Malta responds to Solvency II’s threat to its captive business

The fact that Malta is the only full European Union and Eurozone Member State with Protected Cell Company (PCC) legislation and will soon introduce Incorporated Cell Company (ICC) legislation can only help the cause for Malta as insurance managers seek ways to cope with Solvency II’s expected harsher capital and management requirements, says the local captive management community. The PCC structure in particular is seen as a key selling point for Malta post-Solvency II because it potentially offers captive owners the opportunity to share the higher capital and management costs expected from the new rules in what is already a low cost domicile compared to others. John Stivala, who was appointed General Manager of JLT Insurance Management Malta Ltd last January, certainly believes that the potential for PCC business in Malta is good and that Solvency II could help boost demand.hide“Pure captive business has not really developed that much. It is predominantly third party business here in Malta. My feeling is that we will continue to see companies looking for direct writing capabilities. I see the PCC companies increasing in size. This business has not reached its limit unlike large multinationals in Europe, most of which already have captives, apart from maybe Italy,” he said. Mr. Stivala said that the main concerns over Solvency II he hears from insurance managers are based upon the capital requirements and compliance costs. LONG OR SHORT OF IT He pointed out that the eventual capital requirements will of course depend upon the risk profile of the captive and particularly whether it underwrites short tail or long tail business. “In some situations, such as short tail property business, I do not see a problem, but, in other cases it could be a problem. The standard model is still being developed and ECIROA [the European Captive Insurance and Reinsurance Owners’ Association] is lobbying for simplifications. The last word from ECIROA was that Karel Van Hulle [the man at the European Commission in charge of Solvency II] is more sympathetic, but will require written formal approvals,” he said. Mr. Stivala said that the main question on compliance revolves around the way in which the principle of proportionality, by which the Directive is supposed to allow simpler structures such as captives to suffer less onerous requirements than standard commercial insurance companies, is applied in practice. He supports ECIROA’s position that the implementing measures suggested by the Committee of European Insurance and Occupational Pensions Supervisors [the body of national supervisors that advises the Commission on Solvency II] have deviated too far from the original framework Directive and would severely restrict the application of this principle for captives. “Proportionality, when applied, should reduce the burden. But the implementing measures have deviated from the Level 1 Framework. They have gone overboard,” said Mr. Stivala. Another worry for Mr. Stivala is the potential impact of the Directive on the role of the captive manager itself and the ability of the captive owner to delegate key work such as accounting, investment management and actuarial services. Captive managers argue that the ability to carry out this delegation is one of the main benefits of a captive as it significantly reduces the cost and time commitment needed by the captive owner. Given that the basic tenet of Solvency II is that insurance companies must fully understand their risk exposures and preferably use internal models to do so, outsourcing such key functions will not be looked upon kindly, unless simplification measures are allowed. “For captive managers traditionally you would have everything managed by the captive managers. Take actuarial work. In my view it should remain the responsibility of the captive managers and they should co-ordinate the use of service providers. Should captive managers stop being responsible for compliance? No. I don’t think we should start unbundling services of the captive manager. The captive manager should still be the project manager and the captive owner should still deal only with the captive manager,” explained Mr. Stivala. But he does believe that you could see Solvency II as an advantage for Malta because of the low level of costs enjoyed by the Island. “This will need a higher level of time spent on compliance and costs will go up. Compared to other jurisdictions onshore we have a lower cost base. We also have fiscal advantages when compared with other domiciles,” he said. Stephen Portelli, Vice President, Captive Solutions Marsh Management Services Malta Limited, said that the potential impact of Solvency II on offshore domiciles and the fronting market could prove a bonus for onshore Malta. “If your captive is based in a domicile that is not in the European Economic Area (EEA) you cannot underwrite direct business on an admitted basis in Europe. So a lot depends upon whether the non-EEA domicile achieves equivalence [meaning that the European Commission recognises the solvency regulatory system as equivalent and it should, therefore, be on a level playing field with domiciles that have adopted Solvency II]. If it can, then the reinsurance market will probably grow in non-EEA domiciles but at a cost, in the form of fronting fees and cost of collateral. However if a programme is fronted then you do not have direct control and if you want to change your insurance products you need to go through the fronting insurer. It will be interesting to see what impact Solvency II has upon fronting companies, especially if they are fronting for reinsurance companies in domiciles which are non Solvency II equivalent. Will they be willing to front with Solvency II and if yes at what cost? “he asked. BALANCING ACT Mr. Portelli also pointed out that if, as widely feared, the new rules could drive capacity out of the commercial insurance market because of the increased cost of capital, then this could lead insured companies to carry the risk on their own balance sheet or provide a boost to captive formation. “Solvency II could be a plus for Malta. The history of captives shows that changes in insurance legislation together with the key factors of cost, cover and capacity have provided the necessary impetus for the formation of new captives. Solvency II will provide both opportunities and