Solvency II: bummer for captives

Don’t know why a story about captives and Solvency II ends up in the KC Star, but here it is:

The European captive insurance market should be braced for considerable development as the industry continues to respond to the economic climate and pending regulatory requirements, a new A.M. Best report states.

A brief timeout: A captive is an insurance company with only a few customers, usually one, rarely more than 10. Typically a large non-insurer will form a captive to insure its own risks up to a fairly low limit, then buy additional coverage on the open market. The alternative would be to only purchase insurance with high deductibles (excess insurance), then make sure you have the cash to handle smaller claims. The captive is generally cheaper, because the premium the non-insurer pays the captive is tax-deductible, while the money you set aside to handle claims is not. The difference can more than cover the cost of operating the captive.

The Best report points out that under S-II, all companies, captives included, will have to have more capital. I’d add that as S-II adds demand for actuarial resources, the cost of operating the captive will also rise.

Meanwhile, the current market is not as favorable to forming or using captives as it normally is. The scenario I laid out – cheaper to buy coverage from yourself  – doesn’t work if rates are low. So a soft market means captives are used less. Best points out that one-fifth of captives are currently dormant, though they still require licensing fees, etc. – sort of the vampire appliances of the insurance world.

But this doesn’t signal the end of the captive:

The report also concludes that some parent companies are looking at ways to utilize their captives more fully and are considering using them to provide cover for risks that include credit insurance and employee benefits such as long-term health and long-term disability.