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FINANCE CONFERENCES and SEMINARS

Third Comparative Captives Seminar

Organised by PKF Malta in Luxembourg, 12^th February 2009. A study on the captive insurance status in Europe: the credit crunch has unleashed a hurricane, will Captives avoid falling into this vortex?

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EU Regulatory Changes and Developments affecting captives

By Yannis Samothrakis

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EU Regulatory Changes and Developments affecting captives Third Comparative Captives Seminar – PKF Malta

The reinsurance directive

Definition of captives
Reinsurance captives subject to same rules as reinsurers, in particular:

Authorisation and passport
Solvency margin (guarantee fund of 1 000 000 €)
Management of assets: prudent person principle
Collaterals Treatment of third countries’ reinsurers

Solvency II – Treatment of Captives (1/2)

Principle: insurance and reinsurance captives will be subject to the Solvency II directive (recital 6b)
Exclusion of insurance captives fulfilling certain criteria related to premiums, technical provisions and nature of business (article 4)
Reinsurance captives subject to a guarantee fund of 1,000,000 € (article 127)

Solvency II – Treatment of Captives (2/2)

Some of the provisions of the directive proposal remain unclear:

May Member states impose specific requirements on insurance captives benefitting from the exclusion?
How, in practice, could an insurance captive “opt out” of the system once it has fulfilled all the criteria for three consecutive years?

Solvency II – Pillar I (1/3)

Solvency margin:

Solvency Capital Requirement – SCR: target level based on the European Standard Formula or on an internal model
Minimum Capital Requirement – MCR: level of eligible own funds below which policyholders and beneficiaries are exposed to an unacceptable level of risk - breach entails severe supervisory action
What about internal models?
For the captives being subject to Solvency II, some requirements may prove challenging

Captives could be penalised because of lack of diversification
Processes must be in place to manage breaches of MCR and SCR

Solvency II – Pillar I (2/3)
Solvency II – Pillar I (3/3)

Article 137: breach of MCR

Solvency II – Pillar II (1/3)

Being well managed is not sufficient, the onus of proof is on supervised entity to demonstrate and document good management
Extremely wide scope of the review process – e.g.:

Review and evaluation of strategies, processes and reporting procedures to comply with laws, regulations and administrative provisions
Assessment of the qualitative requirements relating to the system of governance, of the risks faced or that may be faced, ability to assess (properly) these risks
Adequacy of methods and practices to identify possible events or future changes

Solvency II – Pillar II (2/3)

Considerable discretion given to supervisors in appreciating the situation of supervised entities
Procedures should be put in place to manage relationship with supervisors during the recovery stage
The possibilities to challenge supervisors’ decisions will be subject to the laws of the home member state
Responsibility lies ultimately with the board of directors

Solvency II – Pillar II (3/3)

Uneven implementation legislation may complicate this process further in case of cross-border operations
National legislation tackling “emerging” risks may also affect existing cover – e.g.: terrorism risks in France:

cover is compulsory in property damage and motor insurance as long as fire damage is covered, for risks located on French territory => also concerns captives
the industry will need innovative solutions – e.g. French market pool GAREAT which organises the reinsurance of the terrorism risk, including risks accepted by captives established outside of France

Solvency II – International dimension (1/2)

Treatment of captives located outside of the EEA still to be determined - principles of equivalence of prudential regulation, market access and exchange of information
CEIOPS paper on the criteria for the assessment of supervisory equivalence under the reinsurance directive outlines key indicators for equivalence:

Supervisory authority
Authorisation requirements
Business change assessment
Supervisory cooperation and exchange of information
Supervisory and enforcement powers
Financial supervision and solvency requirements

Solvency II – International dimension (2/2)

How could this work in practice?
Would US states and Bermuda qualify?

