The global property insurance market is experiencing one of its most challenging periods in decades. In 2023, the estimated total economic cost of global natural disasters alone was USD$357 billion, with private insurance entities covering an estimated USD$123 billion of that total.
The resulting hard market has prompted insurers to move away from blanket limits to more restrictive coverage, a shift marked by significant premium increases and reduced market capacity. Reinsurance costs have soared by up to 80%, putting increased cost pressure on insurance carriers that get passed along to the insured.
Against this backdrop, captive insurance solutions have emerged as an attractive option for real estate firms and investors looking to manage risks and control costs. By building a solid risk management foundation through captives, real estate firms can safeguard their profitability, mitigate increasing risks, and increase their level of operational control.
What is captive insurance?
Captive insurance has been an option since the early 1960s, when regulated self-insurance emerged as a way to reduce reliance on the commercial insurance market. During hard market periods, commercial insurance is both expensive and reluctant to cover certain types of risk.
Captive insurance is an alternative risk transfer (ART) solution in the form of self-insurance, where a company creates its own insurance entity to manage its risks. This approach allows for greater control, customised coverage, and often significant cost savings over traditional insurance.
Conventional insurance products simply do not cover the unique risks many real estate businesses face, making captives particularly beneficial.
The shift toward captive insurance in real estate
The real estate sector is experiencing unprecedented challenges, all of which have impacted the viability and cost of traditional insurance options.
- Catastrophic risks: Natural disasters, accidents, and other unforeseen events can cause unexpected property damage and revenue loss. In 2023, the direct cost of natural disasters alone was 14% above the 21st-century average
- Market volatility: Economic conditions and fluctuations in the market can make property values and rental income difficult to predict
- Environmental exposure: Environmental hazards, pollution, and high energy consumption can lead to regulatory penalties or cleanup costs
- Rising costs: Global pricing for property insurance rose by 7% in Q3 2023 and 10% in each of the two prior quarters
As outlined above, the hardening market has led many insurers to adopt more restrictive coverage limits and increase premiums. Some have even exited certain markets altogether, leading to concerns about the insurability of coastal markets most vulnerable to the effects of climate change. With a lack of capacity in the market, real estate firms find themselves retaining more risk by increasing deductibles and even insuring at limits below replacement cost.
The benefits of captive insurance in real estate
In response to these challenges, the sector has seen a growing interest in captive insurance options as a tailored approach to risk management in real estate. Self-insuring through captives is an increasingly popular way to control costs while mitigating the risk profile of a property portfolio.
The many benefits of captives in real estate include:
- Bespoke coverage: Captives offer the flexibility to design comprehensive and tailored coverage, addressing gaps in commercial policies
- Economic advantage: By insuring through a captive and retaining a portion of the risk, firms can reduce their reliance on third-party insurers and potentially lower their premium costs
- Amplify profits: Captives can invest their reserves, generating additional income that can be reinvested into the business
- Fill coverage gaps: Captives can extend comprehensive protection for specific risks that are not covered by traditional insurers
- Deductible buydowns: Captive policies can reduce the deductible amount a property owner must pay in the event of a claim, improving financial stability
- Stable underwriting: Captives can be rated based on a company’s specific loss history, offering more predictable pricing
- Data and analytics: Captives are flexible enough to cover emerging risks before traditional markets have developed relevant products
- Control and flexibility: Firms have more control over claims handling and underwriting criteria, allowing for flexibility in the face of changing market conditions and evolving risk factors
Conclusion
The current challenges in the global property insurance market present an opportunity for real estate businesses to explore innovative solutions, including alternative ways to manage risk. Captive insurance presents a strategic response to a hard market, providing tailored coverage, greater control, and improved rates and conditions.
