How Should You Best Manage Your Risk Given the Hardening of Commercial Insurance Markets

Are you getting decline letters from insurance carriers? Did rates go up at renewal resulting in higher premiums charged?  Are you seeing restrictions or retractions in coverage terms and conditions or reduction in limits available?

The pandemic has caused the greatest economic disruption in generations.  All industries are affected, causing many firms to rethink their business models, operations, and risk appetites.  Given the current circumstances, many companies are reviewing their risk management plan and uncovering potential risks and exposures they hadn’t considered in the past.

At Capterra Risk we have played active roles in the insurance industry for 25 years. There has never been one global shared risk that enacted such extensive global changes including those we are seeing in the commercial insurance market encompassing so many lines of coverage.

We are sure you are seeing some of these changes:

  • Premiums are going up, even if claim histories are low
    • Commercial property insurance pricing in the U.S. increased 22% in the second quarter of 2020, according to the Global Insurance Market Index by Marsh LLC.
    • Commercial financial and professional liability insurance average rates in the U.S. increased 30%, as pricing in the directors and officers market was up 59%, with more than 90% of clients experiencing an increase, Marsh said.
  • Insurers are limiting coverage or adding more exclusions
    • Several D&O insurers are also trying to impose both bankruptcy and COVID-19 exclusions in their policies
    • Joe Peiser from Willis Towers Watson adds “we’ve seen intense underwriting reviews, reductions in available limits, non-renewals and even some cancellations.”
  • Companies are scaling back or exiting sectors
    • According to Peiser, for distressed industries like retail, hospitality and health care, rate increases could be even worse, given a dramatic fall-off in insurance capacity for these sectors.

Hardening of Market

In the fall of 2019, the market began to firm and has continued to harden, meaning that insurance companies are reevaluating their coverages offered in light of the changing market and uncertainty. Consequently, we are seeing premium increases, reductions in available limits, retractions in coverage terms and conditions, denials, and even some insurers exiting markets.

With the pandemic, resulting recession, and current social unrest, this hardening market is not likely to change anytime soon.

As an owner looking to cover business risks, the limitations being added to the commercial insurance policies in this hardening market will likely impact you in a significant way.

What Does This Mean to Business Owners?

You have various (some undesirable) options including, but not limited to, (1) purchasing coverage in the traditional market with reduced limits, (2) purchasing coverage in the traditional market with higher deductibles, (3) going without certain coverages and taking on more risk in your business, (4) purchasing coverage with truncated terms and conditions, (5) reducing your highest-risk operations within your Company.

Another option that is getting more attention in 2020 is forming a captive to write coverages and ultimately reduce some of the effects of the hardening market.

Benefits of captive insurance include:

  • Captive owners better control their own risks, customizing policies to fit their operation and needs.
  • Take higher deductibles on traditional policies and have the captive write a deductible reimbursement policy.
  • If there is not capacity in the traditional market for higher limits, the captive may be able to write an Excess policy with additional limits above those written in the traditional policies.
  • A difference in conditions policy can be written to fill those gaps in the traditional policies.
  • Owners retain profits as opposed to simply paying premiums to commercial programs.
  • Encourages you to be better educated on risks, incenting your business towards better risk management behaviors.

Large companies have taken advantage of the benefits of operating a captive for many years.  The 1986 Tax Act provided the 831b captive framework for smaller companies to have the opportunity to form a captive and the ability to manage risks the way a bigger Company could, by utilizing a Captive.

The lines of risk customers are most keen on insuring through a captive are property DIC, directors and officers, cyber, professional liability, product liability, and trade credit.

 

Does it make sense for you to form a captive?

Contact Capterra Risk Solutions, LLC to find out if your Company is a good fit to form a captive.

Now might be the time to consider captive insurance.  Let us provide a free evaluation of your business’ risk mitigation needs and whether captive insurance can benefit you in this hardening market.

Micro Captives Dropped from IRS’ 2020 ‘Dirty Dozen’; Reason to Celebrate?

By Sandra Fenters

For the first time since 2014, micro captives have been omitted from the IRS’ list of what it perceives as areas of tax avoidance.

