Companies are increasingly using captives as a long-termstrategy to insulate themselves against commercial market-cyclevolatility, rather than using captives as a shorter-term solutionwhen 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 theunderwriting cycle for the commercial-lines industry,” explainingthat when the commercial market hardened, businesses formed andincreased the use of their captives to protect themselves from thesteep rate increases. As the commercial market softened and ratesdeclined, captives would be run off or downsized as companies tookadvantage of the lower prices and more generous coverages in theconventional market.

Since 2000, though, A.M. Best says captives “seem to havefound a permanent place in U.S. corporations' risk-managementstrategies.” The report says that analysts have been told that“corporate memories are longer” and companies are using captives tohedge against volatile rate changes and changes in coverageinherent in the insurance pricing cycle. “Some captives rated byA.M. Best have eliminated the commercial insurer altogether andcede directly to the commercial reinsurance market,” says thereport.

Regarding U.S. captives' financial results in 2012, A.M. Bestsays net income for its captive composite was $1.5 billion, down by26 percent compared to 2011. The drop, says the report, resultedfrom a 71 percent drop in underwriting income as well as smallerdips in net investment income and realized capital gains.

Underwriting income was impacted by a $630 million increase inincurred loss and loss-adjustment expenses, due mostly to propertylosses.

Still, despite the reduction in net income, A.M. Best notes thatcaptives' surplus grew $1.39 billion, or 6 percent, in 2012compared 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 longerterm, the resulting five-year combined ratio for the captivecomposite of 92.3 still compares extremely favorably with thecommercial casualty composite of 103.3.”