threats in terms of these key factors and Malta is well placed to benefit from these opportunities.” Ann Finn, Executive Director, Willis Management (Malta) Limited said: “The PCC legislation could be an even bigger sell for Malta. We also have redomiciliation legislation that obviates the need for costly and complex dissolution of the original company if a company wants to be set up onshore. The membership of the E.U. is obviously a good thing because you can write customer risks, compulsory or captive type risks on an admitted basis. The paper from Malta is as good as from say France.” Ms. Finn said that the critical advantage of the structure is that users of cells would not necessarily need to fund the €3.5m minimum guarantee fund required by the Directive for standalone commercial insurance companies, including pure captives as it stands, because of the shared capital base with other cells. This would also deliver lower management and running costs, she said. “If you have parallel cells it should make it easier to manage the capital requirements. A lot of people are worried about the management process and a cell could offer an easier opportunity. An incorporated cell in an ICC in my view is one company and each company needs a minimum guarantee fund therefore there is no obvious advantage for a captive company. Why bother if you still need to put up the €3.5m? I also do wonder how the PCC fits into the standard model of pillar two of Solvency II. We will have to work with the regulator to arrive at a sensible solution. But I do think the PCC structure will help some captive vehicle owners with the management of implementing Solvency II,” said Ms. Finn. Like many other Maltese captive managers Ms. Finn does not rule out the continued growth in numbers of pure captives on the island. But she does think that smaller, niche operators and insurance companies that take advantage of the country’s E.U. membership and therefore passporting rights to underwrite third party business is more likely. “There is no reason why Malta should not attract traditional parent-only captives as fronting is possible for non E.U. risks requiring admitted paper. But for more niche business rather than traditional captives business Malta seems to ring bells. The location is good in the middle of Europe and the language skills are important. Malta is a small place with a lot of small companies and people who are well schooled in running niche insurance companies or brokers rather than big companies therefore it is attractive for niche insurers looking to write cross border business. But there is no reason why pure captives should not come to Malta, it is just that the market has been so soft it has been slow to take off,” she said. Evander Borg, Head of Operations at Heritage Insurance Management (Malta) Ltd and Chairman of the Malta Insurance Managers Association, agrees that the prospects for smaller insurers appear brighter currently in Malta. Mr. Borg said that Malta does boast big corporate names with captives such as Vodafone, Nissan, Renault, BMW and Peugeot and enquiries from such companies continue to arrive. But, for new business development he suggests that the market could target smaller firms. For example Mr. Borg believes that the market is ready for broking firms that seek to set up their own specialist insurance firms and write third party business. “For brokers it could be a means to further extend the service that they can provide through the creation of such a company as part of a panel. The choice is up to the client of course, but the brokers could provide a wider package for their client that could provide coverage that is not normally included,” explained Mr. Borg. He said that both the PCC and ICC structures help to develop such business and pointed out that it can also include reinsurance solutions, particularly if the insurer finds it difficult to find reinsurance coverage from the wider market and would therefore consider the creation of their own reinsurance company. Stanley Mifsud, General Manager at Island Insurance Management Services Limited, believes that Solvency II will probably serve to ‘cool down’ interest in captives generally because of the increased capital requirements if nothing else. IMPACT ON DEMAND “Companies need more time to think about this before going down this route as it is not clear what is required currently. But, it does look like it will require more time and effort and costs and this will inevitably have an impact on demand. This does look too onerous for captives. I appreciate the thinking but I am very much afraid that it will lead to overregulation. It is important to appreciate the costs and risks of setting up a captive but it can go too far. It has to be appreciated that captives are different. And if they don’t accept that then they may have to accept that the business will leave the European Union,” he said. Mr. Mifsud said that because of the focus on costs Malta may enjoy a competitive advantage in the tougher captive environment. “Cost is a factor. Compared to other European onshore financial centres Malta is very competitive for property and professional fees and that does not mean lower quality than others. Dublin enjoyed this, but then with the evolution of the economy there prices have shot up. We may face that in 10 years time, but for now the customer can opt for the same standard of service but cheaper here,” he said. The outlook for Malta therefore looks as tough as it is for everyone else as it suffers from the same economic and regulatory pressures as its rival centres. The search for traditional, single parent captive business will not be easy. But, as its captive managers are unsurprisingly keen to point out, the island’s combination of E.U. membership, quality but flexible regulation, PCC and coming ICC legislation, low cost base and educated and English speaking workforce gives it many strengths to help it through the tricky times ahead. -Valetta, the capital of Malta, is host to the Maltese International Risk and Insurance Congress in November 25-26 during which the latest forces that affect captive formation and management will be discussed along with other key risk and insurance matters. For further details contact Hugo Foster. (HFoster@commercialriskeurope.com).

Malta responds to Solvency II’s threat to its captive business

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