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Are captives prepared for the Solvency II captive evolution?

Ciaran Healy | 24th June 2015

Is Solvency II spelling the demise of European captives?

I remember a number of years back reading an article that predicted Solvency II would spell the end for the majority of EU captives. The argument put forward by the author was that:

  • The majority of captives would simply be unable to deal with the extent of the requirements of Solvency II.
  • Solvency II would decimate the EU captive population.
  • Captives in the EU would either flee offshore or be shut down .

Quite an ominous message for those of us working in the industry, even if it was a little sensationalist.

Now, with less than six months to go before Solvency II is fully adopted and with the benefit of hindsight it appears that this prediction was wide of the mark.

In fact the numbers of captives in those domiciles directly impacted by Solvency II has remained relatively stable. It is true that some captives have closed or moved domicile to avoid the implications of Solvency II, but equally some new captives have been established with even some migrating into the EU from offshore.

So all this begs the question as to how captives have managed to avoid the tragic fate predicted? The answer lies in a captive’s unique ability to adapt and evolve.

Captives have managed to avoid their predicted fate because of their unique ability to adapt and evolve

Captive evolution

Solvency II is not the first regulatory challenge captives have faced and endured, and it is unlikely to be the last. Instead, what is happening now, as happened in response to previous regulatory changes, is that captives are adapting themselves to ensure they can continue to provide the sort of solutions to the parent organisation that they were originally created for. They are evolving.

Solvency II is promoting captives to think more strategically, putting analytics and enterprise risk management at the forefront of what they do, and this can only serve to increase the value it provides the parent company.

Some captive owners are fully prepared for the 1 January 2016 effective date, whilst others have challenging months ahead aligning to the new directive. At this last leg of preparation there are a couple of areas worth highlighting.

Capital usage

The first one is optimising the captive capital usage using the SII capital calculation, which presents a range of challenges.

  • How do you reduce capital requirements?
  • How do you protect against volatility and minimise the risk of having to ask the parent for additional capital?
  • How do you better use the captive to improve the return on capital employed?

When you know what the key drivers are you are looking at a range of options such as prospective reinsurance, retrospective reinsurance, and increased capital efficiency, you can more fully understand the key drivers of your Solvency II capital position.

Own Risk and Solvency Assessment (ORSA)

Another area that many have yet to realise is the implementation of the Own Risk and Solvency Assessment (ORSA), which is designed to ”live” in the day-to-day management of the company by being embedded within the company’s governance and operational structures and processes.

The ORSA is intended to be a process for assessing and monitoring overall solvency, providing a comprehensive and forward-looking understanding of the risks to which a company is exposed and the capital required to cover those risks on an ongoing basis. Captives that establish a structured and practical coordination of each step in the ORSA process will form a valuable management tool for the future.

The evidence suggests that captives in Europe will be around for the foreseeable future.

Captives are by their nature dynamic. They exist in the first place to provide solutions to their parents’ risk-financing challenges and as such are always prepared to adapt and develop new solutions. The spirit of innovation within the captive community has always been exceptionally strong and it should be no real surprise that captives have adapted and developed solutions in response to the challenges introduced by Solvency II.

The journey is not yet complete, but the evidence appears to suggest that captives in Europe will be around for the foreseeable future and in a lot of cases have become more strategically significant in the parent organisation’s thinking. You could even be forgiven for stretching the argument to say that EU captives have become stronger as a result of Solvency II.

What we can say with some conviction is that if the captive’s strategy is sound and the captive is providing the value to the parent that it should, then the introduction of a new regulatory regime should not topple a captive quite so easily.

So if Solvency II is causing your captive particular issues it may in fact be a strategic issue you are facing rather than a regulatory one.

About the author
Ciaran Healy Captive

Ciaran Healy is Director of Consulting and Development for the Willis Global Captive Practice.

In this issue
The unintended consequences of regulation Read more
ORSA summary report “Top 10” checklist Read more
Solvency II equivalence Read more
Are captives prepared for the Solvency II captive evolution? Read more
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