Beyond the challenges: Seizing the untapped potential of captive insurance in India.

Since Indian insurance sector’s privatization in the year 2000, the industry has come a long way. From being nowhere in the global league tables back then to now being the tenth largest insurance market globally (in terms of gross written premium), it is poised to be among top 5 markets in due course. However, one space where Indian market has stayed significantly underdeveloped vs. other large markets is 'captive insurance' (i.e., insurance subsidiaries owned & controlled by firms from other industries).

Why having a robust captive insurance ecosystem is important.

A robust captive insurance ecosystem holds significant potential for a developing country like India, offering risk management benefits that reach far beyond just individual companies. Markets with a developed captive insurance ecosystem enjoy the following benefits:

• Bespoke risk coverage: Captives allow companies to design policies specific to their unique risks, covering areas typical insurers might not cover or cover only at higher rates. This can create savings and improve risk management.
• Better risk behavior & potentially better investment outcomes: Captives provide financial incentives for good loss control and risk management practices within a company. The insured can also exercise greater control over the investments made by the captive insurer and gain from prudent investment decisions.
• Strategic flexibility: The captive structure allows for better adaptability to changing risk profiles and market conditions, improving the flexibility with which new insurance policies are underwritten.
• New revenue stream: Profits earned by the captive insurance entity are retained by the holding company, creating a potential revenue stream - which can be used for reinvestment, supporting business growth, or offsetting other financial risks.
• Addressing unmet needs: By offering protection against specialized, niche, or emerging risks, captives can enhance the parent company's risk management strategy and provide a safety net in areas where coverage by traditional insurers may otherwise be unavailable or exorbitantly priced.
• Better access to reinsurance market: Businesses typically rely on commercial insurers to access the reinsurance market for large claims. Captives, being owned by the insured, can bypass commercial insurers and directly access reinsurance, potentially gaining lower costs and greater control.

What has stopped India from having an active captive insurance market so far?

Unlike some developed markets - especially the US - where 90%+ Fortune 500 firms are known to be actively using captives, Indian captive ecosystem has barely taken off yet. Key reasons for the same include:

• Tough capital entry barrier: Insurance regulator IRDAI has itself called current minimum startup capital requirement of Rs. 100 Cr as being a “barrier rather than a facilitator” & has suggested making requisite policy changes to fix this bottleneck.
• Lack of market awareness: most major domestic companies have never used captive insurance and do not understand the advantages it can bring to their business.
• Limited support to successfully set up a captive: even companies which may understand the benefits would find setting up a captive as a complex activity which would require relevant guidance & attract significant regulatory scrutiny.

What’s next for the Indian captive insurance market:

• Policy landscape is likely to turn positive: IRDAI has already proposed favorable changes to the Insurance Act which may address some key concerns. These can include expanding the scope of captives and reducing capital requirements.
• Growing awareness: Indian firms are increasingly recognizing the potential of captives. Especially large conglomerates and multinationals can look to set up their captives within the next few years.
• Tax free zones to provide further impetus: Development of tax-free zones such as the emerging financial services hub, GIFT City, can immensely boost this sector.

What more is needed on the policy/ regulatory front:

• Simplifying the regulatory framework: Besides capital requirements, the other important change needed would be allowing captives to operate across lines and types of insurance businesses. Globally captives serve as both direct insurers and reinsurers depending on the need. Current regulatory norms only allow a company to operate as a general insurer or a reinsurer. Ideally, captives might even need an entirely new set of regulations which address their distinctiveness vs. regular insurers.
• Providing policy support for developing other parts of captives' ecosystem would be critical. These can include:

1. Supporting the development of captive management expertise and services in India, including talent training and infrastructure.
2. Offer tax benefits like premium tax deductions or exemptions for captives to make them more financially attractive - at least in the short term.
3. Consider providing initial setup subsidies or grants to incentivize captive formation, particularly for smaller companies.
4. Collaborate with industry players to develop best practices and regulatory frameworks for captives.
5. International partnerships: Partner with established captive markets to learn from their experiences and attract knowledge transfer.

The untapped potential of captive insurance in India presents a significant opportunity for stakeholders across the insurance sector. To seize this opportunity, it is imperative that concerted efforts are made - both by the policymakers & the industry. A more supportive environment for captive insurance can unlock their potential to contribute to India’s economic growth and bolster risk management & innovation.

(Disclaimer: the above views are author's own and do not reflect the views of EY or any of its member firms.)