Change is inevitable and no profession escapes it. The alternative risk-transfer field is no exception, but its ability to embrace change more readily than the traditional insurance marketplace has encouraged steady growth and presented some unique challenges for captive owners.
Some changes are not new, just recycled for a new audience. For instance, insurers in the traditional markets are enjoying the fruits of their labors with nice profit margins and increased capital–despite (in a bonus for buyers) reduced premiums in many areas. Although sellers and buyers alike have earned their good fortune, history indicates that such results will be short lived.
In fact, veteran observers are not surprised to see underwriters seeking new business opportunities. As premiums fall and bonuses and salaries are affected, they're looking for other sources of revenue.
Thus, underwriters who would barely deign to sneer at a smallish captive 24 months ago are now looking to buy lunch for captive managers–to "re-assess their strategic mix." Maybe it's time to take another look at this captive stuff.
Domiciles competing hard for new formations are busy updating their captive laws. On the other hand, changes in these laws are becoming a nice new source of revenue for legal firms with insurance connections. The question is, are all of these laws useful, or even appropriate, for the general captive owner?
Through the years I have searched for the magic axe to fall upon the cycle and rid us of short-term thinking in this long-term business. Apparently, the time has not yet come, even though we're more sophisticated in assessing risk and allocating capital.
As underwriters look over the captive field for new revenues, the surprise may be that there is consolidation afoot. The ART market is no less affected by slowing premium growth–though not as much as traditional markets. Business owners seeking to control their own risk dollars continue to approach the alternative market. While new formations have slowed a bit, there is certainly no overall cutback.
There is a continued strong flow of interest, consulting projects and new formations under management. These are largely made up of private firms, or midmarket public companies, investigating the wisdom of getting out of premium cycles at the point in the cycle where reinsurance and excess coverage is affordable and available.
I expect there will be consolidation well into 2007. While Marsh, Aon and Willis will continue to service the jumbo accounts engaged in sophisticated risk finance, firms not grounded in insurance and alternative risk-transfer are learning what some of us have known for awhile–that you can't make money just managing captives. You must tie the onerous, tedious, increasingly expensive duties to other revenue streams.
In other words, if you can't place some coverage or sell some services to the captive, you may stay in business, but the condo on Seven Mile Beach is out.
We are also learning that the National Association of Insurance Commissioners is winning its fight against risk retention groups–not through fighting formations and licensing, but by requiring quarterly filings. Required paperwork will not only drive out firms that have underpriced their product, but it will close down RRGs that underestimated the huge cost of a back room to manage these monsters.
Meanwhile, the insurance industry remains heavily dependent on paperwork–with Sarbanes-Oxley and friends kicking this work into a new solar system.
Large firms that manage captives, provide actuarial services, and place fronting and excess insurance policies can handle this heavy burden. Small, boutique firms relying on being cheaper than the big guys are simply washed away by the streams of paperwork required. (Nor, in fact, do they always understand all that is required, putting their clients in peril.)
Further, those not well versed in insurance and risk finance are probably learning that the captive business is slow but merciless with firms that do not practice good insurance and risk management. This includes not only proper management and control of risk, but also experienced judgment about commercial enterprise.
Insurance and alternative risk-transfer are unforgiving about the maintenance and practical management of a business. The days of accrual accounting with a pencil on the back of a cocktail napkin are long gone. Every clever new twist on the RRG concept is not commercially viable or able to be granted a license. In other words, a terrorism captive for everyone is not the answer.
What we are encountering is consolidation and increased pricing by vendors and suppliers–not because of reduced competition, but because few firms are charging enough of a fee. In addition, there are simply not many qualified individuals who can understand, explain and operate captives. This shortage of qualified staff cuts across all lines, from brokers to managers, to regulators and underwriters.
The consolidation of management, consulting and brokerage firms, combined with the mounting regulatory burden and the perennial shortage of good staff, will be a far greater challenge to the profession than lower premiums and slower formations.
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