Captive Insurance: A Strategic Asset for Mitigating Climate Risks

 
July 1, 2024

As climate change escalates the potential severity of certain weather-related natural disasters like hurricanes and wildfires, corporations face increased threats to their operations and financial stability. Captive insurance strategies are emerging as financial safeguards and vital tools in the strategic management, mitigation, and adaptation of these climate-related risks. Furthermore, a captive can be a risk-financing vehicle that builds up surplus over time to help pay for more catastrophic risks such as hurricanes.

Recent Insights on Hurricane Predictions for 2024

Recent forecasts underscore the importance of robust risk management and climate risk mitigation strategies:

• NOAA Prediction: Conditions are set for significant hurricane activity in 2024 due to warmer-than-average sea temperatures and potential La Niña conditions, highlighting the need for preparedness in facing more frequent and high-category hurricanes (NOAA).

• National Hurricane Center: Without specifying numbers, the NHC indicates that the upcoming hurricane season could see above-average activity, including multiple Category 5 hurricanes, underscoring the critical role insurance and reinsurance plays in managing these risks (National Hurricane Center).

Understanding the Role of Captive Insurance

Captive insurance companies, owned and controlled by the entities they insure, have traditionally provided coverage for risks too costly or complex for the commercial market. With the growing impact of climate change, captives can be an option when crafting customized insurance solutions that address the nuanced risks posed by increasingly frequent and severe weather events. 

Having a captive as part of an overall insurance program provides the opportunity to present better data on individual risks as opposed to the industry average. As insurance-licensed entities, captives can access the reinsurance, alternative risk transfer, and capital markets to fund less predictable risks that are difficult to place in the traditional commercial market. Alternative risk transfer solutions such as parametric insurance (which pays out based on a predefined event, such as a certain wind speed in a hurricane) and derivatives (financial contracts whose value is derived from the value of an underlying asset) are becoming more popular for hedging risks. 

Strategic Risk Management through Captives

• Tailored Coverage for Specific Risks: Captives are particularly adept at filling coverage voids left by traditional insurers, especially for emerging risks driven by climate change. This includes property damage from hurricanes, business interruptions from supply chain disruptions, and environmental liabilities, where captives provide a sense of security and protection.

• Direct Access to Reinsurance Markets: By engaging directly with re/insurance markets, captives can secure terms that are often more favorable than those available to standard insurers, which is crucial for managing the broad, complex risks associated with climate change.

• Enhanced Risk Prevention and Mitigation: Captives facilitate more significant investment in loss prevention and mitigation, empowering parent companies to implement measures that reduce potential losses from climate impacts, such as fortifying infrastructure against extreme weather events.

Example Applications in Diverse Sectors

• Energy Sector: Energy companies use captives to insure against revenue losses from climate-related damage to infrastructure, such as solar panels affected by severe weather events.

• Agriculture: In the agricultural sector, captives insure against crop losses due to climate-induced droughts or floods, with policies tailored to specific crops and regions.

Captives are Well-Suited for Climate Risks

The transition to a low-carbon economy is changing the appetite of commercial insurers for climate-related risks and reducing capacity for certain business activities and geographies. The strategic use of captive insurance addresses the financial implications of climate-related events and enhances corporate engagement with comprehensive risk mitigation and sustainability efforts. The adaptability and customization captives offer are particularly suited to manage the coverage gaps and complex challenges posed by climate risks, ensuring long-term corporate resilience and sustainability. Managing risks related to climate change is one of the biggest challenges of our time, and captives are a great place to start.

Article written by Anna Pereira, Senior Vice President
Insurance Linked Securities, SRS Bermuda

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