Yvette Essen Head of market analysis A.M. Best Europe Rating Services


Yvette Essen provides an overview of the captive market, and indicates that there is cause for both opportunity and caution, with regulatory developments likely to have a significant impact on the sector.


In the past few decades, the industry has embraced substantive change, including the emergence of new domiciles and the development of protected cell companies (PCCs). A.M. Best believes the captive market is again evolving in a variety of ways.


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What was once considered to be a lightly regulated industry has become exposed to significantly higher standards, and the Solvency II Directive may tighten captive regulation further—not just in Europe but in domiciles outside of the European Union.


The cost of complying with increased regulation, combined with


the general desire to achieve greater capital efficiency in the wake of constrained capital markets, has resulted in parent companies increasingly evaluating the effectiveness of using captives. Specialist insurers are consequently developing exit models to run off captives or to purchase some of the liabilities associated with them.


Captive formation has been sluggish in recent years, largely reflecting


soft property/casualty rates and less need for alternative risk transfer. However, some companies are seeking ways to utilise their captives more fully, possibly to cover risks that may include credit insurance and employee benefits.


Regulation remains the primary focus


While captive owners and managers are generally receptive to the prospect of new insurance legislation replacing Europe’s current 14 capital adequacy and risk management directives, the industry is still awaiting clarity on the precise requirements of Solvency II.


Solvency II remains among the biggest hurdles for the captive community ahead of the directive’s scheduled introduction at the end of 2012. There are fears that smaller and more recently established captives may not have built sufficient surplus to comply with financial requirements under the pending regulation. Furthermore, companies are bracing themselves for increased demands on management time to meet the risk management requirements of Pillar II.


The captive community is still uncertain as to how domiciles outside


of the EU will respond to the new rules. As Solvency II raises the bar in Europe, domiciles outside of this jurisdiction are balancing the need to display high levels of regulation alongside the desire to attract captives in pursuit of relief from onerous new rules.


he captive insurance market is accustomed to changing circumstances, and significant new developments could be afoot as the industry copes with the economic climate and pending regulatory requirements.


A.M. Best, which rates more than 200 captives, expects that as a result


of Solvency II, captives outside of the European regulatory environment (particularly those offshore) may move to demonstrate similar levels of security and corporate governance through ratings. More EU captives are also expected to consider obtaining ratings in light of the increased focus on financial strength under the new regulatory regime.


The added value of captives is questioned In the past decade, there has been more corporate governance


involved in running captives, and Solvency II is expected to increase capital requirements. Some companies are reportedly considering their captives in relation to capital efficiency, in part given the capital and time costs that could result from the pending new regulation. As an estimated one-fifth of captives are dormant, some companies may consider these demands to be too onerous.


Captives have ceased to underwrite new business for wide-ranging reasons. For instance, companies can find themselves with more than one captive as a consequence of merger and acquisition activity. Some businesses have also incorporated a number of captives in different domiciles over the years when some domiciles offered more favourable tax advantages.


In the wake of the global economic crisis, companies are constantly examining the best way to deploy their capital. Furthermore, the cost of collateral has become a major issue for some captives.


A range of other factors is resulting in a heightened focus on capital.


For example, a parent company may have a strategic change of direction or may have appointed a new finance director. Some businesses may be looking to release trapped capital for use elsewhere, perhaps to expand their core business, while others may be seeking certainty on historical liabilities.


However, although innovative solutions are increasingly being offered


to close captives or pass on liabilities, most companies currently tend to favour running off the business themselves.


Captive formations are slow, but long-term value remains


The pace at which new captives are being formed has slowed in recent years. This is in part owing to parent companies focusing on their core business during the recent financially challenging years, as opposed to turning to self-insurance.


Captive formation is additionally associated with a hard insurance market when risk managers struggle to find affordable capacity.


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