 13% of our financial institutions captive clients have more than one captive.

One explanation for their strong representation in captives is the sheer size of the financial institutions industry. They use captives for the same reasons other organizations do, including cost, control and flexibility. But there are other reasons captives can be a good fit.

Financial institutions are heavily regulated and have vast experience complying with governance. They have audit committees and strong actuarial/regulatory oversight. And many are so massive in size that they have big risks, including Property, D&O (Directors & Officers), E&O (Errors & Omissions) and Cyber. When you have big risks, you typically need to take on much larger retentions. Typically, the large financial institutions aren’t taking a $250,000 retention, they’re taking something on the order of a $25 million retention. Keeping that risk on their balance sheet is risky, so they tend to set up captives to formalize and fund large retentions in that structure.

Bigglestone: In Vermont, financial institutions are one of our top 15 industry sectors in terms of the number of captives domiciled here. There were more, smaller financial institutions captives 15-20 years ago; now, because of consolidations in banking, many smaller captives have consolidated into a single, large captive. Financial institutions represent an active and robust industry sector for captives.

Ascher: At JLL, our captive use has certainly grown. We’ve shifted as much as possible into the captive to manage liability risks in an organized and cohesive way. The captive helps us follow a strategy, including from a reserving and tax perspective, as well as upfront to buy down deductibles within large retentions. Let’s say we take a $10 million deductible. We then manage the deductible in the captive and charge an allocation for it to various JLL businesses in an efficient way. The increased captive deductible acts to replace capacity in the commercial insurance market, keeping our overall costs of insurance down.  This has proven effective in various markets. For example, with Auto, I never thought our captive would be our primary insurer. But today, the captive is insuring the business for Auto Liability, which has proven to be extremely cost effective for us.

Q: Why are financial institutions drawn to captives?

Bigglestone: Financial institutions have stakeholders who include the public. A large amount of credibility is riding on their reputation for managing money and being responsible and abiding by all the necessary laws, both at the state and federal level. They understand good regulation and know it’s for the protection of consumers. 

Any organization can self-insure risk on its balance sheet, but in times of financial distress, those funds could be deployed for other purposes. A captive serves to segregate risk, and the funding for it, in a regulated entity. There’s capital at stake, but assets are held in reserves and premium is being paid by the business to fund those obligations.

Having a captive can contribute to the financial institution’s strength and strategic standing as it reports to the board. The captive can elevate its credibility and accountability at the external stakeholder level. And if the captive is performing well, dividends could go back to the parent company. Captives can truly support the mission of the financial institution.

Ascher: JLL inherited a captive through an acquisition of another company in the 1990s. Initially, it continued to run fairly dormant, being used in a straightforward way to buy down a deductible for Professional Indemnity coverage.

When I joined JLL six years ago, we made the decision to really wake up the captive and started strategically using it for Workers’ Compensation, Auto, Investment Management Insurance and Property, in addition to Professional Liability. When we examined our liabilities, we found the captive could provide a more cohesive method to manage our insurance program, rather than having bits and pieces of risk on different balance sheets throughout the company. Now, we’re utilizing it in a major way, which has resulted in significant growth to the balance sheet and ultimately profitability to the company.

Serricchio: Financial institutions are drawn to captives for many of the same reasons as any company in any sector. The No. 1 reason for growth in captives is the rate market. The recent growth started with the hardening market in property, then in D&O and Cyber. Property continues to be challenged for many insureds, although signs of stabilization can be seen. Even E&O and Excess Liability had challenges in the 2021 and 2022 era. For all those reasons, many captives were formed or captives that were already formed got bigger.

Q: What types of coverage lines are financial institutions putting in a captive structure?

Ascher: After JLL woke up its captive, we wanted something that would bring in premium volume, to have a diversified base. Given the significant data, long history and big premium volume, Workers’ Compensation was one of the first lines we introduced to our captive program. This was a natural entry point as we could reasonably predict what losses will look like. Then we added General Liability followed by Auto. That rounded out our Liability portfolio.

