Captives and the regulatory environment


Protected cell companies have been making the headlines lately but Vic Wyman reports on whether changes to the regulatory environment might put an end to this.

Phoenicians, Greeks, Romans, Sicilians, Knights of St John, the French and the British are among the many that have, over the centuries, tried to exploit the strategic importance of Malta.

Now the country looks keen for outsiders to exploit a financial regulatory regime that could prove attractive for companies that want to self-insure or reinsure through captives, or cells of protected cell companies. And recent developments in Malta might give the PCC approach a boost.

Claiming a first
For example, Abacus Risk Management claimed to have become Europe's first insurance manager structured as a PCC, aimed at firms that want insurance management within the European Union, says executive director Julian Mamo.

Abacus, which was set up by the shareholders of Maltese insurer Gasan Mamo, has sold its first cell to the local insurance adviser South Risk Management and interested parties include a broker and an Eastern European insurance consultant, says Mr Mamo, who adds: "We have a couple in the pipeline."

He claims that the Abacus PCC structure offers market access at a lower cost than conventional insurance operations, especially when combined with Abacus management.


"We have a couple in the pipeline." Mamo


Meeting requirements
In addition, the captive arm of broker Willis and a Maltese PCC, Atlas Insurance, claimed the first use of a cell to underwrite statutory UK motor liability from Malta, for the online retailer Ocado. Willis will manage the cell, which has been licensed to write motor and general liability risks. In Malta, Ocado may not need to meet the capital requirements being introduced in the EU by the Solvency II risk-based regulatory regime for insurers, to be fully implemented in 2013.

Under Solvency II's Pillar 1 criteria, insurers will have a solvency capital requirement much higher than the capital needed under Solvency I's premium-to-capital ratio approach, to ensure a prudent excess of assets over liabilities. Many captives also claim that requirements for governance and risk assessment under Pillar 2 and information disclosure under Pillar 3 would be excessive.

Capital concerns
Captives argue that they present low risk, often covering just one or two risks for their parents rather than third-party risks, with parents usually willing to stump up more cash if needed.

Nevertheless, the European Captive Insurance & Reinsurance Owners' Association claims that most existing captives should be able to meet the SCR by deploying capital and surpluses built up over years, typically by retaining earnings.


"I don't see a problem with capitalisation." Wong-Fupuy


Major compliance
Jonathan Groves, captive consultant leader at broker Marsh, says that an analysis of more than 60 of the captives managed by his firm shows a 370% increase in statutory capital under the SCR. However, about 80% of the captives could comply, with their parents happy for them to continue operating, he says. Among the rest, Mr Groves expects changes in the business mix, the lines that they write and the risk accepted, along with closure of some captives.

Carlos Wong-Fupuy, a senior director at AM Best, says the secure financial strength ratings and high levels of capitalisation of most captives rated by AM Best should allow them to meet the SCR that is predicted to be up to five times as high as current capital: "I don't see a problem with capitalisation."

Long-term trends
However, the picture may be different for captives with large long-term liabilities: "They are definitely going to struggle," says Mr Wong-Fupuy. Smaller captives might also have a lot to do, although he sees Solvency II as part of a more general move by firms towards better management and better allocation of capital.

Pierre Sonigo, the general secretary of the Federation of European Risk Management Associations - whose members represent many captive owners - claims that, through its efforts, a simplified SCR calculation would probably be adopted for captives, leading to 80% to 85% of the SCR for conventional insurers.


"We think we have won this battle." Sonigo


Winning the battle
"We think we have won this battle," says Mr Sonigo, prior to the publication in March by the European Insurance & Occupational Pensions Authority, the new EU regulator, of the results of Solvency II's fifth quantitative impact study trial. "I think the threat is not as high as it was."

According to Mr Sonigo, without concessions EU captives would stop writing business or relocate to non-EU domiciles that do not adopt Solvency II-equivalent rules and fewer captives would be set up: "This would discourage a lot of potential captive owners."

Uncertain future
Mr Groves, however, says that fewer captives are being formed anyway because firms are waiting for an end to the uncertainty about Solvency II implementation. Alternatives include using conventional insurance, self-insurance without a captive or setting up a non-EU captive.

Mr Wong-Fupuy attributes a slow-down in formation to uncertainty about whether non-EU domiciles will seek Solvency II equivalency and to the difficulty of raising capital. Although he expects more AM Best businesses providing ratings to non-EU captives to show equivalence to Solvency II requirements, he sees a move worldwide towards EU-type risk-based capital and enterprise risk management requirements.


"This would discourage a lot of potential captive owners." Sonigo


Flexible question
"It's a question of what flexibility regulators have to apply the proportionality principle," concludes Valerie Alexander spokeswoman for Eciroa about Solvency II. That EU principle requires measures to be commensurate with objectives. "No one's really sure at this stage how it's going to work," she says.

Pillar 2's requirements, closely linked to Pillar 1, to assess and manage risks could be expensive for captives, she says: "That's going to prove a big burden."

Punishing outsourcing
Eciroa says captives outsource most functions and, therefore, have no audit systems, computer systems or other infrastructure for Pillar 2, which could mean higher audit, capital management, actuarial and regulatory costs. Mr Sonigo says: "It could run as much as 30% to 50% of their general expenses if we have to go by all the rules and apply all the requirements."

To try to limit costs, Eciroa has just delivered to the European Commission suggested best practice guidelines; including allowing a member of a captive's board to carry out risk management and allowing outsourcing of the actuarial function.


"No one's really sure at this stage how it's going to work." Alexander


Mr Groves says that the final burden will be determined by how regulators apply the proportionality principle, while Mr Wong-Fupuy is confident that - provided captives talk to them - they will be flexible.

Disclosure fears
Captives also fear the mandatory Pillar 3 disclosure of key information for market participants. Mr Sonigo says that disclosure of types of risk covered, premiums paid, liability limits, past claims, reinsurance, reserves and so on would identify captive owners and could lead to class legal actions against them. And Mr Groves suggests that potentially providing plaintiffs' lawyers with information could deter some firms from forming captives.

However, Mr Wong-Fupuy sees no reason why captives should not have to prove that their compulsory third-party liability cover, for example, is as good as that obtainable from conventional insurers. Another Solvency II unknown is whether insurers that front captives will demand more collateral.

However, Mr Groves concludes: "The captive is just a tool." Running one or setting one up simply depends on factors such as a company's acceptable levels of risk and the state of the insurance market and thus the cost of conventional cover.


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