Migration forecast as captive owners wait for clarity from EC
Meanwhile, domiciles that have decided not to implement Solvency II such as Guernsey and the Isle of Man believe that they will benefit from a migration of captives to their centres because they will be able to guarantee that captives will not be as heavily regulated as standard commercial insurance companies.
Even Bermuda, which seeks equivalent status, believes that it can now state confidently that it will implement the regime in a proportional manner for its captives.
It is likely that the EU captive domiciles will step up their efforts to seek guidance from EIOPA and the European Commission about how proportionality should be applied in coming months just as the European Captive Insurance and Reinsurance Owners’ Association (ECIROA) has been trying since its formation.
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Formal guidance should arrive when the European Commission announces the final Level 2 and 3 guidance measures. But many captive owners are increasingly nervous about the impact of the new rules on their captives and would like to see some form of guidance earlier.
The implementation of Solvency II is not an option but an obligation for EU domiciles such as Luxembourg.
The regulator, the Commissariat aux Assurances, said it is internally implementing the Solvency II Directive, and the insurance and reinsurance sector will shortly be part of the discussions on the implementation through the creation of a special dedicated working group.
The Commissariat sees both benefits and challenges from Solvency II. “The benefits of implementation are straightforward: companies licensed in Luxembourg will benefit from the freedom to provide services in the other European countries and reinsurance treaties contracted with Luxembourg captives will be fully recognised as risk mitigation instruments,” the Commissariat told Commercial Risk Europe.
“One major advantage which distinguishes Luxembourg from other captive domiciles is that the equalisation reserves will be fully recognised as the best quality of capital (Tier 1) under the new Solvency regime, since this reserve is fully loss absorbent.
Indeed, the Commissariat said that despite a small decrease in the number of reinsurance companies during the last years, “Solvency II does not seem to stop international groups from establishing a captive in Luxembourg, as evidenced by new applications being received on a regular basis.”
It added: “A major challenge will certainly be the requirements of the Pillars 2 and 3 of the new regime. We are, however, confident that all the necessary requirements will be able to be met by a large number of companies.”
Another challenge of the new regime will be for newcomers, that will not have built up sufficient equalisation reserves over time, said the Commissariat.
“When it comes to the principle of proportionality, it remains to be seen how much freedom will be left in this field in so called Level 2 and 3 measures currently being developed by the European Commission. Currently, no special captive-specific proportionality requirements are being developed by EIOPA or the Commissariat aux Assurances, partly because of the fact that the relevant pieces of Level 2 and 3 are not finalised yet,” said the Commissariat.
There is, therefore, a waiting game being played by domiciles making it hard for regulators to announce any plans.
Michael Oliver, Head of Insurance Supervision, Gibraltar Financial Services Commission, said that Gibraltar, as part of the European Union, will implement the Solvency II directive, but at this stage, the Commission does not have a public opinion on the application of the principle of proportionality to recognise the difference between captives and standard commercial insurance companies.
He added that EIOPA continues to work on Level 3 guidance that will influence the way in which the FSC will operate. “The FSC maintains on-going dialogue with all Gibraltar insurers and their insurance managers,” he said. “This has involved working with them on completing QIS5 in 2010 and in discussing their preparations for implementing requirements for the new Solvency II regime.”
As for Malta, which will also implement Solvency II, the key benefits would be a more sophisticated, competitive insurance market which would compete on the same level as other EU countries, according to Chris Cachia of Ganado & Associates in Malta. “This would be achieved through the corporate governance and better risk management systems which would need to be implemented, which would translate to a lower risk profile. This would have the effect of lowering capital requirements and resulting in lower premiums for policyholders and added capital return for investors.” He acknowledged that there is no clear indication on the way the principle of proportionality will be applied to captives as yet, but added: “We believe that the introduction of the Solvency II regime would make Malta a more competitive jurisdiction providing a more sophisticated insurance market.”
Outside of the EU, Solvency II has perhaps been more heavily debated by the captive sector than within the union.
The issue of whether to seek equivalence has been taxing the minds of captive experts and regulators in a number of domiciles which, whilst outside the EU, nevertheless rely, sometimes heavily, on EU parented captives.
