Cayman: not following the crowd

30-11-2011

Cayman Captive

Cayman: not following the crowd

Cayman has opted to stay outside the framework of Solvency II equivalence—at least for now. Here, Cayman Captive explores the merits of the decision.

Following the economic ructions of the past few years, Solvency II is hardly viewed as a panacea for future global concerns, but it is regarded by many in the industry as a step in the right direction: a move towards greater regulatory oversight and capital responsibility. After the meltdowns and bailouts that befell the banking sector, it is hardly surprising that other financial sectors are coming under greater global economic scrutiny. Much of this may well be politically motivated, as governments scramble to fill gaping deficits, but the intent—if not the reality—of greater regulation is laudable. Solvency II forms part of Europe’s efforts to head off a future crisis in re/insurance, but its remit extends well beyond the continent’s shores, including as it does Bermuda and Japan in its so-called “first wave” of equivalency and, more recently, possibly the US.

Cayman, for its part, did consider being included in the first wave of Solvency II equivalence, but opted instead for a wait-and-see approach to the new regime. As Cindy Scotland, managing director of the Cayman Islands Monetary Authority (CIMA) outlined, Cayman is still “evaluating the proposed regime” in order to ascertain whether it is an appropriate fit for Cayman’s specific regulatory environment. Scotland questioned whether the systemic risks that Solvency II is intended to guard against were in fact relevant to Cayman captives, with the regime’s focus being upon the commercial sector. Captives simply do not pose the same systemic risk. Scotland also argued that Cayman’s existing and developing regulatory framework was sufficiently robust to deal with any issues emanating from the captive sector. Its new Insurance Law—due to come into effect at the end of 2011—will apply proportionality to its regulatory requirements, which will help to create a “stratified” approach to risk management. Cayman has evidently opted—for the time being at least—to take its own path.

Opting out

As Brian Schneider, director of the North American Insurance Ratings Group at Fitch, made clear: “Gordon Rowell (head of insurance at the CIMA) has been an outspoken critic of the Solvency II model for some time, arguing that it does not work for all companies as a one-size-fits-all model”. Rowell is not alone in his view. Other captive luminaries have spoken in a similar vein and Cayman is joined by other places such as Guernsey in opting out.

With the regime still to differentiate commercial and captive entities, Rowell may well be right in recommending a more cautious approach to Solvency II. Cayman’s emphasis upon captive rather than commercial insurance would suggest that until true differentiation is introduced into the Solvency II framework, the European circles there appears only limited confidence that captive calls for differentiation will be heeded.

The European Captive Insurers and Reinsurers Association has expressed concern that larger commercial carriers are dominating the discussion. Should they continue to do so, Solvency II may be applied across the board, with evident cost implications for captives caught in the dragnet. Rory McLeay, managing director of Jardine Lloyd Thompson in London, put the additional cost of Solvency II compliance for captives at 30 percent of “base cost”, with such additional expense likely to undermine the attractions of Solvency II and equivalence to pared down captive entities.

"Cayman has scored significant successes in recent years in closing the gap with Bermuda as a leading captive domicile."

As it is, in the short term Solvency II may well prove a boon to those outside the framework. Cayman achieved record captive formations in 2011, although whether this was due to its decision to opt out of Solvency II, to recent tax information exchange agreements, to its new Insurance Law or to the hardening of the commercial re/insurance sector, is hard to quantify. Staying outside Solvency II—at least for the time being—is likely at least to have helped. How long this advantage will be maintained is uncertain; with the implementation calendar of Solvency II still on a backward slide, it may yet be for some time. If, and when, the European Insurance and Occupational Pensions Authority opts to recognise the unique nature of captives within the Solvency II framework, Cayman’s position can change, with the present wait-and-see approach taken by CIMA a good fit for the make-up of the Islands’ insurance sector and the as-yet unclear treatment of captive entities under Solvency II.

Bermuda blunted?

So what about the non-European countries that have opted in to Solvency II equivalence? What are the likely implications for their captive sectors? Addressing Bermuda’s decision to seek equivalency, Schneider said that “uncertainty remains regarding how the equivalency distinction will be interpreted by European regulators”. He said that if Bermuda re/insurers were required to calculate capital under both Solvency II and Bermuda regulation “they could be put at a potential disadvantage relating to capital requirements”, as well as “facing additional regulatory expense”. This is just the kind of regulatory pincer that Cayman is looking to avoid, with its approach enabling CIMA and the captive community to watch how Bermuda and others handle the implications of Solvency II before responding.

"In the short term Solvency II may well create opportunities for Cayman. New formations and redomestications to Cayman's shores are likely to be the reward for its present attitude."

Whether both regimes will be enforced will largely come down to how Europe views Bermuda’s regulatory regime, but Schneider indicated that Bermuda’s regulatory regime “will at minimum become significantly less flexible”, with evident implications for its appeal as a leading re/insurance domicile. Bermuda has always prided itself on its ability to adapt and respond to market conditions. New regulation might just inhibit its sure-footedness. Cayman, for its part, can hope to benefit from a less flexible approach in Bermuda and, if MacLeay’s prediction of increased base cost is also factored in, a cost advantage. Cayman has scored significant successes in recent years in closing the gap with Bermuda as a leading captive domicile. An approach to regulation that places captives at the forefront may yet help to close it further.

Inevitable entry

Despite the delays and opt outs, there does nevertheless seem a certain inevitability to greater regulatory oversight under the guise of Solvency II. Its main focus will inevitably be on the commercial sector, but captives look unlikely to escape greater regulatory demands in the years to come. Asked if Cayman could remain outside the framework of Solvency II in the long term, Schneider said that “Cayman will probably have to operate under Solvency II, although given the expected delay in implementation to 2014 and possibly later, they should still have time to achieve some level of compliance”. Schneider’s remarks suggest that regime compliance will be inevitable in the not too distant future, but with the timeline for implementation creeping ever onwards and a further Quantitative Impact Study likely, Cayman and other domiciles that have for the time being opted out of the framework will probably have some time to prepare for the regime.

In the short term Solvency II may well create opportunities for Cayman. New formations and redomestications to Cayman’s shores are likely to be the reward for its present attitude. Solvency II is, after all, hardly being welcomed with open arms by the international captive sector. In the longer term it seems likely that greater global regulatory compliance and convergence is on the cards. Cayman’s current play will enable the jurisdiction to respond to the evolving regime in a way that best takes into account its burgeoning captive sector. It seems that present differentiation and a more long-term outlook might be just the ticket.

Cayman, Solvency II, CIMA, regulation, captive, insurance

Captive International