Too big a risk for insurers who just fueled a $200 billion market boom in captives

As the domestic insurance market tops a record $200 billion, the reasons behind this boom show how a hotter, less stable planet is redrawing the risk map for corporations.

Captive insurance, where companies create their own coverage vehicles, is on the rise, according to insurance broker Aon Plc. Companies use it to avoid restrictions or prohibitively high prices imposed by outside insurers. And it is a development that is particularly pronounced in sectors related to climate change.

Oil and mining companies “are now using their captives to a greater extent,” John English, executive director of captive management and insurance at Aon, said in an interview. That’s as coverage from outside insurers becomes “unaffordable or unappealing from a price and capacity perspective.” In fact, a number of insurers and reinsurers have simply “divested” from fossil fuel firms, he said.

UK insurers are calling for the rules to be changed to establish a captive insurance regime

It’s the latest sign that climate change is changing the rules that underpin how markets work, as well as the economic cost of covering impact balloons. A recent report by Aon noted that the market for captive insurance has grown “significantly” over the past few years, with about a quarter of the nearly 3,000 companies surveyed saying they have resorted to such arrangements. In 2021, the figure was 17%.

“Climate change has a magnifying effect on all the risks we know,” said Peter Carter, head of climate and captives at broker Willis Towers Watson. And the captives “play a dampening role,” he said.

How captive insurance works:

A captive arrangement usually functions as a special purpose vehicle that is created to insure or reinsure the risk of the parent company that sets it up. Companies transfer premiums to their own insurance SPVs. Construction can sometimes be used to share coverage with outside insurers or to use alternative risk transfer solutions such as parameters.

Captives offer tax benefits, and companies using them can reinvest excess cash from their premiums. Captive insurance is used to cover a range of risks, from the environment to the threat of cyber attacks. Captive data do not capture the full extent to which companies insure internally. That’s because a company can also opt for self-insurance, where it puts money aside to cover future losses without creating a regulated SPV.

The global captive insurance market surpassed $200 billion in premiums last year, marking an all-time high, according to data shared by Willis Towers Watson.

This comes as extreme weather is pushing mainstream insurers from the US to Europe to raise prices to levels that make their services increasingly unaffordable. Sectors affected by the development range from utilities to renewable energy farm operators.

“We have a lot of premiums in the weather,” said Anna Pereira, senior vice president at Strategic Risk Solutions, a captive insurance specialist and former head of captive banking and insurance at HSBC Holdings Plc’s Bermuda office.

At the same time, a growing number of insurers and reinsurers are turning away from fossil fuel companies as they try to comply with climate policies and the transition to cleaner energy. Globally, 46 insurers now have some form of restriction on coal, oil or gas companies, according to Insure Our Future, a coalition of nonprofit organizations.

BHP Group Ltd., TotalEnergies SE, Enel SpA, BP Plc, Glencore Plc and Shell Plc have all created internal entities to hedge their risk, according to company filings. Other commodity companies now banking on the captive market include Thungela Resources Ltd., the spinoff from Anglo American Plc. Australian coal producer Whitehaven Coal Ltd. said it is in the process of establishing one.

In some cases, government-funded programs step in as commercial insurers pull back. North Dakota, meanwhile, recommends that companies turn to captives. In the state, home to 10 percent of U.S. crude oil reserves and one of the world’s largest deposits of lignite coal, the few insurers still willing to cover pure-play coal companies are raising rates and limiting policy renewals, according to an analysis by Bank of North Dakota.

Captive breeding can be bad news for the climate, according to Ariel Le Bourdonnec, an insurance campaigner at the nonprofit Reclaim Finance.

Captives are a “shadow part of the insurance industry” that allows polluting assets to continue to be insured, he said. Ultimately, the development could delay the transition to green energy, he said.

And companies that insure themselves may underestimate the risks they face. The most notable example in recent history is BP, which in 2010 relied on its captive insurance vehicle, Jupiter Insurance Ltd., to cover the Deepwater Horizon oil rig. When that rig exploded and sank, killing 11 people and causing the largest offshore oil spill in US history, BP’s captive insurance settlement was capped at $700 million and there was no reinsurance arrangement. BP is still counting the cost, which has since risen to tens of billions of dollars.

Aon’s English said there was a risk that captives could extend the life of high-emitting assets “if one does it blindly”. But such arrangements also help give companies time to adjust to a changing regulatory environment, he said.

“There’s a period of time where we have to phase these things out,” English said. The question then becomes, “What does that step look like?”

Photo: Firefighters battle a fire at the Deepwater Horizon oil rig in the Gulf of Mexico on April 21, 2010. Photo credit: US Coast Guard via Bloomberg

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