When Solvency II capital standards first became known, owners of captive insurers viewed the new regulations as burdensome and costly. But European captives and their owners view requirements as an opportunity to improve their abilities to function, A.M. Best asserts in a new special report.
“Many European captives have embraced the increased regulatory requirements of Solvency II as an opportunity to focus more closely on risk management and refine their investment strategies,” A.M. Best said.
The ratings entity explained that captives (for the most part) are treating preparation for the new capital standards as an opportunity to review their business models, beyond preparation to meet Solvency II’s qualitative and reporting requirements. (The new regulations kick in on Jan. 1, 2016.)
There is plenty of reason for captives to proactively adapt to the new regulatory regime now. A.M. Best said captives and other specialist insurers aren’t covered well under the Solvency II standard formula. Most will use the standard formula, according to the report, “which treats their limited diversification harshly” and doesn’t necessarily reflect a typical captive’s risks and strategies.
With that in mind, Solvency II has placed greater pressure on captives to justify their reason for existing, and parent companies have been reviewing why they need to operate more than one captive.
“A.M. Best has noted a pragmatic response to mitigating the cost and reporting strain,” the report said. “Parent companies with more than one captive have considered economic efficiencies by transferring risks to just one captive.”
As well, because the standard formula used under Solvency II will hurt insurers more if they don’t produce “a large level of diversification benefit in the calculation,” companies are looking at accepting new risks in existing captives to meet that requirement.
“A captive that is able to accept different risks would ultimately be of increased importance to its parent,” A.M. Best said.
Also, rather than be daunted by Solvency II, A.M. Best said that the captives it rates “seem to hold the view that the higher costs from increased requirements in terms of risk management and governance are offset by the benefits that a better understanding of their risk profile provides.”
A.M. Best argued that Solvency II has been positive for captives, because those that are able to expand their risk management capabilities will be worth more to their parent companies.
“A.M. Best believes that captive owners, especially those whose captives are an integrated part of their overall risk management strategy and not just a financing tool, now take a more favorable view of the process, particularly as Solvency II aims to enhance and incentivize risk management,” the report pointed out.
Beyond this, the new requirement and resulting improvement in captives’ ability to spot and quantify risk and to understand and manage those risks better as they erupt is a good thing, A.M. Best said.
“This has traditionally been a weaker feature of captives,” according to the report.
Source: A.M. Best