Next, we thought of bringing in more on the Professional Liability side. When I joined JLL, our Professional Indemnity was already in the captive. However, one part of our business had a separate Liability policy, which we brought into the captive.

Today, we have a well-diversified portfolio with a balance sheet north of $100 million in assets. It’s a real business at this point. We have a Profit & Loss sheet where we’ve underwritten to the point where we’re profitable.

When I look back to the start, the captive was a monoline writer of Professional Indemnity and was effectively losing money for the company. Being able to turn that around in short order was a great achievement for everyone involved. The captive is now bigger than some businesses within JLL from a revenue and income standpoint, which really puts it in perspective.

• Crime and Fidelity
• General Liability
• Medical Stop Loss
• Professional Liability
• Third-party risk

Those lines make sense because Professional Liability includes Errors & Omissions. Medical Stop Loss is seeing big growth in all industries. Crime and Fidelity are very typical. Third party risk is another growing area in captives; for a financial institution this can be credit card protection that financial institutions offer.

Bigglestone: Cyber has become a growing line of business for captives in the Vermont domicile in the past 10 years. Two other common lines Vermont sees for financial institutions are Directors & Officers and Errors & Omissions. There are other lines that aren’t as common, which include Medical Stop Loss, General Liability, Property and Terrorism, depending on the financial institution and its needs and the conditions of the commercial insurance market.

Cyber has grown in captives in part because ransomware has driven rates up in the commercial market, causing Cyber to be one of the larger ticket pricing items. When banks or other institutions consider market premium for the coverage and the varying terms, they may justly decide to pay themselves that premium in the form of a captive, invest the premium dollars, and hopefully build up reserves and capital. Perhaps there’s no immediate trigger for the coverage, but the funding is there should an event occur. In this way, a captive can help an organization to react and deploy the necessary resources, and consequently provide confidence to their external stakeholders if a cyber event happens.

Q: Elevated commercial insurance rates, during a hard market, aren’t the only reason that financial institutions use captives? Are there other benefits to using a captive?

Serricchio: Even if the market softens, once a company gets into a captive, they tend to stay in it for a long time. They have that discipline and don’t want to be at the mercy of commercial insurance market volatility. If rates soften, you’ll see newer captives grow less, but you’ll see some of bigger captives continue to do what they do. They do utilize the commercial insurance market where coverage pricing is attractive and for higher layers or where coverage is required.

Ascher: The captive gives us more of a straight line in terms of volatility. Where the commercial insurance rate market goes up and down, we can strip volatility by using the captive for lower layers of insurance. I like to provide a straight line in terms of budgeting guidance to the business to cover premiums to the captive, and in terms of how premium gets allocated through the business. The stability of the captive helps us avoid the shock and volatility of the market.

But whether the market is hard or soft, the captive has benefits. If it’s soft, we can buy more insurance. If, for example, the U.S. Commercial Auto insurance market suddenly shifted and pricing and capacity became available at a lower price, versus internal capacity from our captive, I have to judge how much my capacity is worth versus market capacity. Right now, we’re using cheaper capacity, which is our own capacity.

In addition to the captive enabling us to save some dollars in insurance purchasing, another significant benefit is that the captive acts as a full administrative tool for our insurance platform. For a business like ours, with 100,000 employees and operations globally, the ability to administer several programs through a central point has been extremely productive.

Bigglestone: One benefit of having a captive is having the insurance data. Buying a policy in the commercial insurance marketplace, the insurance carrier owns the data related to losses and other aspects of the program, for the most part. Operating a captive gives an organization the data and enables more pure pricing of premium going forward for the risk retained. A captive can incentivize better risk management, because the organization is better vested in the performance of its investment in the captive. The captive owner is responsible for making up any difference should the captive experience adverse results. Captive regulators always believe it’s in the best interest of the captive owner to recapitalize the captive, should things go awry.

Conversely, if the captive performs well, the profits can fund additional risk management initiatives. The captive becomes a focus for strategic risk management. The captive affords a greater level of accountability and attention with managing risk in its own regulated structure.