This is good news for our industry and the broader industry as well.

However, we need to be realistic in understanding that the IRS has not dropped captive insurance from its’ focus in the future.  You will see in the article below that the IRS explicitly states that it will continue to address issues related to micro-captives.

But given all that is on the plate of the IRS and the government in general, we may see less enforcement activity in 2020.

 

ARTICLE:

Micro captives were not listed on the Internal Revenue Service’s (IRS) 2020 ‘Dirty Dozen’ list of tax scams, for the first time in five years.

Published in Captive Insurance Times, July 16, 2020

The annual list is a compilation of a variety of common scams that the IRS suggests represent “the worst of the worst tax scams” and should be avoided by taxpayers.

For the last five years, the IRS has referred to micro captives as an “abusive tax shelter” and suggested that certain micro captive “structures, promoters, accountants or wealth planners persuade owners of closely-held entities to participate in schemes that lack many of the attributes of insurance.”

Although micro captives were not mentioned on the IRS’ official list, it did state that an upcoming series of releases will be published on topics such as abusive micro captives and fraudulent conservation easements.

The IRS said that these releases “will emphasize the illegal schemes and techniques businesses and individuals use to avoid paying their lawful tax liability”.

The IRS has had a number of tax court successes against micro captives over the past few years.

In the Avrahami case in 2017, the US tax court disallowed the “wholly unreasonable” premium deductions the taxpayer had claimed in a micro captive arrangement and concluded that the arrangement was not insurance under long-established law.

Last year, in the Reserve Mechanical case, the tax court determined that the transactions in another micro captive arrangement were not insurance.

Prior to those two rulings, the IRS issued guidance that micro captive transactions have potential for tax avoidance and evasion in 2016, and established reporting requirements for them via Notice 2016-66.

More recently, the IRS mailed a time-limited settlement offer for certain taxpayers under audit who participated in ‘abusive’ micro captive insurance transactions last September.

The IRS announced earlier this year that 80 percent of taxpayers who received offer letters elected to accept the settlement terms.

SIIA Objects to IRS Notification Letter

By Sandra Fenters

On March 20th, just four days after the National Covid-19 Emergency was declared, The IRS sent 150,000 letters to captive insurance companies who take the 831(b) election.

This memo was clearly designed to ignite fear in the minds of captive insurance owners.  It’s yet another scare tactic in the Services’ bullying efforts to induce doubt about the health and viability of captive insurance arrangements.

The timing for the IRS could not have been poorer. Despite presenting massive challenges to the global economy, the coronavirus pandemic may well be captive insurance companies’ finest hour. Last week a number of publications highlighted that high severity, low-frequency events like Covid-19 are when captive insurance shows its’ real value in protecting America’s small and mid-sized businesses from disaster.

SIIA Expresses Concerns about Ill-Timed Letters

The Self-Insurance Institute of America (SIIA) wrote to Treasury and IRS on March 30, calling the letters “insensitive and draconian.”

Ryan Work, SIIA VP of Government Relations who leads the SIIA Advocacy Committee on which I am very active, requested that the IRS reconsider its letter and its timeframes given the crisis.

Given the current crisis, combined with the timing and the burden being placed on small- and medium-sized businesses, the IRS should suspend further audit activity until the National COVID-19 Emergency Declaration is withdrawn so as to allow businesses operating captive insurance to mitigate the risks that Congress and the Tax Code allow them to appropriately address. Furthermore, while the deadline is suspended, the overall need for the IRS Letter itself should be reconsidered and information clarified as it is possible for the IRS to deduce the answers to its own questions from information that has already been reported by taxpayers who have complied with the requirement to file Form 8886 over the past two years.

Here is a link to the full SIIA letter to Treasury Secretary Mnuchin and IRS Commissioner Rettig.

We are hopeful that captive insurance companies play a pivotal role in covering losses in the coming months of the pandemic and that the IRS recognizes their critical and legitimate role in mitigating risk not properly covered by other insurance products.

Captive Insurance Shines in Pandemic

Despite Presenting Challenges, Coronavirus May Well Be Captive Insurance’s Finest Hour

By Sandra Fenters

Times like these are when captive insurance shows its’ real value in protecting America’s small and mid-sized businesses from disasters.

