Expert view: the future of captives
FERMA board member Dirk Wegener answers some questions about captives.
FERMA: When companies are deciding to set up or maintain a captive, how important are:
- Coverage that isn’t generally available on the commercial market?
- Higher limits than available at an acceptable price from the commercial insurance market?
- Better pricing on frequency risks (avoiding euro for euro trading with insurers)?
- Better loss information?
- Ability to plan better for severity losses?
Dirk: In principle, all of the above can motivate a company to set up a captive and the ultimate goal is to optimise the total costs of insurable risks. However, such a decision has always to be taken in light of the individual risk appetite of the company for self-insurance and the regulatory framework of the captive territory. Moreover, the captive has to operate on a sound business case, including risk-based underwriting, proper claims handling, and solid risk, capital and asset management procedures, because it needs to be run on an “arm’s-length” basis.
FERMA: What factors govern the choice of domicile for a captive?
Dirk: It is fair to say that the predominant consideration is the territorial scope of a captive domicile, meaning the type and quantity of risks of the company and in what territories can be insured by the captive. Then, (prospective) captive owners are certainly interested in a supportive environment of their endeavour, which includes responsive and experienced regulators, a reasonable regulatory framework and the possibilities of outsourcing non-core functions.
FERMA: Do European companies typically look for an onshore domicile like Dublin or Luxembourg?
Dirk: Yes, this is generally the case. The EU Freedom of Service principles are instrumental in allowing a parent company to cover a significant volume of risks through an EU-domiciled captive, and some territories have demonstrated more interest than others in providing this attractive environment to captives. Moreover, the EU Solvency II regulatory regime is an advanced risk-based framework to grant a level plain field across the EU regards regulation, which thereby narrows even further the competition of EU captive domiciles on service capabilities.
FERMA: To what extent does it depend on the class(es) of business you want to use the captive for? Or the location of the risks?
Dirk: In principle, all typical captive domiciles allow insurance of all relevant classes of insurance contracts, but there might be some niche product which can only be insured in specialised domiciles or by setting up a structure for the purpose, such as protected cell captives. The location of the risks is a more distinct denominator. Some insurance classes can only be insured by domestic (captive) insurers, for example, such as insurance-based employee benefit schemes. In such cases, non-domestic captives alternatively often act as a reinsurer of a fronting insurer which meets the regulatory requirements.
FERMA: How does a captive support the ERM of a multi-national?
Dirk: Not only is the captive an established tool to optimise the total costs of insurable risks, it also provides transparency on global loss distributions by risk types/exposures and the efficiency and effectiveness of internal loss prevention measures. These insights, gathered from an internal data base via a process which is consistent across all risk types/exposures, makes possible a solid ERM process for existing sites and processes. It also supports investment decisions on future locations.
FERMA: To what extent do you think BEPS will increase costs for captive owners? Is this increase likely to make some captives unattractive for their owners?
Dirk: Firstly, owners of EU-domiciled captives are very disappointed that their captives are exempt from the regular procedures applicable to all other insurance companies. Throughout the entire process of the implementation of the Solvency II regime, we were told to accept being treated like any other insurance company, as we were not any different. Now, we are told we deserve a “special treatment”. This inconsistency is neither fair nor helpful to support the captive concept as effective risk mitigation tool.
And yes, proving to be compliant with the BEPS requirements will absolutely increase costs for captive owners. My hope is that the already complex Solvency II data analytics and reporting will be instrumental to prove BEPS compliance at moderate additional cost for EU-domiciled captives and, therefore, will be not prohibitive to continue the captive as such.