CIMA continues review of Solvency II

According to
the United Kingdom’s Financial Services Authority, the proposed Solvency II
(SII) directive –a regime designed to improve the financial soundness of
insurers and reinsurers, thus effecting better protection for policyholders,
especially during difficult periods – is on track to meet its implementation
date of January 2013. In analysing the local market, it is apparent that whilst
there is a separate reinsurance and captive market in Cayman, we do not have an
exposure in the European Union that would warrant immediate action. 

Regardless,
the numerous changes the directive is tasked to bring about are generally
welcomed by the Cayman Islands Monetary Authority. The anticipated improvements
to risk sensitivity, market sensitivity, supervision of groups and transparency
each further strengthens the insurance regime – a welcome improvement in light
of the financial crisis which saw several well documented financial collapses
of commercial insurers. The area of equivalence alone will raise the bar in group
supervision, a change that is ultimately beneficial for commercial insurers.
This new level of supervision is welcomed by CIMA, as any attempt to bridge the
gaps in group supervision must be applauded.

But
despite the benefits for supervising commercial insurers that SII will bring,
captives do not bear the same systemic risk as their commercial counterparts or
reinsurers. There are also significant risk measures and existing regulatory
standards that have proven effective for as long as Cayman has had a captive
market which must be factored in when determining the extent of change that is
warranted. 

While
CIMA has maintained a view that the Solvency II directive is a good concept,
there are still some issues in regards to the captive market that must be
resolved.

Some
of these ‘grey areas’ are generally well known in the regulatory and market
environments and accepted as unresolved factors. In particular there are six
areas of concern for the Cayman Islands captive industry in relation to the
Solvency II concept.  They
are: 

  • Proportionality 
  • Group
    supervision  
  • Cost
     
  • Definition
    of a beneficiary  
  • Concentration
    of risk and 
  • Transparency 


Proportionality

The
issue of proportionality continues to be one of the largest gaps in the theory
behind Solvency II. SII was specifically developed to curb systemic risk.
However, in the true landscape of the insurance market, captives are neither of
a great size, risk or complexity and therefore do not pose the significant
systemic risk that SII is designed to mitigate. 

Group
supervision

Another
concept of SII that is welcomed in theory for the commercial insurers but has
yet to be clearly defined in regards to the captive industry is improved group
supervision. CIMA feels that this improvement is much needed for commercial
insurers but not necessarily for captives. Regardless, until the definition of
what constitutes a ‘group’ is explicit and accepted, the parameters for this
aspect cannot be developed.  

An
observation that CIMA has made highlights the progressive methodology the
Authority has employed for many years: a focus on risk-based supervision.
Though this may be relatively new for other international counterparts, this is
an approach CIMA has always taken, having realised that an approach that is
both risk-based and proportional to the scope, nature and complexity of the
licensee is fundamental to success.  

Cost

Oftentimes,
significant changes bear significant implementation costs. With SII, this would
be no different. In 2010, a captive owner ran the standard model and discovered
the need for capital to increase by twenty times compared to their risk
retention to capital of one and a half times.

This begs the question: in a time
of recovery from the global financial crisis will captive insurers find this
unachievable? As for regulatory costs, the UK FSA has admitted that the total
implementation costs of Solvency II would be in the region of £100 million, and
ultimately these costs would be shared with the private sector.

The
FSA has acknowledged that the calibration of the standard model remains an area
of concern and continues to refine its implementation strategy, though what the
final cost will be remains unknown. 

Regulatory
bodies, too, will be required to increase their staff complements in order to
appropriately handle the issues of Solvency II, particularly in acquiring
actuarial staff that will have a host of areas to review including the Own-Risk
& Solvency Assessment (ORSA), Internal Models and general risk assessment
of the company. Although the cost to the regulator would be absorbed, it is
still a significant element when discussing the unresolved elements of SII.

Definition
of a beneficiary

Further
causing concern, is the issue of beneficiaries. Beneficiaries under insurance
are the recipient of any payout. The EU has taken the stance that this also
includes the unknown beneficiaries of a liability policy, ie the plaintiff, and
not necessarily the insured under the insurance policy ie the defendant. If
this is the case, couldn’t a case also be argued that self-retention (eg not
insuring), outside of a captive, should also be subject to Solvency II?

