Captive owners hope for proportional treatment under new rules

This is generally regarded as good news as they should deliver more robust and consistently regulated insurance markets. They should also lead to improved governance within the sector. The process is being driven by the International Association of Insurance Supervisors to an extent and this should help create a more level global playing field for insurers and their customers, not least in the increasingly important field of global programmes. It seems, however, that there is a danger that the significant difference between captives, especially those that only underwrite parent company risks, and the commercial insurance sector that underwrites third-party risks has not been explicitly recognised yet.hideIf captives are not recognised as different they could be subject to the same capital charges and reporting requirements as commercial insurance and reinsurance companies. This would make them unviable in the vast majority of cases. Captive owners in Europe have worked hard to try and ensure that captives do not have to comply with the same capital and reporting requirements as commercial insurance companies. Solvency II does explicitly state that captives should be regulated in a “proportional” manner. But it has been left to national supervisors to decide what that actually means. Despite assurances from some supervisors that they will apply the principle of proportionality as intended, there is still a nagging fear among risk managers of European-based captives that this may not occur as they had hoped and costs and the compliance burden will spiral as a result. Risk managers in the Asia Pacific region will have to hope that their supervisors will be willing and able to explicitly recognise the difference as they implement their Solvency II-style risk-based regulatory regimes such as the China Risk Oriented Solvency System (C-ROSS). C-ROSS was implemented in February 2015 and was effective immediately. But a transitional period has allowed insurance companies to follow the current solvency regime while simultaneously submitting a solvency report based on the new requirements. Tracy Stopford, managing director, Willis Captive Management Hong Kong, spoke during the captive session at the Parima conference and believes that regulation is on the right track for captives in Asia Pacific. “Is there a stable regulatory environment? The answer to that is: Singapore—definitely yes; and Hong Kong and China are catching up very quickly. One question is: how do you manage your assets? You need flexible regulation on how to invest your assets. Can you [the captive owner] invest your capital in anything other than cash or cash equivalents?” asked Ms Stopford. The broker said that she sees a real effort from regional supervisors to work with their global counterparts to develop a “gold standard” of regulations for captives that can only be good news. “I see cooperation between supervisors. Business really needs a gold standard of regulatory frameworks based on Solvency II. C-ROSS in China is becoming a reality. Singapore will have its new regulatory system in place in 2017/2018…regulators are really working very diligently to develop a gold standard of captive domiciles,” said Ms Stopford. She later added that a team from the Chinese Insurance Regulatory Committee (CIRC) had recently visited Vermont, one of the most successful captive domiciles in the US, to meet David Provost, deputy commissioner, Captive Insurance Division, to learn about captive regulation. “Vermont is regarded as the gold standard and they [CIRC representatives] held a roundtable with David. This shows that they are keen to learn from best practices and hopefully this will be taken into consideration when they prepare the rules,” said Ms Stopford. But Peter Kuczer, global client executive—Asia Pacific at ACE Insurance, based in Australia, warned risk managers that they need to keep a close eye on regulatory and political trends as things can change rapidly, as they did in Australia. “Look at Australia. It was promoting itself as a captive domicile and as a result a number of Australian corporations redomiciled back to Australia. Then there were the financial problems [not least HIH] in the market, followed by political changes, then a financial services review came in that led to the formation of the Australian Financial Prudential Authority (APRA),” said Mr Kuczer. “APRA makes no distinction between captives and commercial insurers so captives are subject to the same capital and reporting requirements. Therefore, in the space of two to three years every Australian captive left—there is not one left in Australia now. I do not think the Singapore or Hong Kong regulator will make the same mistake,” he added. Rob de Jonge, director, risk and analytics UK/international at Willis, warned potential captive owners, however, that the brave new world of risk-based regulation does mean that risk managers and their captive managers have to take life more seriously than they did perhaps in the past. “Captives nowadays are more work-intensive and most of this is regulation-driven because you need to explain what you are doing. You really need to review what you are doing in what lines, with what limits and the like,” he said. Mr de Jonge said that captive owners and managers really need to dig deep into the risks that they carry. They have to consider the many different risk scenarios and analyse how all the different insurers, sub-limits and retention levels would interact and also, of course, consider correlations. “You also have to make a distinction between low frequency and high impact and high frequency and low impact events. And you also have to look at the appetite of the risk organisation itself—how willing it is to accept risk and the impact on the cashflow? And how much the CEO is comfortable explaining [to investors] the subsequent deviation from earnings,” explained Mr de Jonge. “Then you have the explanations you have to give to the regulators. It is not just a simple interview with the regulator. You need to prove that you have correct governance systems in place, who does what and that procedures are in place. There is much more than in the past,” he said. Mr de Jonge also pointed out that captive owners and managers do not only have to worry about regulators nowadays. Tax authorities are also increasingly interested in such financing vehicles as they seek to maximise revenues. “You need to explain the level of premium to tax authorities that like it explained. This needs to be done because you can get significant tax gains depending upon how you structure your claims and the like and transfer pricing needs to be considered,” he said. “Transfer pricing is more of a bookkeeping way of dong this. Premium allocation is more of a management way of doing this. ‘He who pollutes most should pay the most premium.’ This helps determine how you invest to improve your risk profile,” continued Mr de Jonge. Loss reserving is another area that needs to be taken seriously, he said. “This has become much more detailed as well. Having the right level of reserving determines the capital requirements… so doing well helps reduce the capital requirements. Doing this in an actuarial manner also validates with stakeholders and regulators,” he said.

Captive owners hope for proportional treatment under new rules

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