1 January 1970EMEA analysis

ECIROA: fighting its corner

How are you looking to clarify the role of captives in the minds of regulators?

Too often regulators look at captives and claim that they are instruments intended to circumvent taxes. This makes the lobbying function very difficult. At ECIROA (the European Captive Insurance and Reinsurance Owners’ Association) we find ourselves consistently having to say that this is not the purpose of a captive and explaining to regulators that they perform a valuable role in providing risk retention and coverage for multinationals. We are seeking to clarify the purpose of captives in the mind of regulators and the public—that they are there to optimise the risk transfer structures of their parents, in combination with being a natural home for self-insured retentions.

Are you a little frustrated that the European Insurance and Occupational Pensions Authority (EIOPA) is sticking to the notion that all insurers are going to be included under the same banner?

Not frustrated, no. We have a specialised business model that differs significantly from that of the commercial insurers. But there is noreason why the regulatory criteria being applied to captives can’t be the same as those applied to the commercial sector. Proportionality in combination with flexibility in local supervision should enable all insurance companies to operate within, and conform to, the Solvency II framework. Proportionality is really a common sense approach to the application of this regulation and one that can benefit the captive sector.

The issue with Solvency II is that it sets out targets and is not, in fact, overly prescriptive when it comes to its remit. The regime encourages compliance with as many elements of the directive as possible, but if there are areas that captives cannot provide information on, they simply need to explain why to EIOPA. The big rule that EIOPA has laid out is that re/insurers need to comply or explain. This should help the sector overcome some of the obstacles it sees in Solvency II, with the industry able to positively outline why captives cannot fulfil all the requirements of the regime.

How damaging do you think further delays to Solvency II will be to its credibility?

There are a few perspectives to bear in mind. One is that those insurance companies who have invested a lot of money in the project are prepared—more or less—for a compliance of sorts. They are however a little frustrated that the regime’s start date has shifted back again, because they have had to maintain a level of investment in the project—in terms of capital and time—and they don’t want simply to end that because this will cost money.

On the other hand there is something inexplicably hectic about the process. EIOPA is facing considerable political pressure to complete the Solvency II project, but a number of key questions remain unresolved. It makes little sense to proceed so quickly with the project when its final form and function have yet to be established.

So there are two completely different perspectives on Solvency II, and it makes sense to clarify matters. Issues regarding points such as minimum requirements under Pillar II in connection with, and based upon, the Principle of Proportionality have yet to be clarified and until this happens, confusion will remain regarding its application and a final timeline.

Are delays and uncertainty regarding Solvency II encouraging captives to consider domiciles outside the regime, such as Guernsey?

Guernsey, like a number of other territories, has taken a risk-basedapproach to solvency and is currently taking steps to revise its regulatory environment in response to Solvency II. If captive owners think they can go to Guernsey in order to avoid a risk-based approach to regulation they will quickly find it isn’t going to work.

Offshore domiciles will be obliged to apply similar solvency requirements to those located onshore and within the Solvency II framework. Suggestions that excess risk sensitivity in Europe will have a negative impact on captive business are simply not true.

However, while issues such as proportionality should ease the burden of Solvency II on the captive sector, there are nevertheless significant cost implications for the sector. These costs will then be passed on as increased premiums and this is not a welcome development for the industry.

Is Solvency II considered a beneficial arrangement for insurers in general and is it encouraging captive formations in Europe?

It won’t be a showstopper. If you properly invest capital into a captive and quantify your risks, you will come to realise that it is not an issue. The regime, in fact, makes a lot of sense because captive owners want to optimise their risk, risk-carrying and risk transfer solutions. Solvency II encourages them to do this. We also need to bear in mind that the captive business model is a positive and separate tool from the activities of the owner, one that encourages risk mitigation.

Solvency II will help a number of captive owners to reconsider exactly how they use their captive. I’m pretty sure they will discover that there are some capabilities and uses which they hadn’t considered in the past. We should also remember that for the moment nobody knows what the impact of Dodd-Frank will be in the US. A number of questions remain unanswered and nobody quite knows how Dodd-Frank will affect the state regulation of captives, risk retention groups and other entities.

"We also need to bear in mind that the captive business model is a positive and separate tool from the activities of the owner, one that encourages risk mitigation."

We also don’t exactly know what the remit of the Federal Insurance Office will be and how this will develop over time. I think there are more questions in the US than in Europe. We now know what is proposed under Solvency II, it will just be a matter of taking the steps to implement the regime and working closely with local regulators in order to ensure the burden of the regime isn’t excessive.

There may also be some consolidation as a result, because many companies have multiple captives. It happens regularly among large multinationals—with takeovers you inherit a lot of captives. Instead of three you have five or six, and then it makes sense to combine their efforts to create a stronger and larger captive.

What about the eurozone crisis? Has that had an impact on the captive sector?

The impact of the eurozone crisis on the captive sector has been slight. The industry doesn’t have the same level of exposure to troubled products such as government bonds that others in the capital markets do, and when captives do, the volumes don’t tend to be that big.

The asset management strategies of most captives are closely linked to the treasury departments of their parent and they generally decide on behalf of the captive or in combination with the captive management team how to assign the various investments to the various classes of investment. Everyone is increasingly aware of the low interest rate environment we are in, but this is a global phenomenon, not simply one affecting Europe or the captive sector.

Finally, what about political overtures from governments exploring ways to increase their tax intake?

Governments are all looking at ways to maximise their revenues in the current crisis. Every capital city is looking at who might be able to pay more, with finance ministries looking at who might be circumventing their tax systems in unacceptable ways. Captives are likely to come under scrutiny, although I am confident they will pass the test.

However, as long as the crisis persists, governments will continue to pursue revenue. The question is: do we behave as diligent and prudent citizens or as corporate entities? Sure, there is an opportunity for all kinds of companies to save taxes, but the question is one of ethics. In the end, and despite opportunities that might present themselves to circumvent certain taxes, we have to behave in an ethical way. Today reputational risk is an increasingly important part of our business, particularly when you consider the growing significance of social media, and you simply cannot play games with such an issue.

The crisis has also helped to strengthen the rationale for captives. While the current crisis may be something of a hiccup for the industry, I suspect that insurers will be tempted to increase premiums in response to difficult investment conditions and increased premiums always lead to rising consideration of the captive alternative. And with better and more intelligent development of the risk management function, global companies will have even more reason to take on part of the risk themselves.