Fitch: UK captive and ILS reforms credit-neutral but could raise long-term risk

The UK government’s proposed reforms of insurance risk transformation and captive insurance are credit-neutral for London market insurers as existing regulatory standards will continue until implementation in 2027, Fitch Ratings says. However, the reforms may raise systemic risks in the longer term if risks move out to less transparent market segments.

The UK is seeking to revive its insurance-linked securities (ILS) and captive insurance sectors by easing regulation and expanding risk-transfer options to be more in line with global competitors, such as Bermuda and the US for ILS, and France and Canada for the captive insurance business. The proposals were announced this month alongside regulatory easing for the UK banking sector, and are part of the government’s broader financial services growth and competitiveness strategy.

According to Fitch most of the new ILS and captive business that the UK could gain is likely to come from activity previously booked in other jurisdictions rather than from a significant shift in risk-taking behaviour among insurers. Additionally, insurers are likely to remain involved as arrangers or facilitators for ILS and captive structures, retaining a degree of oversight and control over underwriting and risk management.

The reforms include proportionately lower capital requirements for ILS vehicles and captive insurers, reduced application and administration fees, a faster authorisation process and lighter reporting obligations than for fully authorised insurers and reinsurers. The government expects the Financial Conduct Authority and the Prudential Regulation Authority to develop specific rules for captives, with a view to implementation in mid-2027 following consultations in 2026.

In a statement Fitch said: “Once the reforms are implemented, there is potential for growing pockets of risk to accumulate outside the core regulated insurance sector. Risks would shift to the institutional investors that provide the funding for ILS vehicles or stay with corporates that set up captives, with lighter regulation and capital requirements. This could lead to gradual disintermediation of the non-life insurance industry and make it more difficult for regulators and market participants to monitor the true distribution and concentration of risk.

“A core pillar of the reforms is the planned differentiation between direct-writing and reinsurance captives. Direct-writing captives insure the risks of their own group members, while reinsurance captives reinsure such risks, typically via a fully authorised insurer that retains ultimate liability. This two-tier approach is intended to allow more targeted and proportionate regulation, with regulatory oversight set to be lighter for reinsurance captives than for direct-writing captives.

“The reforms also expand the scope of ILS by allowing transformer vehicles to take risk from multiple counterparties, including non-insurers. Similarly, protected cell companies will be able to assume risk from more than one party, enabling multiple companies, particularly SMEs, to access risk-transfer arrangements without setting up standalone vehicles. This could improve accessibility and flexibility, but it may also increase the risk of contagion across cells.”

Certain business lines will be excluded from the new framework, Fitch pointed out. The UK government does not intend to allow UK-domiciled captives to write life insurance policies, reflecting concerns over long-term liabilities and the need for a strong regulatory regime. However, there is flexibility for specific products, such as group life fixed-term policies, which may be permitted subject to further regulatory consideration. Similarly, captives will be excluded from writing compulsory lines of insurance, such as employer’s liability or motor insurance, on a direct basis, though the government will allow coverage on a reinsurance basis where a fully authorised insurer remains liable.

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