The captive sector continues to grow substantially, according to a report released by rating agency AM Best.

Over the five-year period ending 2003, net premiums written grew by 45% and admitted assets by nearly 29%, said the report. This growth led to a concurrent increase in loss reserves of nearly 35%. However, there was a considerably smaller increase in surplus levels of 2%. As a result, while the underwriting risk covered by captives has grown, it has come at the cost of increasing leverage.

AM Best has accumulated statistics on captive insurers with data current through the most recently completed fiscal year, 2003. This composite includes 159 insurers which file a statutory financial statement with AM Best. Of this total, 126 carry a financial strength letter rating. Additional captives rated by AM Best file financial reports other than statutory statements and therefore are not included in these analyses.

Captive insurance companies are not immune to the vagaries of the insurance market, nor from the financial impact of incurred losses. In addition, management decisions have a direct bearing on the success or failure of any company. The last several years have been both a challenge and an opportunity for the captive industry. To varying degrees, captives have had to cope with fronting availability, cost and control problems.

The report observed that captive owners have seized these circumstances as an opportunity to take aggressive actions to ensure captive insurer viability and long-term financial strength. In many cases, premium rates were raised to reflect true loss costs and reinsurance expenses. Underwriting standards were tightened and many accounts in group captives were reunderwritten. Policy wordings were reviewed in light of current risk situations. Carefully considered expansions into other lines of business were implemented, in part to address a lack of commercially available insurance and in part to balance the overall portfolio of risks assumed by a captive. Applicants to group captives were screened with greater scrutiny and many turned away in order to ensure the integrity of the current program, commented the report.

Both as observed in the special report’s financial results and in anecdotal evidence gathered during the interactive rating process with AM Best-rated captives, managements have focused on program credibility and return value to the parent. They aim for critical mass to ensure an adequate spread of risk while not burdening parent organisations with such onerous capital needs as to affect the operations of the parents themselves.

AM Best said it anticipates that captive insurers will remain focused on underwriting profitability commensurate with their mandate to act as the insurer of their parent organisations. Market conditions might improve underwriting results as some of the high retentions necessitated by recent reinsurance pricing will be reduced as more reasonable terms and conditions become available again.

Additionally, captives are not excluded from the insurance industry concerns for the continuation of the federal Terrorism Risk Insurance Act program affecting most commercial writers. Over the next several years, if commercial insurance rates continue to decline, captives might lose a share of their business and will need to respond with lower rates or product enhancements.