AM Best


Bermuda’s captive sector looks finely poised to carve out a beneficial position within the Solvency II framework. Steve Chirico of AM Best discusses the regimes benefits and the Island’s unique position within the global regulatory landscape.


How do you view benefits of Solvency II from rating agency perspective?


We view it as a huge benefit. A lot of the tenets of Solvency II touch upon the rating process—issues such as a risk-AA capital approach— and whether a company uses its own Solvency II-led models or those that AM Best employs, the strengthened overview of risk and capital adequacy associated with Solvency II is a beneficial development for the sector.


The only risk in implementing Solvency II is that when you get into Pillar 2 and Pillar 3, some of what is required from a risk management and reporting perspective is not applicable to smaller organisations. Formalised processes and documentation is sometimes not necessary for smaller captives.


Applying proportionality to the process makes a lot of sense. If you are not applying a risk-based approach these days you really are positioning yourself behind the eight-ball.


Minimum capital requirements essentially say nothing about financial strength because they don’t incorporate the risk that the company is bearing and that’s what a risk-based capital model such as Solvency II will do.


With Pillar 2, a lot of the risk management is already present in well-run and rated captives. It is in the formalisation of this risk management process where a smaller captive would differ, but if proportionality is applied under Solvency II, then smaller entities will still find it possible to conform to the European regulatory regime. You would want to see all the right things are being done and all of the controls over the claims and underwriting process and loss control are in place, but it’s the formality of the process that could be lightened.


For Pillar 3, there is a lot of talk about reporting requirements and how companies measure up from a compliance perspective. This adds a layer of additional resources dedicated to tracking a company’s performance. I don’t think that anyone would argue that this is a prudent approach, but the formalisation of the process has costs that for a smaller organisation may or may not make sense.


AM Best is a strong proponent of Solvency II implementation with proportionality and we believe that international insurance regulators


are going to have to respond to Solvency II in some way, shape or form. Latin American regulators are already discussing how they will respond and I suspect that it will become the gold standard for insurance regimes globally.


Assuming Europe approves a captive carve-out, do you think others will follow the same approach?


The carve-out is really the only answer that makes any sense from a cost:benefit perspective. Logical thought processes will prevail. The discussion regarding whether such an approach is appropriate is a good thing, but in the end the regulatory cost will be money well spent. We view the issue as something everyone will have to respond to. If there’s a carve-out in Europe, then the other domiciles that have looked at whether they’re going to seek equivalent status with Solvency II are likely to adopt the same approach or something similar.


You mentioned Latin America. What about the US response to Solvency II?


Now is an interesting time for global financial services regulation. We can start with the convergence of US generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS). Included in the initial phases of convergence is a re-look at insurance contracts. There’s going to be significant and substantial changes made to the way insurance companies report results such as earnings and profit and loss, and that’s happening concurrently with changing global insurance regulation.


Solvency II has a chance of beating by a year or two accounting standard convergence, because it’s more of a myopic project. Every domicile that has any significant insurance presence will have to respond in some way to Solvency II. First, there will be global competition for quality regulatory environments and second, it just makes logical sense. While there will be an initial discussion over all the extra costs that a regime like Solvency II ushers in, no-one can say that it doesn’t make good sense.


The big trick in the US is in getting the National Association of Insurance Commissioners (NAIC) to start thinking about how they’re going to respond. They may take their time, because I think they believe their regulatory environment is robust and that while Solvency II may have some particular strengths over the current regime here in the US, it would be marginal.


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