One interesting thing to note, according to Mr Groves, is that the stress tests carried out by the European Insurance and Occupational Pensions Authority (EIOPA) have to date not really focused on traditional liability-focused insurance matters, rather more on the asset side of the business. Captive owners must ask therefore ask themselves whether they are really qualified to participate alone or need help.

The key start point for a captive owner is therefore to ask exactly what EIOPA regards as the key threats to the business from an insurance company perspective.

The first piece of advice for captive owners is therefore to simply ‘engage’ with a wider audience at the firm. “There will be many people who will understand this and I’m sure many of you already engage with a wider audience to discuss these types of risks. But our first question should be: Do I actually fully understand these risks and therefore am I engaging with everybody that I should engage with in the business?” he explained.

The next critical thing to do is talk to the regulator and find out what they really want and need to know, said Mr Groves.

And, according to Mr Groves, it is critically important not to simply delegate relations with the regulators. “It’s vital that you as an owner actually have a dialogue with the regulator,” he said, with the support of third party experts.

Mr Groves then asked the pressing question of: What strategy could and should really be adopted by a captive insurance company to manage some of the different requirements under the different pillars?

He said that the Chartis captive team has identified three core responses for captive owners.

These are:

Retreat: “If you’re sitting here as a captive owner, fundamentally concerned about where this is going and worried that there will be significant difficulties for you to meet capital, compliance or disclosure requirements, you might move into a retreat mode,” explained Mr Groves;

Enhanced: “If you’re sitting there thinking not only do I have more capital than I need but we are really seeking to make more use of our captive—you’re perhaps in the enhanced category,” he said.

Tidy up: By which a captive owner may decide to use the arrival of Solvency II to make a clean break by placing long tail liabilities aside through tools such as loss portfolio transfers.

Mr Groves said that those captive owners that may consider retreat will probably be doing so because of the results of QIS 5 which saw capital requirements for captives driven by three distinct areas.

The first was around catastrophe risk, the second concentration risk, in terms of where the assets were invested (or managed if all held by a central treasury group), and the third was related to intra company reinsurance, particularly where it was with an entity that was based outside of the EU, he explained.

“So, in essence, if you were looking to retreat and just make this absolutely as simple as you possibly could to reduce the capital as far as possible and to reduce your operational costs, then you may well take out two risks which are directly impacted by those three factors,” said Mr Groves.

Those risks would be the catastrophe risk and any risk that has a ‘tail in it’, he said.

Mr Groves explained that business such as general liability or excess property really drove capital requirements. Captives that underwrite risks that include a combination of ‘tail’ and ‘cat’ such as professional liability risks could really exacerbate the capital cost.

“You may well consider asking: Do I actually need to operate a captive? Perhaps some of these risks can be taken more directly onto the balance sheet rather than coming through the captive. But that leads to potential compliance issues. These are all factors which are at play and may possibly persuade a captive owner to retreat from the use of the captive,” suggested Mr Groves.

Alternatively a captive owner may seek to enhance or step up the use of the captive through the addition of new risks such as employee benefits and cover for the Environmental Liability Directive (ELD), for example.

“Employee benefits have been talked about for a very long time [in relation to captives] but are of more recent development, and ones which are perhaps much closer to home for a risk manager, who is typically not directly involved with the HR side of things, are things like environmental impairment liability (EIL), particularly with the ELD directive. Also there is trade credit, particularly in an environment where a lot of the traditional insurers, as they say, took the umbrella away once the rain started!” said Mr Groves.

Another enhancement strategy could be to widen the number of reinsurance entities used, said Mr Groves, adding that it is not that simple though.

“We should not make the mistake of opting for simple diversity and ignore the standing of the reinsurer. There is no logic in saying: ‘I’ve got a AAA reinsurer but because I’ve got most of my risk with it, I’ll now use two BBB reinsurers instead because it provides diversity,” he explained.

“It is about maintaining quality but looking at the counterparties themselves in terms of whether that assists the strategy and mitigates a risk. Equally it’s about where you go with the underwriting, the investment portfolio and the way that you do it,” added Mr Groves.

Tidying up is most relevant to the many captives that have written historic liability business, and hold long tail risks.

“If we think back to where the general liability market has been, where the market was in 2002-2004, there may well be captive owners that still have a lot of residual liability sitting on their balance sheet and which must now be more explicitly recognised in capital calculations,” said Mr Groves.

The option to move such risks off the balance sheet through tools such as a loss portfolio transfer may be attractive as strategies are reviewed to prepare for Solvency II, he added.

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