14 February 2013Asset management analysis

Captives outperform economy, but challenges remain

According to a special report issued this week by AM Best, captives survived the economic collapse thanks in large part to their conservative investment strategies and decreased exposure to sovereign debt.
Solvency II’s implementation - widely considered unlikely before January 2016 - presents considerable problems for the industry however, including increased competition between domiciles and increased costs.

It is likely that the costs associated with captive insurance will increase; while many captives rely on bare-bones staff and senior management performing a variety of jobs; Solvency II will increasingly demand a clear segregation of roles. In addition, smaller captives will require infusions of capital in order to meet regulatory requirements. AM Best expects that those captives whose value has not been proven to parent companies over a number of years will be closed or enter run-off.

Solvency II also places domiciles—particularly those offshore—in an uncertain position. While it is too early to determine whether captives will redomicile in response to the impending regulation, AM Best stated that: “Solvency II has raised the prospect of greater regulatory arbitrage among domiciles attempting to attract new captives. Nevertheless, AM Best notes that regardless of whether offshore domiciles seek equivalence, regulatory frameworks for all captive domiciles are being strengthened.”

While dangers exist, Solvency II can open doors for properly managed captives. As AM Best writes in their report: “those that focus on risk and capital management and maintain well-diversified or defensible niche strategies are well-prepared for Solvency II. By maintaining sufficient capital levels, they will be able to take advantage of opportunities to expand their roles, should they arise.”