Co-operation is key

In Cocoa Beach, Florida, where I now spend a lot of my time, the world-famous Ron Jon surf shop defines itself as “one of a kind”. This motto could be cast on the front door of every captive insurer’s European offices.

In the Solvency II legislation debate, many stakeholders challenge that captives deserve preferential treatment compared to other insurance and reinsurance companies. ‘Unfair’, say large insurers, trade representatives and a few control authorities arguing for a ‘level playing field’. ‘Totally justified’, is the reply from captive domicile legislative bodies, captive managers and captive owners generally represented by Eciroa and Ferma.

Captives are different from other insurers. The shareholder and the insured belong to the same economic entity. This substantially changes the requirement for security. The parent company has a moral obligation to recapitalise the captive and insured subsidiaries have a moral obligation to accept rate increases to pay back the captive. A captive is mostly a funding mechanism to spread the cost of risk.

Captives don’t compete for market share: they co-operate with insurers by funding self-insurance of large deductibles, insuring non-insurable risks, providing additional capacity on difficult to place events, and improving risk quality through loss prevention. Risks written in a captive and shared with or reinsured in the traditional market are usually of better quality than standard risks. The risk manager has access to privileged group data and technical information. Claim information is available internally and calculation of technical reserves is more accurate.

Captives are managed by highly qualified professionals, funds are usually handled by the group treasury function and the parent company financial rating often equals or exceeds that of many conventional insurers. Captives are audited by both external and internal group auditors. And captives are not managed to provide short-term return.

One of the aims of Solvency II is to guarantee that 99.5 % of European insurance and reinsurance entities will not go bankrupt. This means that every year, there should not be more than one in every 200 companies in financial difficulty. For the past 30 years, this has not been the case for any of the 400 or so captives established in Europe.

If captives were to apply the same formula as any other insurance undertaking to calculate their capital requirement, they would need so much additional funding that many of them will disappear or relocate.

Risk managers would lose an important strategic tool. Captives deserve special treatment under Solvency II and should each be considered “one of a kind”. ¦