Concentration
of risk

Concentration
of risk is a component of the Standard Model and Internal Mode but is presently
weighted toward large, diverse commercial insurers. What of captives where the
risk is obviously concentrated? As it stands, this risk metric will unfairly
penalise the Solvency Capital Requirement (SCR) of a captive owner.

Finally
the transparency

Calibration
factors in the standard model are somewhat skewed against captives. Two
specific areas are the earlier mentioned concentration risk and the use of a
combined ratio (losses plus expenses) of 100 per cent, both of which unfairly
penalise captive owners because typically, a captive will run a combined ratio
of 60 per cent. Based on this factor, a captive owner would face an SCR that is
significantly higher than the commercial market and reinsurance market.

What
CIMA has done 

The
Cayman Islands has been a top three captive jurisdiction for many years and for
many reasons. CIMA has consistently taken a unique approach to the captive
market in its efforts to holistically understand not only the insurance captive
programme but also the role of the captive as part of the overall risk
management programme of the parent company. 

This
focus enables the Authority to build a strong relationship with the principals
of the captive, and creates channels for feedback in anticipating and avoiding
problems that may occur during different market cycles such as soft pricing,
credit availability, etc.

As
the directive continues to make strides, CIMA has continued to work with the
captive stakeholders to ensure the preparedness of the jurisdiction to
implement the new regime, where and if applicable. There will be ongoing
discussions with the private sector to monitor concerns coming out of industry.
The Authority remains committed to working with all captive insurance
stakeholders in Cayman to ensure that the local market remains engaged in the
processes that may eventually lead to a new solvency standard. 

CIMA
will also continue its advisory role to the Cayman Islands Government which has
been proactive in maintaining our legislation on the forefront of development.
For example, CIMA led the development of the new insurance law in October 2010
that, when combined with our existing practices, will fully meet the overall
guiding principles of risk-based supervision as well as the principles of the
Solvency II regime, if it should come in force in Cayman.

CIMA
has also been proactively providing input that could help to clarify its
concerns on the ‘grey’ issues by participating in the consultation processes of
the Committee of European Insurance and Occupational Pensions Supervisors, now
named EIOPA, particularly in highlighting some suggestions to the regulation of
captives under Solvency II. (https://eiopa.europa.eu/fileadmin/tx_dam/files/consultations/consultationpapers/CP79/Comments-received-from-CIMONEY-on-Consultation-Paper-79-09.pdf

SII
– No crystal ball

The
challenges of Solvency II to captive regulation are not unique to the Cayman
Islands – they extend to all international captive jurisdictions. With the
myriad issues that are as yet to be settled in regards to Solvency II, it would
be premature of the Authority to proffer a final judgement on how this
directive will truly affect the Cayman Islands’ captive industry. For this
regime to be successful, it is paramount that the framework include mutually
agreed upon definitions and methodologies. 

As
previously stated, the Solvency regime is a welcome introduction to the
insurance market as a whole. As 2013 draws nearer, CIMA will continue its
efforts of proactive involvement to ensure that the stability, sound regulation
and growth of the Cayman Islands’ captive market are not endangered.

The Tax Information Authority also
administers bilateral agreements with the 27 EU member states in relation to
the automatic reporting of savings income information, in effect since 2005.
The Cayman Islands does not operate a withholding tax.

Amendments to the Tax Information
Authority Law were made in December 2008, which provide for a parallel
‘unilateral mechanism’ for cooperation in tax matters that can be used in
addition to bilateral agreements. The mechanism is designed to reflect OECD
technical standards for transparency and provision of information 

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Cindy Scotland

Cindy Scotland has served as the Managing Director of the Cayman Islands Monetary Authority since June 2002. In this role she oversees the implementation of policies to ensure the sound management of the Cayman Islands’ currency and the effective supervision of the more than 14,000 regulated entities operating in and from the Cayman Islands. She also has responsibility for the development and maintenance of strong working relationships between CIMA and other international regulatory bodies.

Cindy Scotland
Managing Director
Cayman Islands Money Authority
PO Box 10052
Grand Cayman KY1001
Cayman Islands

T. +1 (345) 949 7089
E. c.scotland@cimoney.com.ky
W. www.cimoney.com.ky