George M. Mangion | Wednesday, 04 March 2009

Cashing on Captives

It is interesting to note that for the second year running Captive Review has organised the Malta Insurance Rendezvous to discuss worldwide issues relating to captives. Indeed this year, the two-day event will start on Wednesday 4 March at the Westin Dragonara Hotel where a number of international delegates will meet to discuss topical issues hitting the sector. I think that the support given by the government to such foreign conference organisers is to be applauded as it attracts to our shores captains of industry from all quarters which otherwise will be rather difficult to reach. Top calibre executives are welcome here. I read in tabloids how much the private sector, aware of the global recession has been prodding the government to take immediate action and lay extra cash on the table as a stimulus package. Naturally, this sense of impatience appears to be mounting in its intensity as more sour financial news hit the headlines on an alarming rate. I appreciate that the government is taking a prudent approach and is not splashing taxpayer’s cash around just to win political kudos. In my opinion, supporting events like this and others in international fora is the best form of a stimulus package that it can afford. Thus the government has quietly implemented its strategy via the MFSA and FinanceMalta without the usual political fanfare. I augur that more initiatives like this will be supported as they go a long way to attract foreign investment. Obviously we need to take a proactive role to attract investors at a time when the credit crunch has dampened confidence on most financial sectors. For example, the global insurance market has taken its toll from the sub-prime demise in America. It is only relevant here to mention how America International Group Inc (AIG), the largest US insurance company had to be bailed out last year by the US government. AIG recently reported a massive US$99.9 billion loss for 2008 and unveiled a plea for a new federal rescue plan that includes up to $30 billion in additional assistance making the total of $160 billion so far. Its results last year had been negatively affected by continued credit market deterioration and the general soft market for insurance services. All this is given in the context that the Malta Insurance Rendezvous will be a unique venue to discuss and try to find a solution to mitigate this sorry state of affairs. Going through the official programme one reads about an impressive list of speakers and thanks to the support of MFSA and other sponsors, the event will showcase Malta’s abilities as a premium captive centre.
The crowning topic of the event is surely the latest regulatory developments surrounding Solvency 11. Now, with the latest results of the Qualitative impact Study no 4 which was recently concluded last year, delegates will be given an insight on how it impacts on risk based supervision particularly on captives and reinsurance industry. So what is the aim of Solvency 11 project and how is this far-reaching mechanism trying to achieve a smooth harmonization of regulations? The aim of a solvency regime is to ensure the financial soundness of insurance undertakings and in particular to ensure that they can survive difficult periods such as are being experienced in the credit markets today. This is a EU sponsored project aimed to protect policyholders and to help the stability of the financial system as a whole. ‘Solvency II’ will be implemented in 2012 is expected to increase competition, especially for mass retail lines of business, such as motor, life and household insurance, putting downward pressure on premiums. Product innovation will give consumers more choice. By comparison, its predecessor Solvency 1 started in the early 1970s and it was felt that a new regime is necessary to address present day conditions. It stipulates the minimum amounts of capital based on a scientific assessment of risk profiles that face both insurers and reinsurers. Will it apply to all and sundry? Yes it applies to almost all EU insurers and reinsurers but smaller entities with lower than €5 million premium income are excluded but can opt in.
It goes without saying that the Solvency 11 rules also lay down the principles that should guide insurers’ overall risk management so that they can better anticipate any adverse events and be in better shape to handle such situations. All this culminated in a paramount need for EU members to share in the single market when competing for insurance services. Anything less would otherwise lead to a situation where there is a patchwork of disparate regulatory requirements across the 27 members. It was appropriate that the third-generation Insurance Directives established an “EU passport” for insurers based on the concept of minimum harmonisation and mutual recognition. Thus Malta as a full member can encourage captives to set up base here and facilitate the passporting of risks across the euro zone.
The new ‘Solvency 2’ rules will replace old requirements and establish more harmonised requirements across the EU, thus promoting competitive equality as well as high and more uniform levels of consumer protection. With the progress achieved so far in the Solvency 11 reform one hopes that minimum and solvency capital requirements will also be more comprehensive than in the past. Whereas at the moment the EU Solvency 1 requirements concentrate mainly on the insurance risks, the proposed regime will also take account of the asset-side risks. It will be a regime where all the risks and their interactions are considered. Contrary to the past, more attention will be given to the internal assessment of market risk such as the fall in the value of insurers’ investments. Other improvements will cover the assessment of credit risk together with operational risk. The latter arises when systems start breaking down or in the case of malpractice. Without sounding alarmist, given the current financial turmoil it is rather important that all these risk types are fully accounted for since they can pose a material threat to insurers’ solvency. An impartial observer will definitely comment that in times when insurers are facing a severe credit crunch much will depend on how counter-party risks will evolve. In this growing uncertainty it is important for regulators to draw in their horns and provide a solid platform of realistic regulation for the insurance industry. It is therefore opportune to introduce via the Solvency 11 regime a more risk-sensitive capital requirement and to focus on and devote significant resources to the identification, measurement and proactive management of risks. Gone are the days when under Solvency 1 one would base solvency margins on historical data. The new rules will require insurers also to think about any future developments, such as new business plans or the possibility of catastrophic events which might affect their present and future financial standing. Thus it introduces a new mechanism called “Own risk and solvency requirement. “This is in addition to a new requirement termed the “Supervisory Review Process” (SRP). The purpose of the SRP is to enable supervisors to better identify insurers which might be heading for difficulties. These new measures are intended to instil a new discipline to the industry that will help in ensuring the stability and long-term sustainability of the European insurance industry. Despite the many safeguards in the Solvency 11 framework designed to minimise the likelihood of insurance failure and the costs to policyholders it is not a safe-safe solution.
Malta is well poised to welcome the delegates to the latest Insurance Rendezvous as it proudly opens its gates to attract more growth in its family of hybrid captive and PCCs. In the words of Prof. Bannister: “Malta is a stable jurisdiction that has not been affected by the financial turmoil in the banking system.”

George Mangion
Partner at PKF – an audit and business advisory firm



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04 March 2009

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