The introduction of new regulation is always a concern for the captive sector.  Captive (re)insurers are more sensitive to the burden imposed by regulation than other sectors of the insurance industry.  Captive owners are generally non-financial service groups who use their captive as an efficient way of accessing the (re)insurance markets and generally managing group risks. 

Increased regulation generally means increased costs (whether represented by increased time commitment from group management or increased fees to managers and advisers).  Increased regulation may also represent a greater risk profile for the group because if the captive cannot comfortably comply with the increased regulatory requirements, it may face reputational damage because of regulatory sanctions.  If the aggregate cost of operating a captive (whether financial or other costs) is perceived by management to be too expensive, then other risk transfer/management solutions will be explored.

In Ireland the main regulatory preoccupations for the captive sector are:

CP53 – the proposed Corporate Governance Code for Captives

CP53 was published earlier this year and it described the proposed Corporate Governance Code for the captive (re)insurance sector of Ireland.  The consultation period closed on June 10 and the Central Bank is currently considering the comments received.  Areas of concern for industry include:

• The “documented risk appetite” – a captive board is required to address the short, medium and long term horizons. This requirement may pose a difficulty as the nature of captives is that there is often no differentiation between short, medium and long term horizons
• Reporting to the Central Bank – where a captive no longer complies with the definition of a captive, the Central Bank must be notified within 5 days. In practice, such a determination may take longer, including notification to the board
• Deputy Chairman –  if the proposal that a captive must appoint a Deputy Chairman  proceeds, this may require a change to the articles of association of many captives as standard articles generally state that if a Chairman is not present, any director can assume the role.  It is not clear why the Central Bank is proposing a Deputy Chairman role for every captive
• Captive Manager – there is an inference (which caused some concern amongst self managed captives) that a captive must always appoint a captive manager.  However this is probably not the intention and the point is likely to be clarified when the final Code is published.

Despite these concerns, it is probably the case that the captive sector breathed a collective sigh of relief when CP53 was published.  There had been a concern that many of the intrusive characteristics of the Corporate Governance Code for Credit Institutions and Insurance Undertakings would also be proposed for captives.  However, the Central Bank should be commended for producing a consultation paper which is proportionate as far as the captive sector is concerned and, subject to the concerns outlined above being addressed, would probably be generally welcome by the sector.

The Audit Committee requirements of SI220 of 2010

Under CP53, the Central Bank does not consider it necessary that captives establish an audit committee or risk committee, provided that the board discharges these functions. Ironically many captives (especially those who are owned by non-EU groups) are obliged under SI220 of 2010, the EC (Statutory Audits)(Directive 2006/43/EC) Regulations 2010 to establish an audit committee. 

It is a matter of great frustration for the captive sector that these Regulations require captives to establish an audit committee because one of the consequences of this requirement is that a captive must appoint two independent directors (one of whom has to have competence in auditing or accounting) to constitute the audit committee.  The requirement is not mandated by EU law.  It is hoped that the Department of Jobs, Enterprise & Innovation will deal with the matter sensibly and quickly.

Solvency II

Captives are unclear how the Solvency II Directive will affect their capital and reporting requirements. The industry is also seeking clarification on how proportionality will shape the regulation of captives. The impact of Solvency II on the use of captives is not yet generally known because the Level 2 guidance is not expected to be formally issued until mid-2011. Some concerns which captives may have in regard to Solvency II are:

• Solvency II may increase the capital requirements of captives, to the same level of commercial insurers. This has prompted some firms to reconsider the viability of having a captive insurer
• The Directive makes no distinction between the reporting requirements of commercial (re)insurers and captives.  Captives or their parent could be required to disclose publicly the captive’s financial statements and certain material matters that impact its financial condition
• The uncertainty surrounding the equivalence treatment of non-EU (re)insurers is making it difficult for any group that has a captive in a number of jurisdictions to plan its medium and long term strategies with regard to consolidation of its captives. 

Contributed by John Larkin.

This article appeared in the June 2011 edition of Finance Dublin.