Many captive owners interviewed by CRE in recent times have expressed fears that pressure from the insurance company lobby that regard them as competition and the lack of time available to the European Insurance and Occupational Pensions Authority (EIOPA) and the EC as they prepare for the final stages of the Directive would mean that their special position would be overlooked.

The response of supervisors recently quizzed by CRE also suggested that, without any clear direction from the Commission or EIOPA, some of them feel they would have to regulate captives in the same way as standard commercial insurers. But Mr Van Hulle stated firmly that the principle of proportionality was clearly expressed in the Framework Directive and that supervisors would have to act upon this accordingly.

“This has already been clarified,” Mr Van Hulle told CRE. “We have worked a lot with the captive industry and provided detailed feedback on this area and we have adapted to the position of groups such as ECIROA (the European Captive Insurance and Reinsurance Owners’ Association). It must be recognised that specific risks for captives, such as concentration risks and the calculation of certain risks need to be recognised as lower for captives and therefore applied in a lighter way to the rest of the market by the supervisors. This has been explicitly included within the Level 2 draft and there are a number of specific references to captives within the document and how they should be treated in a more simplified way in certain areas,” said Mr Van Hulle.

“Also, and there is no doubt about this, the national supervisors must apply a proportionate approach to captives and other simpler and smaller insurers because this is clearly stipulated in the text of the Framework Directive. As ever the proof of the value of the cake will be in the eating. It must be recognised that this was not an uncontested area of discussion,” he continued.

“Some parts of the commercial insurance industry were not particularly pleased with the concept of treating captives in a simplified and proportionate way because they regard them as competition. Most people agree that captives have a valid role to play and should continue to do so, but at the same time it has to be accepted by the captive community that standards have to be applied to them as with the rest of the market. But yes, we have allowed simplifications for captives in the standard formula and have provided specific simplifications,” added Mr Van Hulle.

But a number of risk managers and experts who took part in CRE’s latest Risk Frontiers seminar in Frankfurt clearly still need to be convinced.

Praveen Sharma, Senior Vice President, Global Practice Leader—Insurance Regulatory & Tax Consulting at Marsh Multinational Client Service, said during the conference that, despite Mr Van Hulle’s assurances, captive owners still need more detail and clarification if they are to plan their businesses properly.

“The key problem is the lack of clarity on ‘proportionality’ and how the rules will actually be applied to a captive that only writes group risks and not third party risks. The captive in such instances is effectively managing the group deductible and there is little or no risk for any third party. At present, if a risk manager requests his CFO for additional capital for a captive that only writes group risks, the CFO will want certainty as to how much is needed or allocated to the captive. But we don’t know what it will be because there are still not clear guidelines beyond the general guidelines. This makes it very difficult for planning an appropriate risk management strategy using a captive,” explained Mr Sharma.

“When considering the viability for forming a new a captive the risk manager needs to prepare a three year business plan showing capital, underwriting profits, investment income and cost of management. A captive is a long-term venture and therefore any business plan needs to be robust from a commercial perspective reducing if not eliminating any uncertainty. At present this will be very difficult to achieve in any meaningful manner, particularly as there is little or no guidance on how ‘proportionality’ would apply to a captive that only writes group risks. So the EC needs to come up with a clear definition of how the rules will apply to such a captive urgently to remove any uncertainty and they need to be less onerous for captives that only write group risks,” he added.

Mr Sharma’s point clearly fell on welcome ears among the risk managers at the conference.

Gregor Kohler, Head of Insurance at German chemical giant Bayer, said: “I don’t understand why Solvency II applies to captives that only underwrite their parent company business. Such captives do not present a risk to any third party policyholders so why are they included at all? It does not make sense.”

Marisa Attard, Head of Insurance at the Malta Financial Services Authority and a member of the European Insurance and Occupational Pensions Authority (EIOPA), the body that advises the Commission on the technical content of the Directive, said ‘it is not that simple’.

“If something goes wrong with such a captive it could have a wider impact on the group, its client, employees and the market in general as reputation does play an important role in business nowadays,” she said.