What we are seeing is:  operating businesses with captive programs that insure relevant risks have both more complete and flexible insurance as well as access to more capital than most of their competitors. This is a major benefit.

The media is beginning to notice

There have been two columns written in the last few days that highlight what captive insurance brings to cover unlikely events.

Columnist Paul Sullivan of the New York Times wrote an article titled, “Once Scrutinized, An Insurance Product Becomes a Crisis Lifeline.”   In it, Sullivan points out that:

“[Small Captive Insurance companies are] proving to be beneficial as the coronavirus pandemic shuts down local economies.”

Some of the more common coverage options, like the risk that business will be interrupted or a supply chain disrupted, are claims that business owners need to make. In this economic crisis, captives may be showing their worth.”

And yet another view:

Reporter Maria Ward-Brennan of the Captive Insurance Times interviewed Ben Whitehouse, an attorney nationally recognized in the captive insurance industry.  Whitehouse states:

“The current COVID-19 pandemic is creating captive insurance’s chance to shine” and the “time is now for companies to start looking at captive insurance.”

“It is this kind of environment where a captive insurance company can be given a chance to shine. A captive not only gives businesses the chance to recapture unused premium, but it also allows for more flexible policy forms without the fine print exclusions that lead to coverage gaps.”

The full article is here.

While the full effects of the coronavirus on the economy are yet to be tallied up, the businesses with captive insurance policies are in a stronger position to mitigate their risks and thrive in the future.

Sandra Fenters Featured in Cyber Security Article

Rolling the Dice on Emerging Risks

Captives seen as promising solution for reining in costs related to cyberattacks, political instability, extreme weather and other serious concerns in the years ahead.

By Bruce Shutan

Published in Self Insured Magazine, March 2020 edition

Since the most serious insurance risks will continue to evolve in an ever-changing world, top priorities may shift right alongside the moving targets of catastrophe. But one prudent strategy remains the same: the use of captive insurance to avoid financial ruin. Industry observers say this alternative risk transfer vehicle will keep powering organizations through a maze of uncertainty that includes cyberattacks, political instability, extreme weather, supply chain disruption, the mounting use of drones and legalized marijuana.

Captives can help minimize any losses from cyberattacks by offering a layer of protection beyond where the commercial insurance marketplace is willing to tread and speed a return to business as usual, says Harry Tipper, III, chief operating officer – insurance, for CaptiveOne Advisors LLC. They serve as a risk-management mechanism that may include state-of-the-art cybersecurity insurance inclusive of a financing mechanism for cyber intrusions.

“Think of a cyber incident your company may experience,” explains Tipper, who moderated a workshop on using captives to cover emerging risks at SIIA’s 2019 national conference in San Francisco. “A captive insurer may not solve the problem of a cyberattack, but it can help provide funds by which you can start to bring in the experts who can do some additional security work, as well as providing the funds needed to hire a public-relations firm that can rebuild your brand or reputation.”

Captives help fill gaps resulting from numerous exclusions in cyber insurance policies, notes Sandra Fenters, President, Capterra Risk Solutions, LLC and a member of SIIA’s Captive Insurance Committee.

“That’s why we’ll write a difference-in-conditions policy,” she says. “A lot of times they keep their traditional policy and buy expanded coverages.”

One such example is an act of war, which is typically found in property insurance policies and other types of coverage. Fenters recalls how Merck & Co. lost $1.3 billion in a June 2017 cyberattack traced to Russia’s military intelligence agency, which crippled more than 30,000 laptop and desktop computers. Most of the pharmaceutical giant’s 30 insurers and reinsurers denied coverage and the case was later litigated.

Captive solutions come in various shapes and sizes – from individual and group captives to heterogeneous and homogeneous entities. One example that Tipper cites is a trade association that forms a captive insurer to make some of these insurance coverages and services available at a discount as a benefit of membership.

His company’s clients include smaller businesses that don’t necessarily have the resources for costly cybersecurity as a shield for personally protected information or confidential health information. In many cases, he says they have to balance the breadth of coverage with budget constraints, particularly in the area of ancillary risk management/risk mitigation services.

