Companies are increasingly using captives as a long-term strategy to insulate themselves against commercial market-cycle volatility, rather than using captives as a shorter-term solution when rates harden, a new report says.

In a Special Report on U.S. captives' performance in 2012, A.M. Best says, “Before 2000, the captive cycle followed the underwriting cycle for the commercial-lines industry,” explaining that when the commercial market hardened, businesses formed and increased the use of their captives to protect themselves from the steep rate increases. As the commercial market softened and rates declined, captives would be run off or downsized as companies took advantage of the lower prices and more generous coverages in the conventional market.

Since 2000, though, A.M. Best says captives “seem to have found a permanent place in U.S. corporations' risk-management strategies.” The report says that analysts have been told that “corporate memories are longer” and companies are using captives to hedge against volatile rate changes and changes in coverage inherent in the insurance pricing cycle. “Some captives rated by A.M. Best have eliminated the commercial insurer altogether and cede directly to the commercial reinsurance market,” says the report.

Regarding U.S. captives' financial results in 2012, A.M. Best says net income for its captive composite was $1.5 billion, down by 26 percent compared to 2011. The drop, says the report, resulted from a 71 percent drop in underwriting income as well as smaller dips in net investment income and realized capital gains.

Underwriting income was impacted by a $630 million increase in incurred loss and loss-adjustment expenses, due mostly to property losses.

Still, despite the reduction in net income, A.M. Best notes that captives' surplus grew $1.39 billion, or 6 percent, in 2012 compared to 2011.

The composite's combined ratio for 2012 increased to 97.5, compared to 90.9 in 2011. But A.M. Best notes, “Over the longer term, the resulting five-year combined ratio for the captive composite of 92.3 still compares extremely favorably with the commercial casualty composite of 103.3.”

Special Reports /

Buyers Using Captives to Escape Market Cycle, Rather Than in Reaction to It

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