Ms Attard also pointed out to delegates that further details on how to apply the principle of proportionality will shortly arrive and stressed that how captives are regarded will indeed depend upon their structure and lines of business written.

“It depends upon whether it is insurance or reinsurance. Both the Level 2 and Level 3 Implementing Measure will explain further how it will apply. You have to look at the business, the nature of the business, whether it is liability and property, simple or complex, manages everything in-house or outsources elements. Also do not forget that the fit and proper standards apply to captives. At the end of the day this has to be done on a case by case basis,” she said, which in itself strongly suggested that Malta for one will apply a proportionate approach.

Jonathan Groves, Head of the Continental European risk management group at Chartis, agreed that the rules are not set out in detail yet but advised captive owners not to simply bleat about it and do nothing. There is enough direction to make a start at least, he said.

“If you look at the equivalence papers they state that the meaning of proportionality has been defined and, in their minds [EIOPA] it is quite clear. But I think that proportionality has no bearing on Pillar I. It is quite clear that there is a minimum capital requirement of €1m or €2–3m depending upon the type of business underwritten. So you can work out a worst case scenario and should use that as a base point to work from,” he said.

Mr Sharma was not ready to back down on behalf of the risk managers though and pointed out that the Pillar II reporting requirements are just as uncertain and troubling for captive owners adding that the supervisors are struggling to help.

“There is a second area of uncertainty here around Pillar II costs, including documentation and the like. If you are saying go and talk to the regulator to find out how to apply this then there is a problem because they do not have the time or any specific information that they could provide to the risk manager.”

Mr Groves said that the predicament of the captive really depends upon whether it is an existing structure or a start up but again stressed the need to make a start, regardless of the supposed uncertainty, and not live ‘in denial.’

“When you look at Pillar II there are things to figure out. In my view it would be wrong to do nothing and wait until everything is clear right at the end before you start working on this. You cannot run your captive business by perpetually putting it off. You need to make reasonable assumptions and go to the regulator to work it out…You cannot live in denial. You have to manage expectations of your own management so that they can appreciate and expect the worst case and if it is better at the end of the day then that is a good result,” he advised captive owners.

Günther Dröse, President of ECIROA and Head of Insurance at Deutsche Bank, is also not sure that captives actually need more regulation because there have been so few examples of failure to date. He also said that he would like to see the supervisors given true flexibility to apply proportionality rather than have to stick to a detailed rule-book.

“I disagree that you need exact requirements for all types of insurance companies. You cannot do this. The system needs to be flexible. Also you do have to ask the question of the 900 or so captives in Bermuda how many have gone bust in the last 10 years? Zero,” said Mr Dröse.

Mr Sharma agreed that the evidence does not really support the need for more captive regulation: “How many insurers and captives that write group risks only have gone bankrupt as a result of a lack of capital in the last 10 years? Very few. Those insurers that have become insolvent only failed because the current regulations were not applied properly.”

And Carl Leeman, Belgium-based Chief Risk Officer at logistics firm Katoen Natie and head of the International Federation of Risk and Insurance Management Associations (IFRIMA), said that he is actually not sure that the Commission wants captives to prosper under Solvency II at all. “You also have to remember that in all times of crisis authorities are simply looking for money. So you have to ask if the agenda of the EU is to have less captives and get more money out of this.”

Mr Dröse disagreed that the intention was to force captives out of business and believes that they will survive. But he did say that strategies would have to be adapted. “Karel van Hulle has said for the last three years that the EC is not looking to get rid of captives. I think he really believes this and he is backed by Peter Skinner [MEP and Rapporteur of Solvency II] in this regard,” he said.

“The problem is more how you adapt the strategy and tools of the captive to the changed environment. I predict that captives will survive Solvency II. There will be pressure and people will ask whether the capital could be better used by operating divisions on the underlying business. This is fine and a question that should be asked. But you have to adapt your strategies and systems to work under Pillar I and Pillar II. It may be more difficult to include long tail and catastrophe risks but I know that the leading captive management companies are working on strategies and structures to try and deal with these issues,” he said.

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