The Captive Landscape in Canada
Canadian companies are facing an abundance of opportunities and challenges in the always-changing risk landscape. The uncertainty around what the new North American Free Trade Agreement replacement, known as the United States-Mexico-Canada Agreement (USMCA), means for the future of Canadian trade deals, the November changes to the Personal Information Protection and Electronic Documents Act (PIPEDA), and the revelation that Canadian insured losses from catastrophic events exceeded US$1 billion for the fifth time since 2010 are just some of the challenges they face.
While commercial insurance offers solutions to manage some of these risks, companies may also choose to self-fund part, or all, of their risks. Typically, organizations will build their pre-loss funding strategy on a pay-per-claim method. This approach can lead to financial volatility in cash flow and inefficiencies in tracking loss causes and payment of claims.
A frequently overlooked self-financing option for Canadian companies is a captive insurance company. A captive can introduce structure and protect the company’s balance sheet while maintaining flexibility in program design and providing potential savings.
Canadian companies that understand the value of captives are typically motivated by the following common drivers (see also, the Six Cs of Captive Value):
- Market pressures: A captive can alleviate market pressures, capture potential underwriting profit for expensive insurance placements, and provide access to reinsurance to fill capacity. Some companies even use their captive to strategically replace commercial insurance capacity on excess placements and evidence their strong risk management approach in negotiations with insurers.
- Bridging risk appetites: Captives can help in balancing the varying risk appetites of corporate and business units through deductible buy-downs and reducing volatility for the units.
- US operations: Given that Canada and the US have one of the largest trading relationships in the world, it’s natural for many Canadian companies to have US operations. If these operations are significant, it may be a viable opportunity to use a US-based captive to access the reinsurance backstop offered under the US Terrorism Risk Insurance Act (TRIA) and Terrorism Risk Insurance Program Reauthorization Act (TRIPRA). These Acts provide insurance coverage for nuclear, biological, chemical, and radiological (NBCR) exposures, which traditional insurers are not able to offer.
- Multinational operations: Captives can potentially generate tax efficiencies on non-Canadian premiums and tax deferral on Canadian premiums.
- Group captives: Not every Canadian company is an ideal candidate to form a captive. A significant scale is often required for a single parent captive, especially for those with a local or small geographic footprint. However, a captive can become more feasible when companies group together through professional associations, franchise associations, or industry groups. These group captives can add value by merging gaps in risk appetite, providing better coverage, and lowering rates for individual members.
- Third-party risks: Companies can use captives to insure third-party risks such as franchise operations, employee benefits, and extended warranties. For example, companies in the automotive, manufacturing, and telecommunications sectors have profitably utilized their captives to generate a competitive edge in the marketplace by providing their customers with additional value while earning underwriting profit.
While the majority of Canadian company or association owned captives are domiciled in Barbados and Bermuda for their innovations and positive regulatory environments, some companies that don’t have foreign risks may want to consider maintaining a captive locally in Canada. The only province with captive legislation is British Columbia (BC), which as of 2017 supports 21 captives (March 2018, Business Insurance). A BC captive has reasonable capitalization requirements, a favorable regulatory environment, and no “mind and management” issue for Canadian organizations.
As Canadian companies continue to become more sophisticated in managing their risks and exploring captive solutions, they should be aware of several regulatory and market trends, including:
- Recent US tax cuts: With the overall reduction of the US corporate tax rate to 21% (in addition to state taxes) from 35%, the impact on US-domiciled captives and offshore captives has been a mixed bag (learn more about the Impact of US Tax Reform on Captive Insurance Companies).
- Large flood and fire losses in Canada: In 2017, catastrophic events, including record breaking wildfires, led to approximately CAN$1.33 billion in insurable losses in Canada (Canadian Underwriter interview with CatIQ Inc.). These high-severity events resulted in greater volatility in the insurance market, leading some companies to restructure their property risk placements. Increasing premiums and coverage limitations in commercial insurance caused some large companies to pay greater attention to their risk management strategies, including exploring options for higher self-retentions and alternative risk solutions, such as catastrophe bonds and insurance-linked securities (ILS).
- Growth in captives writing non-traditional risks: Captives offer flexible options to finance non-traditional and high-severity risks, such as cyber liability, supply chain, and environmental liability. For example, from 2012 to 2017, there was a cumulative growth of 240% in Marsh-managed captives writing cyber liability.
- Employee benefits (EB). Multinational companies with large number of employees dispersed across geographies may look to finance portions of their EB programs through a captive. Pooling of EB can result in greater market strength, paving the way for savings on a consolidated basis and providing a centralized view for rewarding risk-reducing behaviors, enhancing safety programs, and gaining control over costs.
The flexibility and innovation in solutions offered by captives and the growing number of domiciles available is expanding the captive market for Canadian companies of all sizes, especially those looking to accelerate corporate risk management objectives.