Guernsey was one of the first domiciles to announce that it had no plans to seek equivalence with Solvency II. Martin Le Pelley, Chairman, Guernsey International Insurance Association, said this was largely because of the lack of commercial reinsurance activities with European insurers.
“The reason for Solvency II equivalence is to protect the European insurance market from doing business with third country (non-EU) jurisdictions where the regulatory regime may not be as robust for reinsurance. Whilst Guernsey’s regulatory regime is fully compliant with international best practice, as evidenced by the recent IMF report, there is little commercial reinsurance business transacted in Guernsey, and so there is no need to provide assurance by seeking equivalence,” he said.
According to Mr Pelley, Solvency II is supposed to be ‘risk based’, “but the standard formula is quite inflexible as to the recognition of risk for non-commercial insurers. This makes Solvency II disproportionate for captives. Consequently, Guernsey has chosen to avoid making changes to its regulations which are disproportionate for captives, and rather is continuing to offer a regulatory regime which is currently appropriate for captives and will continue to be so after the implementation of Solvency II.”
He added: “We expect captives will want to redomicile to Guernsey, especially where the solvency requirements in the EU do not properly reflect the risks associated with the captive, which will happen because the Solvency II standard formula is calibrated to that of a mid-sized commercial insurance company, and not a captive…the uncertainty of Solvency II in Europe, combined with a greater focus on risk management by medium-sized firms, makes the captive option ever more attractive in managing risk.”
The Isle of Man is another domicile that is not currently seeking third country equivalence. Alan Rowe, Head of Supervision—Non Life, Isle of Man Insurance & Pensions Authority, said: “The key reason for this is the continuing concern expressed by specialist insurers, notably the captive sector, that Solvency II is not yet a proportionate regulatory framework for their particular risk profiles.”
The danger for domiciles that do not seek equivalence is a possible exodus of captives for corporate governance reasons, but Mr Rowe said that the Island did not expect to see an outflow of captives as a result, not least because “sound governance is a central feature of our developing regime based on the core principles of the International Association of Insurance Supervisors.”
On the contrary, he said the Isle of Man, like Guernsey, expected to attract some captives, which may or may not be EU-based, and seek a specialist location for their business, because of the issue of proportionality.
“Current expectation in the Island’s captive market is that there is significant potential for growth and that this will result in increased captive numbers over the next few years, despite prevailing market conditions,” he said.
One domicile that has clearly stated its aim to seek equivalence is Bermuda, and the domicile is one of the first to be assessed for Solvency II equivalency.
The European Insurance and Occupational Pensions Authority (EIOPA) recently published its draft report providing advice to the European Commission on the equivalence assessment of Bermuda’s insurance supervisory system against the Solvency II framework.
The report advised that Bermuda is overall equivalent on each of the three assessment criteria for the commercial insurance sector. According to Richard Lightowler, Lead Partner, Insurance at KPMG in Bermuda, “Of real significance is the fact that the draft essentially provides for segmented equivalence, that is, equivalence for the commercial sector without requiring the unnecessary burden of a Solvency II equivalent regime for the captive sector.”
He added: “All constituents of the market should be able to take comfort that they will be appropriately regulated. The commercial sector will be required to meet the exacting standards of Solvency II, with the Class 1, 2 and 3 companies continuing to be regulated commensurate with their limited purpose, and therefore risk. In my view this outcome truly reflects the concepts of risk-based and proportionate regulation.”
The reach of Solvency II goes well beyond Europe, and regulatory authorities around the globe, including the US, are looking to tighten up regulations. Even domiciles in the Middle East have taken note. The Qatar Financial Centre Regulatory Authority has, in response to international developments, such as Solvency II, recently published a consultation paper on a series of proposals to review the existing captive regulatory framework in Qatar.
The Authority said that these proposals will provide the basis for a state-of-the-art regulatory framework, planned to be operational towards the end of 2011, in which international captive managers will be able to conduct business.
Commercial Risk Europe has partnered with ECIROA, the DVS, the BfV and the German Confederation of Industry—BDI—to hold a conference on Solvency II, captives and global programmes in Frankfurt on November 2. It is free for CRE readers but places are limited. Please contact Hugo Foster—[email protected]—to reserve your seat