Solvency II To Transform EU Captive Industry
Friday May 20 2011 | 07:56 AM

Increased regulatory requirements due to be enforced under Solvency II will change the captive insurance market environment dramatically, with regulatory capital requirements likely to increase by as much as four-fold for European Union domiciled captives, according to recent findings.

Solvency II aims to establish a revised set of EU-wide capital requirements and risk management standards, which will replace current solvency requirements. The implementation date is set for January, 2013, with Solvency II to be adopted by each of the 27 EU member states, plus three of the European Economic Area countries. It will apply to those insurance firms with gross premium incomes exceeding EUR5m, or with gross technical provisions surpassing EUR25m.

The impact of Solvency II has been questioned in a series of different findings since its formal adoption by the European Council in November, 2009. Now, a new report by the insurance ratings and information agency A.M. Best Co. has warned that it will force captive parent organizations to take a fresh look at the role of captives, in light of the vastly increased regulatory requirements expected under the new regime.

The findings are as follows:

• While most captives operate with multiples of the current regulatory capital requirements, many owners will have to commit more capital to their captives under Solvency II;
• Pillars II and III, which tighten risk management, governance and transparency standards, are predicted to lead to higher operating costs;
• Captives writing business inside the EU but domiciled elsewhere will be tied to the achievement and application of regulatory equivalence with the new EU system;
• Since many captives operate as reinsurers, equivalence could be a key consideration, as some reinsurance business is already supported by collateral or deposits of reserves with a fronting company;
• Captive centres clearly have a difficult balance to strike between obtaining equivalence and remaining attractive to captives; decisive factors are likely to be how proportionality is implemented within the EU, and the impact of collateral posting on captives. It is currently unclear whether proportionality - simplification provisions designed for smaller insurers - will apply to the captive sector;
• In order to minimize the impact of Solvency II, captives should prepare for a worst case scenario (namely the non-grant of proportionality), and try to mitigate the new regime's effects; and
• Participation in the European Insurance and Occupational Pensions Authority's quantitative impact studies, and the parallel development of partial capital models, best reflecting each captive's risks, are seen as key steps towards ensuring readiness.

Nonetheless, those captives able to obtain a secure financial strength rating should not have major difficulties adapting to Solvency II, according to A.M. Best. In particular, strong risk-based capital, robust risk management and governance, close integration with a securely rated parent and effective reporting systems, are believed to be mechanisms with which captives can position themselves to satisfy the demands of the new regime.