Sandra Fenters

Tipper recalls a conversation he had about three years ago with one vendor that his company was considering to provide cybersecurity services to its clients. It guaranteed that its firewalls and real-time threat analysis would eliminate any cyber incursions, but the cost of this platinum service was an eye-popping $250,000 a month. He describes the amount as “unfathomable” to smaller businesses which currently must rely on the services of third-party vendors, the commercial equivalent of LifeLock, Norton or McAfee, to provide them with cybersecurity.

Cyber insurance is one of the most expansive policies in the market with at least 10 insuring agreements largely because there are so many disparate areas to address, Fenters surmises. There’s a myriad of subcategories under the cyber-risk umbrella, including computer security and privacy breaches, cyber theft, espionage, extortion and cyber terrorism.

CHAIN REACTION TO CYBERATTACKS

The frightening part is that these episodes bleed into larger business concerns that include loss of revenue, reputational damage, business continuity and supply chain disruption. “It’s a massive exposure that touches the most exposure points I’ve ever seen,” she opines. Countering cyberattacks and data breaches, which have increased exponentially, is a chief concern across all organizations between a deepening global interconnectedness, as well as an explosion of mobile devices and social media.

Despite these mounting risks, her client base has been fortunate thus far. The closest any of them have come to a cyberattack was when a distributor of fuel products lost nearly $50,000 in damages from someone stealing credit card information from a gas station pump.

However, newer worries are fast emerging over a related area, which is the uncertain impact of political risks in an increasingly unstable geopolitical environment. She cites several examples
that include government confiscation of property, civil commotion, an inability to convert foreign currency, terrorism and trade embargoes.

“There are a number of political risks that we see many of our captives writing administrative-action type policies to cover,” Fenters reports.

Supply chain disruptions in an increasingly global economy are another emerging area of mounting concern among smaller American businesses. While politics makes some coverage problematic currently, Tipper’s current firm has worked with its clients to provide a means within a captive insurance vehicle to develop a funding mechanism in the event trade disputes have to be litigated outside the U.S. in the supplier’s home country’s courts where it can be much more expensive.

“We’ve seen and heard horror stories of the impact on supply chains from governmental intervention,” he notes, “and have at least found a partial solution.”

In this case, he says many of his clients are following a simple, prudent risk management
strategy by choosing a heterogenous group of suppliers or vendors that’s not limited geographically.  “It’s acting in the same way that you don’t put all your investment portfolio into one sector of the economy.” The biggest challenge to the supply chain now is underwriting political risk, he adds.

BRACING FOR HEAVY WEATHER

Captives also help fill coverage gaps for other emerging risks, including the growing category of weather-related concerns. Tipper once ran a Bermuda-based company that focused on captives.
While there, the firms that create the hurricane models for the insurance industry added a severity component to the computer model that previously just calculated the frequency probability of a
hurricane or other catastrophic weather events occurring in a geographic area.

In response, several insurers writing property insurance asked several coastal communities
in the Northeast to absorb an increase to their deductibles on their property policies between
$25 million and $60 million in the space of just one renewal period because of concerns
about climate change and severe weather, he recalls.

“Fortunately with a little bit of work, a captive was used to fund that gap so that they could build
up a pool of resources over a period of time that in the event a severe storm came by and inflicted reasonably predicted damage, they would have the funding available to rebuild the community,” according to Tipper.

Rolling the Dice

Whereas the cyber area was a unique and highly specialized emerging risk 20 years ago, increasingly severe weather driven in large part by climate change is an emerging space for captive insurance, observes Mike Woytowicz, director of business development for Artex Risk Solutions’ International division. He’s based in Bermuda where hurricanes and Bermuda Triangle folklore are cultural markers.

Woytowicz recently helped incorporate a captive that essentially mirrors the weather derivative contracts available in the market for an energy distribution company to deal with Mother Nature’s
wrath. The captive is being used to “de-risk” electric operations and assist weather risk  management strategies by allowing the client enough flexibility to increase or decrease the insurance market attachment point (i.e., strike price) for various options available.

