Captives presented opportunity for greater proportionality under Solvency II

Since Solvency II came into effect across the EU on 1 January, 2016 captive insurers have been subject to much the same regulation and reporting requirements as large commercial carriers. The captive market has long argued for greater and more consistent application of the principle of proportionality, but has largely been disappointed in the response of EIOPA and regulators across the continent.

EIOPA’s published opinion as part of its 2020 review of Solvency II includes suggestions of how more proportionality can be applied, however, including limitations of the extent of reporting on areas including investments and derivatives, assets and liabilities by currency and variation analysis. It also recommends the own risk and solvency assessment (ORSA) for captives be submitted every two years rather than annually, while the Solvency and Financial Condition Reports could be stripped back for captives and not be required to be publicly available.

The proposals will ultimately need to be approved by the European Commission and are unlikely to come into effect in 2021, but leaders within the captive industry welcomed the development.

Fabrice Frere, managing director within global risk consulting for Aon in Luxembourg, told the Global Captive Podcast in an episode before Christmas that dialogue between the Federation of European Risk Management Associations (FERMA) and EIOPA had been much more productive in the past 12 months than it was when debating the development of Solvency II in 2013 and 2014.

“The discussion has been much more open, there is clearly a better understanding of the captive busines model, recognition that captives are specific frameworks that need specific rules, but also enable more proportionality than others,” he added.

Lorraine Stack, international advisory and sales leader at Marsh Captive Solutions, said the potential for reduced reporting and disclosure limitations would be welcomed. It is important to note, however, that any regulatory relief is only likely to be applied to smaller, first-party risk captives and will not extend to those writing third party or non-affiliated business.

The reduced burden of reporting is also unlikely to have an impact on captive management fees. “We argued from the start that captives should not be subject to the public disclosure because it doesn’t make sense for captives to do public reporting,” Frere said. “How impactful that is going to be in terms of true workload and costs for the captives, probably not dramatically impactful.”

There are also some additional criteria added for captives that may be required to qualify for some of the proposed proportionality. One standout example introduced for captives to qualify is that loans to the “parent or any group company do not exceed 20% of total assets held by the captive”.

“While we have not discussed this with our clients yet, it is conceivable that this could lead to an erosion of capital base because captive owners might dividend out all profits and surplus cash rather than increase an existing intercompany loan,” Stack added. “Once equity leaves captives it is very difficult to get it back so this could prove a counter-productive measure. External investments are only returning negative interest rates leading to further erosion, whilst intercompany loans tend to be profitable and have recalls built in for security.”