Q: Is awareness of captives increasing among financial institutions? And what are some considerations for financial institutions that are new to exploring captives?

Bigglestone: Companies exploring putting a line of coverage in a captive in Vermont go through a feasibility analysis. It’s not only about the ability to pay the premium to the captive, it also requires capital. Then there are the costs to operate a captive, such as annual actuarial work and an independent audit. If there aren’t the necessary resources for operating an insurance entity in-house, a captive owner will typically outsource work to captive managers to do the day-to-day accounting and compliance work. The feasibility process usually involves an actuary looking at historical losses and pricing policies and coming up with a loss pick (or estimate) for reserves based on the policies the captive may write. The estimated costs for operating a captive, along with the work of the actuary, will help to develop financial projections, which will demonstrate how the captive is expected to perform over a five-year period, both on an expected and a stress-case scenario.

A company may determine, after performing the feasibility study, that it’s better to stay in the commercial market, especially if losses are expected to be more severe or more frequent.

Good risk management plays a significant role in the success of the captive.

Ascher: People in the risk management space have become familiar with captives. It’s not overly complicated. It’s about looking at your company and how you’re already spending dollars and doing so in a more strategic way to bring holistic benefits to the transaction of insurance and risk management. You need to bring in some financial concepts, lean on your tax experts and make sure you understand the full impact. It can be a really efficient tool to be able to drive a holistic strategy for your risk management operations.

In terms of considerations, it helps when the culture and governance structures are there and when there’s an ability for stakeholders to understand the benefits of centralizing risk and being able to manage liability centrally, which for us has been one of the biggest benefits.

Serricchio: Awareness has increased. When financial institutions began forming captives many years ago, there were only a couple domiciles, such as Bermuda and Barbados. Over the last 25 years we’ve seen a slow evolution of more states becoming domiciles and businesses moving captives from offshore to onshore. Now nearly 40 states are captive domiciles, so that a Delaware corporation or a Vermont bank or a Tennessee bank can set up a captive in their own state.

For the captive owner, in addition to being convenient for getting to meetings, this can be viewed as good corporate citizenship — the premium tax revenue flows into their own state, and having captives within their state can support jobs in their state.

For the state, being a domicile can help the state show that it supports business. Being seen as such can help keep corporations in state and creating high-paying jobs and being innovative.

Q: Does it matter what type of carrier a captive works with as a fronting partner?

Ascher: For JLL, our fronting insurance carrier partner isn’t just providing fee services for our captive. Zurich supports us with a lot of risk transfer in other areas and programs between International Liability, global Property, D&O and several other Financial Lines coverages. JLL is a global business and Zurich is too. We value those capabilities and having that tremendous relationship and support across broad portfolio needs.

Serricchio: Very few companies will self-insure 100% of a risk; they won’t want to roll the dice and then have a $400 million loss. They can buy (re)insurance for, say, $300 million in excess of $100 million, with the first $100 million in a captive and the next $300 million in commercial insurance. So they are still in need of reputable, reliable commercial insurance providers.

Bigglestone: There are certain coverages, General Liability for example, that organizations are required to have. If there’s a financing arrangement, the organization typically must have coverage on rated paper (which is to say, from an established carrier that can issue a Certificate of Insurance).

It’s also important to note that captives do not replace commercial insurance carriers. A captive owner doesn’t establish a captive to exit the commercial marketplace altogether. The captive and carriers are supposed to complement and work in tandem throughout hard and soft market cycles. Captives can help fill coverage gaps. And oftentimes captives utilize fronting arrangements with commercial carriers like Zurich. Having access to carriers with an interest in supporting clients who are captive owners, who understand the business of captive insurance and how they’re regulated, is so important.

Adriana Scherzinger is Head of Alternative Risk Solutions for Zurich North America until September 2024, when she will become Group Head of Captives for Zurich Insurance and based in Switzerland.

Alex Muralles is Head of Financial Institutions for Zurich North America’s U.S. National Accounts business, whose client base includes many businesses that use captives to insure some of their risks.