Along with rising interest rates, commercial real estate risk professionals face the challenges of managing escalating insurance costs - up 73% from 2017-2022 per Moody's - further squeezing net operating income. Captives, a form of self-insurance via a wholly owned subsidiary, can provide more flexibility and control but have traditionally only been viable for large firms. However, as open market insurance pricing climbs, captives may become more commonly used to mitigate cost increases.^[1]

Challenges in The Commercial Property Market Drive Captive Interest

Property insurance rates are rising rapidly amid shrinking capacity and increasing losses, a challenging dynamic expected to persist through 2024 without changes. Global property insurance pricing rose 7% in Q3 2023 and 10% in the prior two quarters per Marsh index, partly driven by high reinsurance costs and strong demand for limited capacity. In the US, property insurance rates have increased 14% year-over-year and for 24 straight quarters. Other regions like Latin America, the Caribbean, Europe, and parts of Asia also saw premiums rise from 1-8% in Q3. From 2017-2022, the annual global average catastrophe loss was $110 billion, more than double the prior 5-year average per Swiss Re, further fueling the hardened market.

CAPTIVE INTEREST

Captive use has been growing in response to the hard market, and the latest figures released by AM Best in August 2023 show that the captive surplus has grown by about USD 4 bn or 17% since 2018. Combined with stockholder dividends of about USD 5.3 bn, captives have saved their enterprises USD 9.4 bn over the past five years in money that could have gone to the traditional insurance market. The US captive market has grown significantly in recent years. US domiciles account for 52.4% of all global captives and North American offshore domiciles, including Bermuda and Cayman, account for 33.1%. ^[2]

The use of captive insurance by commercial real estate companies is a growing trend, particularly in response to challenges in the commercial property insurance market. Captive insurance companies have been outperforming commercial insurers, and captives have increased related to property coverage. Given the shrinking insurance capacity and rising premiums in the commercial property market, this trend is driven by the need for more flexible and cost-effective risk-financing options. Experts predict a 5% to 25% increase in commercial property insurance premiums in 2024, further highlighting the commercial property insurance market challenges.

The Flexibility of Captives

Captive insurance provides an effective option for organizations seeking more control and flexibility amid challenges in the commercial property insurance market. As in prior hard markets, more companies are utilizing captives - either forming new entities or expanding existing ones - to access additional capacity, achieve better rates/terms, address coverage gaps, and develop customized solutions. For those with existing captives, funding more property risk is straightforward; others may consider creating one given the current dynamics.

• Captives bring additional capacity to supplement commercial insurance
• Enable policyholders to increase control over property risk program
• Can improve rates, terms and conditions from the commercial market
• Fill in coverage gaps left by traditional policies
• Allow customized coverage solutions not available commercially
• Existing captive owners can easily fund more property risk
• Forming new captive may be appealing based on the current market

Effective Captive Solutions Must Be Technology Enabled

Progressive commercial real estate companies are adopting technology-enabled platforms to holistically control risk. A prime example combines a full-stack risk management platform tailored for CRE with captive insurance structures. Here are the critical capabilities provided by solutions of this type:

Risk Analytics Powered by AI - At the core is a digital risk analytics engine powered by artificial intelligence (AI) and machine learning algorithms. AI can dynamically track tenant default risk at the unit level and across portfolios by ingesting data from property management systems and external sources. This enables superior, transparent risk pricing and underwriting versus traditional methods.

Automated Captive Insurance Platform  - The full-stack CRE risk management platform and AI engine automate the administration of an owner-controlled captive insurance entity. Premiums based on a portion of rent create a shared coverage pool for the entire portfolio. The captive structure provides tax advantages and transforms security deposits into working capital for owners.

Streamlined Integration  - Integration with property management software and APIs enables smooth workflow embedding across underwriting, policy administration, claims management and trusted, end-to-end transaction security.

Strategic Partners Provide Reinsurance - Partnerships with established insurers allow the platform to access reinsurance and experienced captive management resources. This provides credibility and administrative simplicity.

Improved Risk Management - The solution incentivizes selecting lower-risk tenants and proactive risk mitigation by owners to control claims costs over the long term. Premiums and improved revenues offset 
TCOR.

Regulatory and Tax Compliance -Experienced insurance partners ensure the captive structure meets all regulatory and tax requirements. Owners receive only legally compliant benefits. In essence, alternative risk financing transforms insurance from a grudge purchase into a value-generating component of the multifamily enterprise system.

Conclusions

Current market dynamics make conventional coverage unsustainably expensive and risky for owners. By embracing captive insurance programs centered around insurtech platforms, multifamily firms can control costs and risks on their terms.

The future lies in fully integrating risk analytics and management into core business operations. When risk management and financing are seamlessly unified, premiums become intelligently invested capital rather than a pure cost. AI and automation provide the key to unlocking this potential. Multifamily firms that leverage alternative risk financing today will reap the benefits in long-term viability.

[1] CRE Insurance Primer: How To Navigate Tumultuous Times in the Insurance Industry | Moody's Analytics, Jan 2024

[2] The Rise of Property Captives in the US | Alesco, Nov 2023