Captives Feeling the Squeeze As Global Pressures Intrude: A.M. Best

August 6, 2012

Captive insurance firms in the United States are feeling the squeeze of an ongoing soft insurance market, low investment yields and a bleak global financial picture, a new report revealed.

A composite of 209 U.S. captive insurance entities and alternative risk vehicles followed by A.M. Best Co. saw 2011 net income decrease by $537 million, or 21 percent. The decline is attributable to decreases in underwriting income, net investment income and realized capital gains. Other items also contributed to the decrease in net income, such as increases in other expenses and income taxes.

Underwriting income for 2011 decreased because of increases in loss- and loss-adjustment expenses (LAE) incurred ($318 million, or 6 percent) and underwriting expenses incurred ($129 million, or 8 percent), partially offset by a decrease in dividends to policyholder/owners of $129 million, or 29 percent, and an increase in net earned premiums of $59 million, or 1 percent.

The increase of incurred loss and LAE primarily reflects decay in losses in the medical professional liability insurance (MPLI) line of business. Written and earned premiums for 2011 were essentially unchanged compared with 2010. The pure loss ratio for MPLI increased 5 points in 2011 due to rate decreases and increased loss activity in this line of business. Most other lines of business experienced declines in pure loss ratios or small increases that were driven by deterioration in premiums as well as some increases in incurred losses.

The increase in underwriting expenses is attributable to increased net commissions incurred of $46 million, or 16 percent, coupled with an increase in other underwriting expenses of $83 million, or 7 percent. Other underwriting expenses are composed of items such as premium taxes, salaries, rent and equipment, and other expenses. All expenses except salary expense were essentially flat between 2011 and 2010, and salary expense increased $57 million, or 11 percent, in 2011 compared with 2010.

Net investment income decreased in 2011 by $95 million, or 7 percent, due to a 30-basis-point decrease in yield on fixed-income securities, which was only partially offset by a 3.4 percent increase in invested assets. Asset allocations explain the decrease in net investment income, since bond and stock allocations dropped from 59.1 percent and 10.2 percent of invested assets for 2010, respectively, to 58.4 percent and 9.8 percent of invested assets for 2011, respectively. Cash and short-term investment allocations increased from 7.3 percent to 8.0 percent of invested assets for 2011 compared with 2010.

The changes in allocation have further strained investment yields and net investment income, but they make sense in light of the flat yield curve coupled with most captives’ investment philosophy, which considers preservation of asset value as the principal objective. These reallocations provide for a relatively safe investment portfolio that is somewhat insulated from downside valuation shocks at the cost of yield. It should be noted that captives’ investment portfolios performed significantly better than commercial insurance companies’ portfolios during the crisis of 2008-2009.

Source: A.M. Best

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