Captive evolution


Yvette Essen

Captive evolution

Yvette Essen provides an overview of the captive market, and indicates that there is cause for both opportunity and caution, with regulatory developments likely to have a significant impact on the sector.

The captive insurance market is accustomed to changing circumstances, and significant new developments could be afoot as the industry copes with the economic climate and pending regulatory requirements.

In the past few decades, the industry has embraced substantive change, including the emergence of new domiciles and the development of protected cell companies (PCCs). A.M. Best believes the captive market is again evolving in a variety of ways.

What was once considered to be a lightly regulated industry has become exposed to significantly higher standards, and the Solvency II Directive may tighten captive regulation further—not just in Europe but in domiciles outside of the European Union.

The cost of complying with increased regulation, combined with the general desire to achieve greater capital efficiency in the wake of constrained capital markets, has resulted in parent companies increasingly evaluating the effectiveness of using captives. Specialist insurers are consequently developing exit models to run off captives or to purchase some of the liabilities associated with them.

Captive formation has been sluggish in recent years, largely reflecting soft property/casualty rates and less need for alternative risk transfer. However, some companies are seeking ways to utilise their captives more fully, possibly to cover risks that may include credit insurance and employee benefits.

Regulation remains the primary focus

While captive owners and managers are generally receptive to the prospect of new insurance legislation replacing Europe’s current 14 capital adequacy and risk management directives, the industry is still awaiting clarity on the precise requirements of Solvency II.

Solvency II remains among the biggest hurdles for the captive community ahead of the directive’s scheduled introduction at the end of 2012. There are fears that smaller and more recently established captives may not have built sufficient surplus to comply with financial requirements under the pending regulation. Furthermore, companies are bracing themselves for increased demands on management time to meet the risk management requirements of Pillar II.

The captive community is still uncertain as to how domiciles outside of the EU will respond to the new rules. As Solvency II raises the bar in Europe, domiciles outside of this jurisdiction are balancing the need to display high levels of regulation alongside the desire to attract captives in pursuit of relief from onerous new rules.

A.M. Best, which rates more than 200 captives, expects that as a result of Solvency II, captives outside of the European regulatory environment (particularly those offshore) may move to demonstrate similar levels of security and corporate governance through ratings. More EU captives are also expected to consider obtaining ratings in light of the increased focus on financial strength under the new regulatory regime.

The added value of captives is questioned

In the past decade, there has been more corporate governance involved in running captives, and Solvency II is expected to increase capital requirements. Some companies are reportedly considering their captives in relation to capital efficiency, in part given the capital and time costs that could result from the pending new regulation. As an estimated one-fifth of captives are dormant, some companies may consider these demands to be too onerous.

Captives have ceased to underwrite new business for wide-ranging reasons. For instance, companies can find themselves with more than one captive as a consequence of merger and acquisition activity. Some businesses have also incorporated a number of captives in different domiciles over the years when some domiciles offered more favourable tax advantages.

In the wake of the global economic crisis, companies are constantly examining the best way to deploy their capital. Furthermore, the cost of collateral has become a major issue for some captives.

A range of other factors is resulting in a heightened focus on capital. For example, a parent company may have a strategic change of direction or may have appointed a new finance director. Some businesses may be looking to release trapped capital for use elsewhere, perhaps to expand their core business, while others may be seeking certainty on historical liabilities.

However, although innovative solutions are increasingly being offered to close captives or pass on liabilities, most companies currently tend to favour running off the business themselves.

Captive formations are slow, but long-term value remains

The pace at which new captives are being formed has slowed in recent years. This is in part owing to parent companies focusing on their core business during the recent financially challenging years, as opposed to turning to self-insurance.

Captive formation is additionally associated with a hard insurance market when risk managers struggle to find affordable capacity.

There are certain lines of business where insurance premiums have increased, but the property and casualty market is generally soft, and reinsurance pricing has broadly fallen. Given the soft market, there is not significant pressure for alternative risk transfer, including the use of captives.

However, there is an understanding that the inherent value of captives extends far beyond merely obtaining lower premiums by acting as a catalyst for enhanced risk management. The use of a captive is recognised as a long-term strategy, not a shortterm solution. There does not appear to be a major rush of captive closures in this soft market, perhaps as companies understand that while obtaining reduced premiums can be the primary function of a captive, awareness of risk management can increase through self-insurance.

A slowdown in captive formations could in part be attributed to many larger companies already owning captives. It is estimated that fourfifths of FTSE 100 companies currently have their own self-insurance vehicles, and it is the small to medium-sized enterprises that tend to be currently creating captives or considering the use of PCC.

Potential new lines of business emerge

Larger companies tend to use captives predominantly for property and casualty lines and other conventional risks, and are reportedly considering utilising PCC for one-off risks, including for environmental lines of business.

Some companies are also considering utilising captives for particular lines of business where rates and deductibles have increased in the wake of the financial crisis, in particular for credit insurance or professional indemnity cover.

Discussions surrounding the use of captives for employee benefits have returned to the fore in recent months, with long-term health and long-term disability being proposed as lines of business that more captives could offer.

Companies are considering using their captives in innovative ways, although captives need to find a balance between writing profitable business and serving their parent companies.

Promising prospects await the industry

The captive industry is undergoing a further period of change, although uncertainty is set to remain until further details of Solvency II’s impact on capital requirements emerge from QIS5.

The challenging economic climate is also impacting the captive and PCC markets, and there are reduced opportunities for self-insurance if parent companies are under pressure. Companies with captives and PCCs are looking at utilising these vehicles for different lines of business, although captives and PCCs must continue to focus on appropriate pricing of risks.

Despite the range of challenges facing captives, A.M. Best expects the sector to experience some stability, with ratings affirmations vastly outnumbering downgrades.

Captives have changed tremendously over the past decades. That evolution will continue in the next few years as the industry braces itself for further significant development.

This article is based on a report published by A.M. Best. For the full report, Europe’s Captives Navigate Recession, Regulatory Changes, please go to

Yvette Essen is head of market analysis at A.M. Best Europe Rating Services. She can be contacted at:

A captive market in the Middle East?

The benefits of operating a captive are increasingly being considered in the Middle East, with member states of the Gulf Cooperation Council (GCC) attempting to establish themselves as captive centres. A greater understanding of enterprise risk management (ERM) is also being encouraged among insurance market participants operating in the region.

Dubai, Qatar and Bahrain have introduced captive legislation in recent years. In February 2010, the Qatar Financial Centre unveiled intentions to become a captive, reinsurance and asset management centre as part of a revised financial strategy. Kane Group, which has a presence in Bahrain and Dubai, anticipates growth in this region and became the first captive manager awarded a licence by the Qatar Financial Centre Regulatory Authority in September 2010.

The United Arab Emirates is also attempting to establish itself as a captive domicile and offer opportunities to self-insure. The Dubai International Finance Centre recently reduced its application fee for captives from $15,000 to $5,500 and for PCCs from $40,000 to $8,000 for the core cell, plus $1,000 per additional cell.

It is hoped that a number of companies could utilise captives for energy risks. However, to date, captive formation in the Middle East has been muted. There is still a lack of awareness and understanding surrounding captives, as they are a relatively new offering.

A common attraction of the captive structure is the ability to lower premiums, but insurance prices are already generally low in the GCC as there is great competition in the region, particularly among local insurers. There is therefore little incentive for companies to self-insure; nevertheless, captive formation in the region is considered to be a long-term undertaking.

AM Best, EMEA, ratings, regulation, captive, insurance

Captive International