potentially punitive impact of European regulation on its insurance industry. With captive entities forming the vast majority of insurers on the island, and the “risk profile of captives quite different from those of traditional commercial insurers”, Le Pelley indicated that Europe’s “one size fits all” formula was inappropriate for the island’s sizable captive sector. Opting instead to continue with its own stringent, international regulatory standards, Le Pelley indicated that Guernsey’s captive sector is hoping to benefit from the burdensome regulatory framework in Europe and attract new business to Guernsey’s shores.
And the latest findings from QIS5 appear to justify concerns that Solvency II will be excessively punitive on captives, with a report from Fitch entitled QIS5: Insurers Capital Solid finding that “small niche insurers typically face more of a threat from Solvency II” than their larger counterparts, due to higher capital requirements and their inability to use internal models to measure their capital position. Captives appear likely to be caught in the net of such demands.
As Wittbjer made clear, “the cost of doing business has already increased under Solvency II, and if you are running a small insurance company like a captive, any relief from burdensome regulation is attractive from a competitive point of view”. Such concerns are already being factored into the calculations of those opting out of Solvency II, he said, and one would imagine that excessive demands upon European captives might encourage them—where appropriate—to consider US domiciles as an alternative.
Addressing the potential advantage of being outside of a tough Solvency II framework, Rehagen indicated that the flexibility of existing US regulatory measures could put US captives at an advantage when compared to their European cousins. “Most US captive domiciles have regulation that provides certain minimum requirements, but allows for flexibility based on the size and complexity of the captive programme.” Solvency II may well not include such give in its requirements. And as Rehagen made clear, “if Solvency II compliance does not provide a benefit to offset the cost, there may be some captives that choose to move from that domicile”. Landry was of a similar opinion, and suggested that a tough regime in Europe “might encourage global companies to reconsider their captive strategy”. If regulation in Europe becomes too onerous, she said, captives may well “decide to set up a US captive because there is more flexible regulatory oversight”. The US and its captive industry might potentially be the main beneficiaries of any heavy-handedness on the part of the European regulators, but treatment of captives remains murky. As Wittbjer put it when addressing whether a tougher European regulation would be a benefit to the industry in the US: “The jury’s still out.”
Safe hands What does seem likely however is that co-operation between
European companies and non-compliant captives will be complicated by the new directive, with those companies operating within the Solvency II framework obliged to treat captives in compliant and non-compliant domiciles differently. Wittbjer indicated that those captives within the framework will be “regarded as being sound re/insurance partners”, whilst for those outside, greater regulatory demands are more likely. Wittbjer said that for domiciles outside
Solvency II, the question will inevitably be: “How will the local [European] regulator look upon that insurance asset? Will it be regarded as a safe pair of hands?”
Being outside the European regulatory framework, such questions
have obvious implications for the US. Should its regulatory environment be regarded as less stringent than Europe, then there could well be an impact on the pricing of business ceded by European business to non-compliant captives. As Wittbjer indicated, “it could well be more costly to cede business to a non-EU company than an EU one”. Such a situation would mean that although the cost of compliance could well be burdensome, those within the Solvency II framework will likely want to cede business to compliant insurance entities, rather than face greater regulatory demands on their international business. This could “cause distortions in relationships”, Wittbjer said, with the European parents of US captives potentially punished by European regulators. “Those that are within the Solvency II framework might have issues with, and place higher premium on placing premiums with, non-Solvency II equivalent captives,” he said. It would seem that despite the advantages of being outside a tougher regime, the situation for US captives with business ceded from Europe will nevertheless be complicated.
Addressing the ratings implications of such developments, Katsipis
stated that “failing to ensure regulatory equivalence between the US and EU will affect companies domiciled on either side of the Atlantic. It will result in companies having to revise the profitability of their operations (given the likely increase in regulatory capital) and, in some cases, re-examine the viability of these operations.” This might or might not play into the hands of US captives, but changing circumstances will likely encourage some captive owners to re-examine the location and viability of their captive business, with obvious implications for the sector. As Katsipis indicated: “The impact on ratings is likely to be mostly driven by changes in strategy and profitability”, with the ripples from Solvency II set to impact parts, if not all, of the captive sector in the US.
Rehagen, for his part, gave a US regulator’s perspective, stating that there are “some international insurers with captives in Missouri that will be affected” by Solvency II, but saying that insurance regulators in the US would work with their captive partners to “incorporate international standards when appropriate”. With US captives predominantly representing American business, such concerns might not be as big a headache as would first seem, but it will nevertheless create some complications as the global industry moves towards greater international consensus on insurance regulation.
Muddling on
Addressing Solvency II versus the current US regulatory system, Landry indicated that “there is not one perfect way to regulate insurance companies”. Instead it seems that the US, Europe and the rest of the world will have to muddle their way towards a strengthened regulatory environment, which might or not might take into account the particular needs of the captive industry. While they do, US captives—particularly those with premium ceded from within the Solvency II area—can expect further, if not dramatic, regulatory strengthening, some of it emanating from Europe, but far more of it likely reflecting the specific concerns and developments of the US regulatory environment.
US Captive . April 2011 25
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