Wednesday, July 24, 2024

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Solvency II reform no “revolution” but greater proportionality welcomed

  • Greater regulatory proportionality expected across EU member states
  • Lighter touch approach to ORSA and SFCR reporting requirements
  • Reforms could encourage more formations within the European Union
  • Welcome exemption from climate change reporting

There is hope that Solvency II amendments will allow for greater proportionality in the regulation of captives domiciled within the European Union (EU), but the proposals stop short of giving captives their own classification.

Since 2016 insurers and reinsurers, including captives, have been governed by the EU Solvency II Directive.

In April, the European Parliament voted overwhelmingly in favour of proposed amendments to the Solvency II Directive that is anticipated to bring some regulatory relief to captives from 2026.

Speaking on an upcoming episode of the Global Captive Podcast Charles Low, head of EU affairs at the Federation of European Risk Management Associations (FERMA), said: “What was experienced by FERMA, its members and others, was that in some cases, captives were being treated in the same way, prudentially, as large insurers in some markets.”

He added that captives, conceptually, were “unfamiliar territory” to many regulators and the principle of proportionality was not harmoniously applied across EU member states.

“There can be divergences across member states and we’re fine with that, but the issue that we took was the spirit, nature, scale, and complexity of the operations of captives were not necessarily adequately taken into account,” he said.

There is hope that lighter captive regulation across the EU might attract a greater number of captive formations within Europe.

Elizabeth Carbonaro, regional managing director for western Europe at WTW, told Captive Intelligence: “Even though we do tell people the regulation is proportionate today in Europe, people are always scared when they hear Solvency II is the applicable regulation. The fact that we are formally making it a lighter touch obviously helps a lot from a perception point of view.”

Dublin-based Dominic Halpin, senior account manager and risk consultant at Strategic Risk Solutions (SRS), said the decision to establish captives will continue to be driven by the parent’s ability to generate financial or strategic value from the structure.

“However, any movement towards less onerous regulation is welcome and could well positively influence the internal decision-making process,” he told Captive Intelligence.

Non-complex undertakings

It had previously been hoped that a new “captive undertaking” would be specifically defined under Solvency II, but the EU has stopped short of an automatic classification.

“Earlier indications were that there would be an automatic classification for captives as being small and non-complex, which would have automatically qualified for the new proportionality measures,” Halpin said.

“That being removed is disappointing, however we expect a large proportion of captives to still meet the criteria.

“Our industry has always maintained that supervisors and regulations should recognise the unique risk profile and business model of captives, due to the limited risk in terms of policyholder protection.”

Carbonaro said this had been an opportunity for Europe, the regulator, countries and tax authorities to understand the important value of captives.

“It’s a pity that the regulator did not go that step further in terms of definitively promoting the use of captives by making them an insurance company in their own right from a regulatory point of view,” she said.

Although not giving captives their own classification, the proposed legislation does cite captives under its definition of small and non-complex undertakings.

“‘Small and non-complex undertaking’ means an insurance and reinsurance undertaking, including a captive insurance undertaking and a captive reinsurance undertaking, that meets the conditions set out in Article 29a and has been classified as such in accordance with Article 29b.”

It is expected most European-domiciled captives will fall into this new ‘small and non-complex undertaking’ class.

“Undertakings complying with the risk-based criteria should be able to be classified as small and non-complex undertakings pursuant to a simple notification process,” the amendments state.

“… Once classified as small and non-complex undertaking, in principle, it should automatically benefit from identified proportionality measures on reporting, disclosure, governance, revision of written policies, calculation of technical provisions, own-risk and solvency assessment, and liquidity risk management plan.”

Also speaking on the Global Captive Podcast Laurent Nihoul, a FERMA board member and head of FERMA’s captive committee, said that the reforms are not a “revolution”, but more consistency and some relief will be good news.

He said it is welcome that undertakings classified as small and non-complex would be allowed to use all proportionality measures.

“Except when the supervisory authority expresses serious concern in relation to their risk profile or other criteria, but this has to be duly explained to the insurance company,” he added.

Nihoul also noted this should bring more consistency across domiciles in the EU.

“And more predictability, and the predictability principle is really crucial because we now have in the new text a list of clear criteria with which any insurance or insurance company should comply with to be considered as a small and non-complex entity,” he said.

“Even more importantly, there is now a derogation for captives because the texts say that captive companies can be classified as small and non-complex entities even though they do not comply with all these criteria, provided that they comply with a couple of other criteria.”

The risk the captive is insuring must belong to the Group, while any risk covering individual people should not be for more than 5% of the technical provision. The captive must also not have any compulsory liability in its portfolio.

A previous complaint with Solvency II legislation was that individual regulators had a large amount of freedom when it came to applying proportionality, leading to some EU jurisdictions being more stringent than others.

“What we have experienced since the introduction of Solvency II is that proportionality was not really applied in a consistent way, depending on the country,” Nihoul said.

“In Ireland, for instance, with the Own Risk Solvency Assessment (ORSA) or in Luxembourg for quarterly reporting, the criteria were not really consistent. It was really left to the member states to define what was really proportionality and how it should be applied.”

Halpin added: “There appear to be still some elements that are left open to the individual regulator, and that’s an important point because ideally, we’d have a complete level playing field across the EU.

“Particularly in terms of the Solvency II audit there is still scope for individual regulators to impose their own requirements.”

Carbonaro said that from a Malta perspective, she hopes the Malta Financial Services Authority (MFSA) applies the requirements to not audit the Solvency and Financial Condition Report (SFCR) because it can be a rather burdensome exercise.

“If I’m looking from a Malta point of view, that might be the biggest change I would see happening in terms of how the MFSA regulates captives,” she said.

Carbonaro is not sure there will be much change in Luxembourg, because the Commissariat aux Assurances (CAA) already takes a proportionate approach when it comes to regulation.

“Dublin as well may also consider elements of proportionality going forward,” she said. “France looks like it’s relatively proportionate except it seems to require the quarterly returns which might be reduced.”


Under the new Solvency II reforms, there are a number of changes that are expected to lighten the reporting burden on captives.

Under the new proposals, captives will only need to submit an ORSA every two years, rather than each year.

“The ORSA process has become more complex in recent years due to the emergence of risks such as inflation, climate change and pandemic risk,” Halpin said.

“This is a helpful change as for most captives, unless they’re writing new lines of business or significantly taking on more risk, then the ORSA process is very similar year to year.”

Currently, captives must review their entire suite of corporate governance policies every year.

“It appears that this review may be extended up to every five years under the proportionality measures, which is another positive change as it’s recognising that the business and operations of most captives are very stable,” Halpin said.

Captives will also only be required to submit the quantitative data for the Solvency and Financial Condition Report (SFCR).

“There is a requirement now for the balance sheet disclosed in the SFCR to be audited, which will not be applicable,” Nihoul said.

Climate change

Captives will also be exempt from new ORSA reporting requirements regarding climate change risks and scenarios.

“This is a clear practical relief if we think about how complex and burdensome this could be, and it would have added significant complexity for captives,” Nihoul said.

The amendments state: “In particular, while the assessment of the materiality of exposure to climate change risks should be required from all insurance and reinsurance undertakings, long-term climate change scenario analyses should not be required for small and non-complex undertakings.”

Halpin said the exemption from the requirement to model long-term climate change scenarios is “definitely welcome”.

“Even among large commercial (re)insurers there’s a lot of concern and uncertainty over how to comply with the regulatory expectations in this area,” he said.

“The large firms are very sophisticated in how they model risks, but the idea of accurately modelling up to 80 years into the future even for them is not practicable.”