We often hear about the impact of Solvency II on European captives; but it’s rare to hear anyone talk about Solvency II and North American captives as well.

Although it’s not always the case, European companies often:

  • Use local, commercial, fronting insurers to insure their third party, life and pension risks, in return for a modest fee; and
  • Arrange for the fronting insurer to fully reinsure these risks back into the company’s North American captive. 

There are many reasons for this. European and Member State laws require companies to insure some risks locally, but this can be expensive. At the same time, with luck and good risk management, a company may be able to “retain” at least some of its premia within the captive, without “losing” the premia and the investment returns associated with the premia to the commercial insurance market.

So, what’s that got to do with Solvency II?

Unfortunately: plenty.

Under current European rules, fronting insurers can often take regulatory capital credit for the value of the captive underwritten reinsurance. And, under Solvency II, they’ll still be able to take at least some of that credit, if the captive is in the European Economic Area, or a Solvency II equivalent jurisdiction. If it isn’t, the value of that credit will fall – perhaps to nothing - unless the captive posts collateral to “guarantee” the value of the reinsurance.   This is likely to be especially significant for North American captives – in part, because there are so many; and, in part, because we now know that North America will not be Solvency II equivalent on any basis. This has at least two potential consequences: European companies may have to capitalise their North American captives to a much higher extent than before; and/or the cost of fronting arrangements may increase to reflect the higher capital cost of fronting a captive reinsurer.

It’s not yet clear what impact this will have on the international captive market.  Many European captives will have to comply with Solvency II in the same way, and to the same extent, as other insurers. Some non-European captives may now have to comply with a back door version of Solvency II as well. Watch this space.