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EIOPA issues opinion on the supervision of Captive (Re)Insurance undertakings
The captive (re)insurance approach offers potential benefits such as reduced costs, greater control over policies and coverage for niche risks. However, it also brings its own challenges such as the complexity of setting up and managing a separate insurance entity and meeting regulatory requirements.
The opinion aims to promote a consistent and risk-based approach to supervising captives across the European Union (EU). It emphasises the need for a level playing field for these businesses while accepting some flexibility for national specificities.
EIOPA recognises that while the unique nature of captives is considered in Solvency II, proportionality must be applied. This includes managing cash pooling arrangements and maintaining robust governance through adequate outsourcing of key functions whilst adhering to Solvency II requirements.
The opinion focuses on two key areas of supervisory expectations:
I. Cash Pooling Arrangements and the Prudent Person Principle.
II. Governance: Administrative, Management, Supervisory Board (Board) composition and outsourcing of key functions.
Key Takeaways
1. Cash pooling arrangements and application of the Prudent Person Principle
Cash pooling (intra-group arrangements for sharing liquidity among entities to manage cash within the group effectively) is favoured by groups as it reduces costs and often increases the total interest received on the net cash balance compared to individual balances.
EIOPA highlights the responsibilities of National Competent Authorities (NCAs) in ensuring captives properly account for cash pool assets and liabilities in their Solvency II balance sheet. This includes classifying them based on their economic substance and applying the appropriate Solvency Capital Requirement (SCR) calculation.
EIOPA has noted concerns with these arrangements; namely that the interest rates to individual entities are not at arm’s length, incorrect credit ratings, increased concentration, default and liquidity risks and potential contagion.
To mitigate these risks, NCAs will ensure the correct credit rating is applied and assess the creditworthiness of the counterparty in a cash pooling arrangement. A decision tree, as shown below, is provided to help NCAs assess the appropriate SCR treatment for each cash pooling arrangement.
The classification of a cash pool asset for SCR purposes depends on two key factors:
- Loan v Cash at bank: If the cash pool arrangement is structured as a loan, the asset is included in the Market SCR calculation, which considers market risks.
- Restriction on withdrawal: If there are restrictions on how quickly a company can access its cash, it is considered high risk and included in the Market SCR calculation. If the cash is immediately available, it is included in the Counterparty SCR calculation, which focuses on the risk of the bank holding the cash defaulting.
This may require some captives to review their current arrangements, particularly those structured as loans or with withdrawal restrictions. Any resultant changes in cash pool accounting might result in adjustments to the Solvency II balance sheet. A full review of the cash pooling contract is recommended to ensure proper classification.
2. Governance Expectations for Captive (Re) Insurance Undertakings
Board Composition
NCAs should ensure the board of a captive possesses the necessary qualifications and experience to perform its duties effectively, including seniority, relevant skills and professional experience. There are no exceptions to this requirement for captives compared to traditional (re)insurance companies. Firms are encouraged to review their board's composition to ensure alignment with the EIOPA opinion, the Central Bank Corporate Governance Requirements for Captive Insurance and Captive Reinsurance Undertakings 2015 and their business strategy.
Outsourcing of Key Functions:
The report addresses outsourcing key functions by captives, accepting that it is economically unattractive to hire a full team. Nevertheless, outsourcing arrangements must comply with Solvency II regulations and EIOPA guidelines. Where outsourcing is utilised, captives must designate a responsible person (that is fit and proper) to oversee the outsourced function. This person can be an internal employee, an individual under NCA supervision with a formal connection to the company or someone from the same group, as long as the arrangement is properly documented.
Additionally, the opinion stresses the importance of segregation of duties when multiple services are provided by the same service provider or captive manager.
Impact
The impact of the EIOPA Opinion varies depending on existing practices. Captives with loan-structured or restricted cash pools might need to review accounting policies and potentially adjust their Solvency II balance sheet. Board composition should also be reviewed to ensure alignment with EIOPA’s expectations and business strategy.
While some compliance burden exists, the opinion fosters clarity, consistency, and stronger risk management practices across the EU. The impact will be felt most in finance, risk management and at the board level.
In conclusion, this report by EIOPA establishes a framework for a more consistent and risk-focused approach to supervising captives throughout the EU. By outlining best practices for cash pool accounting and corporate governance, the opinion aims to create a level playing field for these businesses regardless of where they are supervised while acknowledging the need for some national flexibility. The implementation of these principles will ultimately contribute to a more stable and efficient Solvency II framework within the EU.
Next Steps
To be in line with these regulations and meet EIOPA expectations, it’s recommended that captives:
- Gap Analysis and Review of Cash Pooling Arrangements: Assess your current cash pool practices, identify areas for potential adjustment, and ensure compliance with the Opinion's requirements and the Prudent Person Principle.
- Solvency II Balance Sheet Review and Adjustments: Review Solvency II balance sheet and make any necessary adjustments to reflect changes in cash pool accounting.
- Board Review and Skills Matrix Development: Evaluate the effectiveness of your board (self-assessment or externally facilitated) and develop a skills matrix to identify any gaps in expertise that need to be addressed.
- Outsourcing: Review outsourcing arrangements, ensuring the operational risk arising from outsourcing is adequately captured and that appropriate segregation of duties remains in place.
How can we help?
Our Prudential Risk experts recognise that regulations are pivotal drivers for the strategic priorities of financial institutions. Our team utilises their industry and Central Bank experience to support clients within the insurance sector to navigate the intricate web of regulations. We work in partnership with our clients to identify their regulatory responsibilities and develop strategies for full compliance.
By leveraging our expertise, captives can ensure a smooth transition and achieve compliance with the EIOPA Opinion. We can help you strengthen your governance framework, optimise your risk management practices and ultimately contribute to the long-term success of your captive (re)insurance undertaking.