The arrangement, which ultimately provides less downside or upside volatility in the company’s operations, serves as a hedge on either side of what’s being bought in the traditional derivative marketplace to guard against soaring gas prices in frigid winters or much higher electricity costs in scorching hot summers.

“If they were buying a put or a call at, let’s say, $50 per kilowatt hour strike price,” Woytowicz explains, “we used the captive to fill that in below that strike which buys that strike down.”

The pricing becomes more affordable as carriers move away from the attachment point or strike price in the traditional marketplace because the lower the strike price, the quicker the derivative triggers.

A derivative contract also can be structured as an insurance policy that does not trade on the derivative market. Many organizations do not necessarily think of using insurance or a captive to also supplement or complement the same derivative strategy, according to Woytowicz.

BREAKEVEN POINT

While companies that increasingly use captives to rein in employee benefit costs on the medical stop-loss side can expect dividend payouts in good years, that experience doesn’t translate for weather-related risks. “The weather insurance market, in its current state, is pricing coverage at what seems to be basically breakeven,” Woytowicz reports.  “No one’s really making or losing money, or not like you see with a traditional insurance policy.”

There are other considerable differences such as a short tail vs. longer-tail nature. For example, he says while medical stop-loss isn’t exactly long tail, employers don’t necessarily know whether or not they’ve hit their aggregate until several months after claims have been sorted out and final bills are sent.

On the weather side, however, Woytowicz notes that the cost of oil or gas can be tracked on a daily basis. “There are energy transmission organizations that coordinate the movement of wholesale
electricity and they monitor and collect the pricing data for every hour of every day,” he says, “and if the price of energy hits the strike on any given day, you know instantly when the contract triggers, so it’s a bit different of an animal.”

DRONES AND MARIJUANA

Other emerging risks include the use of drones and legalization of marijuana across the U.S. dubbed “the green goldrush.” Fenters has many construction clients, whose industry is known for using drones to track the progress of a large or complex building projects, as well as on the agricultural side, which relies on drones to survey crops and make more effective use of the land.  Major retailers are also looking to follow Amazon’s lead by testing drones for home deliveries.

But the question is, how businesses can reap the benefits of an unmanned aircraft and protect themselves from the risk of property damage or loss of growth in that area? “Drones do crash,” Fenters says. “If the drone is carrying cargo, what safety features do they have to prevent damage? The FAA finally starting to come up with requirements for how to operate them and to meet the licensing requirements.” She notes that the Insurance Services Office is currently working on a drone-related product for property coverage.

As for marijuana, she reports that insurance carriers are scrambling to determine the ramifications of driving under the influence and other issues in states that legalize medical marijuana and/or recreational use. Fenters says another area of concern is the impact on workers’ compensation due to an accident in the workplace resulting from a poor decision by an employee under the influence of marijuana.

Meanwhile, the way emerging insurance risks are managed in the years ahead will offer an opportunity to break silos that have separated the risk management and insurance teams and more finance-focused derivative teams, which are purely focused on hedging. As global companies evolve, Woytowicz believes it is possible that risk managers will be increasing their collaboration with the derivative teams on strategies to minimize potential losses to a company’s balance sheet by either utilizing a captive and derivative combination.

Bruce Shutan is a Portland, Oregon-based freelance writer who has closely covered the employee benefits industry for more than 30 years.

SIIA Believes IRS’ Recent Press Release on Captives Is Misleading

You may have heard that the IRS recently published a News Release (2020-26)  which provided an update to its settlement offer to certain taxpayers who are currently under audit with their captive program.

During last weeks’ meeting in Miami, FL with the Self Insurance Institute of Americas’ (SIIA) Captive Advocacy Committee, Capterra Risk Solutions requested that SIIA research the IRS’ claims and provide a summary of their findings. The article summarizing their findings can be found here.

Summary:

  • The IRS claims that nearly 80% of taxpayers under audit that are receiving these settlement offers agreed to such settlements and announced the establishment of 12 audit teams to look at certain captive structures.
  • The release is misleading because 80% of the taxpayers have agreed to consider a settlement, not actually settle.
  • In SIIA’s research, not a single captive has engaged in a final settlement agreement.
  • The IRS’ supposedly 12 audit teams will most likely be looking at other issues unrelated to the captive industry, not solely focusing on captives themselves.

