With Europe poised to enact strict regulations regarding capital adequacy and risk management, the decision by the Cayman Islands to stand on the sidelines and monitor developments looks increasingly wise.
Nearly eight years after the financial crisis that threatened to bring the developed world to its knees, European regulators are finally ready to implement the most important and wide-reaching overhaul of regulations the financial services sector has seen in a generation.
Solvency II will introduce new regulations governing capital requirements of European re/insurers as well as introducing an agreed set of risk management requirements. It was expected to be in place by January 2013. However, after several delays, Solvency II is scheduled finally to come into effect from January 1, 2016.
While Europe-based firms and their national regulators have had to adjust to the new requirements, other regulators have been forced to make a decision: adjust their own regulations to be closer to Solvency II, seek full compliance or equivalence with Solvency II—or ignore it completely.
While Bermuda looks as though it may achieve equivalence but has sought the regulation of its captives sector to be exempt from this, Cayman has gone in the opposite direction and adopted more of a ‘wait and see’ approach.
This is increasingly looking like a sound course of action as even within the EU, Solvency II’s blanket approach to the regulation of re/insurance operations sits badly with the captive structure, as the regulations are designed with the commercial marketplace in mind.
"CIMA’s current wait-and-see approach is prudent and perhaps advantageous, should Solvency II equivalence place a disproportionate burden on captives.” Piers Dryden, Ogier
Since captives have no dealings with the general public, forced compliance is seen as a somewhat disproportionate response.
Cindy Scotland, managing director of the Cayman Islands Monetary Authority (CIMA), says the regulator’s approach was prudent given that the US—not Europe—is the originator of much of the business carried out on Cayman.
“Since over 90 percent of the Cayman captives underwrite North American risks, and the North American regulators are not expected to follow the Solvency II model for capital regulation, CIMA has taken a decision not to achieve equivalence under Solvency II,” Scotland says.
She adds that: “CIMA will continue to monitor the progress of Europe’s Solvency II directive and its potential impact on captives.”
A trigger for growth
The approach could drive some new business. Global broker Marsh predicts that following the introduction of Solvency II “some new growth is expected in captive formations in EU domiciles”.
That may well be the case but, according to Scotland, the position adopted by Cayman is reaping its own rewards.
“CIMA has seen a few new captive redomestications in the Cayman Islands as a result of some other jurisdictions deciding to pursue Solvency II equivalence,” she says.
Two trains of thought have dominated captive domicile thinking with regard to Solvency II—adopt a new and improved solvency regime of your own or seek equivalence with Solvency II regulations.
Guernsey, on the European continent, is not a member of the EU and is not therefore required to implement Solvency II. However, it has taken it upon itself to update its own risk-based, proportionate solvency regime in line with the Insurance Core Principles (ICPs) of the International Association of Insurance Supervisors (IAIS).
Crucially, Guernsey’s new regime distinguishes between commercial re/insurance and captive insurance. Guernsey captives will operate under a minimum capital requirement of £100,000 ($150,600) and confidence levels of 90 percent.
Guernsey hopes that its “proportionate approach” is very attractive to current and potential captive owners, especially those who still want a domicile within the European region.
Closer to home, Bermuda considered equivalence with Solvency II a priority in order to keep Bermuda being viewed as a key jurisdiction in the global insurance industry. Together with Switzerland and Japan, it was one of the first countries to seek equivalence under Solvency II.
Piers Dryden, senior associate at legal firm Ogier says: “Given the fact that the large majority of Cayman’s insurance business comprises North America-based private self-insurance captives (and Solvency II is a European initiative), CIMA’s current wait-and-see approach is prudent and perhaps advantageous, should Solvency II equivalence place a disproportionate burden on captives.”
Cayman’s Minister for Financial Services, Wayne Panton, commenting in his foreword in this publication adds: “Cayman’s legislative and regulatory framework makes it absolutely clear that Cayman is a progressive country. We have a demonstrably strong track record of thinking globally and acting locally in response to international financial services initiatives.
“In light of every current international discussion we will make further improvements to our financial services regime.”
Andrew Schofield, a director with KPMG in the Cayman Islands, says: “As the global regulatory reform process continues, CIMA, the Cayman Islands government and the financial services industry will need to adapt to the challenges of new regulation.
“Given the recent history of industry consolidation, a willingness to implement legislative changes and the adoption of innovative solutions, the financial services sector in the Cayman Islands is well-placed to strike the right balance.”
Assessing Solvency II equivalence
Non-European jurisdictions may choose to achieve an equivalence status under Solvency II. Such jurisdictions will be assessed on three levels of equivalence with Solvency II:
• Insurance considerations: treatment of third country insurance (specifically the need to collateralise insurance arrangements with assessments within the European Economic Area);
• Group solvency calculation: the ability to use local regulatory capital amounts in the Solvency II capital calculation; and
• Group supervision: reliance on a third country for group supervision (ie, European supervisors need only to consider individual entities within their jurisdictions on a standalone basis).
Keeping up with change
As well as dealing with Solvency II, the CIMA must constantly tweak its approach and its laws based on a wide range of regulatory developments.
OECD Common Reporting Standard (CRS) regulations are in force from October 20, 2015 and are a key component of Cayman’s implementation of automatic exchange of financial account information in accordance with the internationally agreed standard.
Officially referred to as the OECD CRS for Automatic Exchange of Financial Account Information (AEOI), the Cayman Islands has committed to implement this with effect from January 1, 2016.
Further parts of the regulations, addressing compliance, are scheduled to be issued in December 2015. These may include details regarding penalties for non-compliance.
CRS is far-reaching in scope and requires compliance in 2016 and exchange of information initially in 2017, between 50-plus ‘early adopter’ countries, and by 2018 between 90-plus countries.
The Cayman Islands is one of the first countries (referred to as the Early Adopter Group) that have agreed to implement AEOI exchanges under CRS by September 2017.
CIMA has issued guidelines on the outsourcing of material functions and regulatory requirements by regulated entities. This requires such entities to put in place certain internal procedures where functions are to be outsourced, with the proviso that CIMA may, on a case-by-case basis, impose additional requirements on a regulated entity where an outsourcing arrangement has a potential negative impact on the entity or its customers.
Regulated entities are required to implement a risk policy with respect to outsourcing. This will require putting in place procedures to, among other things, identify all material outsourcing arrangements and to control and monitor such arrangements.
Guidance has been issued to ensure that the outsourcing of functions by a regulated entity does not expose that entity to greater strategic, reputational and operational risk and that customers remain adequately protected.
Any deficiencies in risk management policies should be addressed by August 2016. CIMA, however, gives no definition of what constitutes a ‘significant deficiency’.
CIMA is currently in the final stages of development of a regulatory framework to review Internal Capital Models (ICMs). ICMs allow re/insurers to better integrate the processes of risk and capital management within the company. Development of an ICM review framework is seen as a commitment to building a world-class reinsurance regulatory framework that allows licensees innovation and sophistication
The Foreign Account Tax Compliance Act (FATCA) is a US Regulation—enacted in 2010, took effect in 2014—aimed at foreign financial institutions (FFIs), which can include captives. Administrative reporting (IRS Form W8/W9) by foreign captive insurance companies may be required in certain scenarios. Foreign captives that make a 953(d) tax election to be considered a US corporation for tax purposes may not be required to file Form W8/W9 in certain cases.
The Cayman Islands Department for International Tax Cooperation on March 23, 2015 launched its AEOI portal enabling reporting by Cayman financial institutions.
Solvency II, Marsh, CIMA, Cayman