Devastating hurricanes in Florida, catastrophic flooding in Kentucky, and crippling heat waves and forest fires in the Western and Northeast regions of the U.S. — all in all, the U.S. experienced 18 catastrophic disasters in 2022 according to a recent report from the National Oceanic and Atmospheric Administration (NOAA). Damage from each disaster exceeded $1 billion and totaled a staggering $165 billion last year. Over the past decade, many community banks have formed wholly owned captive insurance companies (captives) to help them pre-fund and prepare for future natural disasters and to cover risks that their commercial insurers will no longer fully insure.

What Is a Captive and How Can It Benefit Community Banks?

A captive is a wholly owned subsidiary of a bank’s holding company, operating as a licensed insurance company. The bank pays annual premiums to its captive for coverages not included in their regular commercial policies. A captive structure is not meant to replace a bank’s current commercial policies, but to strategically augment them.

Captives can cover insurance deductibles and exclusions, as well as emerging risks such as increasing climate catastrophes. With enhanced risk management and a meaningful federal incentive, banks in the KeyState Bank Captive Program can reduce the annual “total cost of insurance” by 20–30% and increase their average annual EPS by 1–2%. Insurance premiums do not leave your bank’s economic family unless you have to pay claims.

What Banks Can Form a Captive?

S and C Corp banks with $750 million to $15 billion in assets are well-suited for KeyState’s Bank Captive Program. Over 100 community banks have joined the Program since it was launched in 2012, including numerous banks in Mountain West and a large number of banks in the Midwest. Considering its compelling benefits and ease of use, KeyState added six new banks in 2022 and expects the Program to grow by over 10% in 2023.

Captives and Climate Catastrophes

Severe weather events aren’t new, but experts have noted a disturbing trend of increased frequency and severity of catastrophic natural disasters in the U.S. and around the world. Many companies in regions that are more prone to natural disasters have been utilizing captives as a risk management and funding mechanism for many years. Ten years ago, in the wake of Hurricane Sandy in 2012, one of KeyState’s bank clients in New Jersey with numerous coastal branches experienced significant changes to their commercial “named storm” coverage. Their commercial carrier raised their per-branch deductible to $250,000. The bank has five branches concentrated in a small stretch of the east coast which could all be impacted by a single future hurricane due to their proximity. The bank evaluated its options and ultimately decided to form a captive to help pre-fund for these potential future losses.

Of course, banks in hurricane-prone regions are not the only banks facing exposure to losses from natural disasters. The increase in frequency and severity of natural disasters over the past decade has caused banks to re-evaluate their overall insurance programs and consider forming captives to enhance their coverage. Beyond natural disasters, a captive can also be structured to provide additional coverage for other types of man-made disasters like riots, cyber attacks, and terrorist attacks.

Why is Now the Time for Community Banks to Evaluate Captives?

In 2021, the 10 largest U.S. captive domiciles saw 95 new captive insurance company formations, which is a significant increase over previous years and an early indication that 2022 captive formations will exceed 2021 numbers.

Large U.S. companies have used captive insurance companies for decades. With a hardening commercial market and increased risk of natural and man-made disasters, there are compelling reasons for banks to assess their current commercial insurance and consider future scenarios. Below are some examples as to where a captive could cover unfunded risks:

• Commercial premium increases: Along with increasing costs for natural disasters, cyber coverage premiums are up 20–40%, while banker’s professional liability and crime bond premiums have risen 10–30%.
• Commercial coverage limits: Higher deductibles, broader exclusions, and sub-limits applied to certain coverages make captives a viable alternative.
• Coverages not available commercially: These include reps and warranty coverage for M&A transactions and legal expense coverage for class-action nuisance suits.
• COVID claim rejections: While many commercial carriers have denied COVID business interruption claims, KeyState’s Bank Captive Program has settled more than $4 million in COVID claims.

David Guerino is Senior Vice President & Managing Director-Captive Insurance for The KeyState Companies, which manages tax advantaged investment and insurance structures for over 130 community banks across the country. He oversees KeyState’s Bank Captive Program, which has been endorsed by 30 state banking associations including the Colorado Bankers Association.