Captive groups seek talks with ministers and EC on Solvency II

FERMA and ECIROA and the captive management operations of brokers Marsh and Aon have written to the ministers to tell them that if the new capital regime is applied as it stands many European captives will be forced out of business and that non-E.U. captive domiciles could gain an unfair competitive advantage as a result. Some experts have advised, however, that while the Commission and the European Parliament have publicly signalled that they are happy to listen to further lobbying on Solvency II, they want to hear achievable and simple solutions, not further long lists of complaints.hideSTAKES RAISED The captive industry’s decision to raise the stakes and write to national Ministers as well as the Commission directly has been in the making for some time. The first spark came when CEIOPS seriously toughened the basis of its capital calculations since its last draft (Quantitative Impact Study 4) because of the lessons it said it had learned from the credit crisis and subsequent global financial and economic downturn. The tougher capital rules, when combined with new disclosure and corporate governance requirements, would deliver much higher costs for insurers and force a consolidation in capacity, argued insurer and insurance buyers’ representatives. The final advice that was delivered in late January was less tough than the consultation issued late last year and CEIOPS conceded that it had watered it down after listening to the reaction and advice of the industry. But, insurance representatives say that the advice that CEIOPS has provided to the European Commission is still far too tough. Michaela Koller, Director General of the Brussels-based Comité Européen des Assurances (CEA) told CRE: “We are still disappointed. We really thought it was overly conservative and it is also fair to say that they (CEIOPS) have strongly overinflated the prices used and presented advice that is over the top of what everyone expected. I personally expect CEIOPS to carry out further analysis and comment more, ideally before QIS5, because we would agree that it would be dangerous to test on the wrong numbers because these are the final calibrations and one should be as close as possible to reality.” To make matters worse for insurance buyers, the original Solvency II Directive made it clear that captives should benefit from the principle of proportionality under which local supervisors would be able to apply a simpler version of the rules to reflect their simpler structure. But, CEIOPS proposed a stricter definition of captives than FERMA, ECIROA, the captive managers and captive domiciles within the European Union had hoped for and they believe will mean that many captives will not qualify for the simplifications. The captive representative bodies argued strongly for a looser definition when they responded to the final consultation in December. But their calls fell on deaf ears. ‘The introduction of Solvency II without recognition of the simplicity of captive structures will have a dramatic impact upon the captive community, leading to increased costs for all and possibly the demise of some,’ stated the letter. The letter said that the group had met CEIOPS to discuss how Solvency II would apply to captives. But, they said that unfortunately the meetings had not led to a ‘common understanding’ of what captives really do. As a result, the group said that it now felt it was necessary to explain in more detail how captives differ from commercial insurance and reinsurance companies. ‘Until this is clearly understood, any Level 2 implementing measures which are being proposed for captives will at best be ineffective and at worst damaging to the future of the captive industry in Europe, to the benefit of non-equivalent jurisdictions,’ stated the group in its letter. The group also pointed out that the current requirements for catastrophe risk and concentration risk in particular would make it difficult to see how the simplifications could be applied at all. ‘The proposed standard formulas, when applied to captives, result in much higher levels of prudence for captive undertakings than for commercial insurers and reinsurers because the current formulas are not adapted to the business model of captives. Both the formulas and the corporate governance principles need to be simplified and aligned to the captive business model,’ continued the letter. PROPER APPLICATION The group said that, because of the limited captive definition and increased calibration requirements, it felt that it needs to now communicate directly with the European Commission, local finance ministers and supervisors, to alert them to the importance of the application of the proportionality principle to captives. ‘The proper application of the proportionality principle will have a very significant influence on the continued existence of captive insurance companies in Europe. We strongly believe that its application should reflect the principle-based approach of the Framework Directive and therefore should not be applied in a rigid and inflexible manner,’ stated the letter. Jonathan Groves, Senior Vice President responsible for the captive consulting services of Marsh, agreed that the focus should be upon implementation rather than capital requirements at this late stage. “For capital requirements, the standard formula has already been established under QIS4. The full details of how this will finally be applied will not be known until QIS5 is released. But the standard formula itself has been fixed,” he said. “The biggest operational impact will be on governance requirements. There are significant governance requirements for documenting, checking and reporting and having an ongoing policy of migration. That will be a key aspect for captives,” explained Mr. Groves. He said that the biggest uncertainty is over how the principles of proportionality will be applied in practice and what they actually mean. Mr. Groves pointed out that CEIOPS has stated that it will not give further guidance on how the principles are to be applied in practice and believes that this is a ‘big concern’ for captive owners. “We will have no clear idea until the Level 3 advice is ready and it becomes clear how the regulators will apply the rules in reality,” he added. Mr. Groves said that the risk governance requirements of Solvency II should be looked at as closely as the capital requirements if not more so because they are potentially tough if a captive does not qualify for simplifications. “You could argue that it is good business practice to have in place proactive systems that ensure catastrophes, market risk, underwriting methodology and the like are documented, managed properly and the right back-up systems are in place. The risk management has to be documented and clear and must be reported on a regular basis. This is a lot of work,” he said. “You cannot just rely on the good name of the company that may be carrying out this work for your captive. You also need to have a specific actuarial function. You don’t necessarily need your own actuarial staff but you need your own function that needs to be internally managed. Does this mean that the directors of the captive need to understand the details of the stochastic models?” asked the broker. “Also the Directive requires that companies need to have a dedicated risk management function and it needs to be demonstrated that the calculations and assumptions have been carried out properly and externally viewed. And if they have not, then it needs to be explained why,” continued Mr. Groves. The Marsh captive expert said that the cost of compliance with the risk governance requirements could potentially increase ‘massively.’ “Solvency II has been around for several years now and the captive industry now needs to debate the ‘how’ not the ‘if’. The real question is really what kinds of management policies are needed and whether captives will need employees or quasi managers,” he added.

Captive groups seek talks with ministers and EC on Solvency II

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