We agree with SIIA’s view that the IRS release is misleading.

As early adopters of the SIIA Captive Code of Conduct, as well as contributing authors of industry best practices and trailblazers in advocacy efforts, we will continue to bring you the latest developments directly from Capitol Hill.

Reducing Liability Exposure through an Agency Captive Solution

Summary:

A national building supply wholesaler sought to protect against unexpected high dollar claims on its employees’ long term workers compensation.

Challenge:

The multi-billion dollar business found that the occasional big dollar hit from a workers compensation claim – often many years later- could be very detrimental to the company’s finances.

Solution:

The Risk Manager wondered why the firm didn’t utilize a captive program to take part of the risk of the long term workers compensation liability.

Accordingly, he transferred the long-term workers compensation claims (over $50K and up to $1M) to a captive via deductible reimbursement.

Results:

The program has served the firm very well. The wholesaler was able to reduce its’ long-term liability by over 70%.

If you are interested in discussing if this is a solution for your company, please feel free to contact our office at 412-802-2600.  Thank you.

Using Captive Insurance to Provide Liability Insurance for Contractors/Installers

Summary:

A national building supply wholesaler looks to create comprehensive and long-term relationships with its’ contractor customers.  These deep connections lead to repeatable sales over many years.

Challenge:

Smaller contractors and installers can sometimes fall short of fully qualifying for needed general liability insurance.  Such limitations could prevent contractors from taking on jobs and consequently reduce contractors’ purchases.

Solution/Results:

The head of insurance for the supplier has found captive insurance to be a very effective vehicle to solve this business issue. He set up a captive a number of years ago to take on a portion of this general liability risk (the captive pays a significant percentage of the first $500K of claims).

Several years later, the firm identified that some of their smaller deck installers did not qualify for their insurance requirements. Through the captive, the firm offered the installers affordable insurance whose premiums could be easily be deducted from the payments to installers at the conclusion of the project.

The program has strengthened the relationship between the wholesaler and its’ contractor/installer base.

 

If you are interested in discussing if this is a solution for your company, please feel free to contact our office at 412-802-2600.  Thank you.

Gaining Access to Coverage Is Top Benefit of Having Captive

Captive International surveyed its readers on the top benefit of captive insurance.

Many Americans, especially those who work outside of the insurance industry, think that the single biggest reason to have a captive is to gain tax benefits. This idea became more entrenched when the ceiling for tax deductions on captives was raised to $2.2 million in 2015’s PATH Act.

Interestingly, respondents to this 2019 end of year survey (readers who work in the industry) said tax benefits ranked low among choices for the top benefit.  Instead, nearly half of respondents (45%) said that gaining access to coverage not available elsewhere is the single biggest benefit of having a captive.

About a quarter of respondents said gaining greater control over claims was the biggest benefit.

Less than 10% said the biggest benefit was gaining access to reinsurance markets

And only 5% cited tax advantages as the number 1 benefit of a captive.

Some respondents argued that it was hard to single out a single top benefit as the true value of captive insurance is “the accumulation of multiple factors, including strategic control of risk finance over a sustained period.”

Published in Captive International.

Captives Set to Increase Cyber Coverage in 2020

Captive International surveyed its readers about which business lines they expect to see captives increase their activities in for 2020 (respondents were permitted toselect multiple answers).

Cyber coverage came in first, with 64 percent of respondents predicting captives will increase their activities in that area.

Directors and officers (55 percent) and general liability (53%) were the next most popular choices, followed by professional liability (38%) and catastrophe (35%).

Notably, workers’ compensation, which is one of the lines most closely associated with captives, was only selected by 12 percent of respondents. It is likely that captives which need this coverage are likely already writing it.

There has been a lot of discussion about captive coverage for cannabis growers, only 22 percent saw this as a growth area for captives next year.

Many of the respondents to the survey said their focus will be on areas with the biggest rate rises in 2020 making the question, in effect, a prediction about where rates will rise.

Published in Captive International.