Dewey & LeBoeuf Worldwide
Contact details

Yannis Samothrakis Dewey & LeBoeuf 51, rue Pierre Charron 75008 Paris Direct: 33 1 53 93 77 14 ysamothrakis@dl.com

Treatment of Captives - Solvency II

by Jeanette Roedbro - ECIROA

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European Captive Insurance & Reinsurance Owners‘ Association - ECIROA

Position paper on treatment of captives in Solvency II (DVS, bfv, BDI)
ECIROA formed 19 August 2008
Object:

protection and support of captive industry
official lobby group

Members:

Adidas BMW E.ON HSBC Merck
Akzo Nobel BT Group plc EADS Ikano Michelin
ArcelorMittal Clariant Evonik Degussa Israel Chemicals Nycomed
BASF Deutsche Bahn Heineken Lundbeck NS Group
Bayer Deutsche Bank Henkel LVMH Group Royal DSM
ThyssenKrupp TNT Vattenfall VW

Solvency II

What will change?
Balance sheet values
Either 16% of premium or 23% of claims

Solvency II & captives

Pillar I:

Actuarial calculations QIS 4: 2 weeks 4,000-20,000 EUR
Simple structure (few insurance lines, limited investment portfolios, low number of transactions etc.) penalised in standard formula

Pillar II:

CEIOPS Issues Paper on Pillar II asks for the following functions:

Risk management
Compliance
Internal audit
Actuarial

Pillar III:

Disclosure to supervisor OK
Public disclosure -sensitive

Fronting

Risk charge for reinsuring to captive for fronting companies

Unrated EU company: BBB
Unrated 3rd country company: CCC

One captive reinsuring to a sister captive in for example Bermuda

Quantitative Impact Studies QIS 4

Fair value on assets & liabilities
Probability of failure 0,5% in one year (1/200 years)
Test of proxies and simplifications
Made on annual accounts as per 2007…

QIS 4 – Technical provisions

TP QIS 4 generally lower than TP in SOLVENCY I
Equalisation provision treated as capital instead of TP

Most Luxembourgish reinsurance captives were solvent because of the classification of the equalisation reserve

Problem: lack of enough statistical data

QIS 4 - SCR

Catastrophe risk major problem (61% of SCR for Lux Captives)

Method 1: (based on amount of premium) not appropriate to business written by reinsurance captives
Method 2: (based on local scenarios) impossible as business is world wide
Method 3: (personal CAT scenarios by undertaking)

Directive says 4/year
QIS 4 tested corridor 20-50% of SCR – independent from SCR??
68% of captives needed to use floor

ECIROA plans

Meeting with actuaries 17 Feb. –Annexe
Questionnaire
Co-operation with FERMA and its members
Present ideas to CEIOPS mid-March
QIS 5 including special test of developed simplifications for Captives (spring 2010?)

Captive Insurance and the Credit Crunch

by Callum Beaton FCII Chartered Insurer

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Did St Paul discover an insurance centre?
He faced risks of:
…tempest, grounding, lightening, general average, travel delay, snake bite, even death
embracing the following insurance classes:
…hull, cargo, P&I, travel, healthcare and life
He was swept ashore to find:
“…the Island was called Malta and the natives showed us unusual kindness”
Was this the first Protected Cell?
Discussion points

Current market situation
Are there driving forces at play or just inertia?
Do we see new strategies or is the cartwheel being reinvented?
What has delivered success?
Where do we go now?
The sole purpose for establishment of a captive is the development of long term shareholder value

Current market situation

Real growth is stagnant
Cell numbers are not reported in all domiciles so actual figures may be clouded
Parent company failures will impact on captive numbers – solvent run-off will be essential
A few new domiciles are emerging but in many cases they are chasing the same business
Massive differences in premiums/captive numbers remain between East and West

Driving forces or inertia at play?

The captive concept is counter cyclical
Thorough research is paramount
Good quality reinsurance is essential
Now is not the time to be risk averse
Nor is it the time to be complacent
Job security is a key inhibitor to new risk management initiatives

New strategies or reinventing the wheel?

Client and broker
Broker and insurer
Insurer and reinsurer
Captive and manager
Manager and captive board
Risk manager and finance director
Nothing has actually changed!

Credit crunch risks

Directors’ & Officers’ liability
Third party deductible exposures
Warranty programmes
Collapse of the holding structure
Corporate governance failure
Investment exposures
Traditional insurance risks

Added credit crunch pressures

Demand for new strategies
Corporate cost cutting
Long term shareholder value
Pressure on underwriting returns
Pressure on reserving policies
Pressure for dividend returns
Increased regulatory scrutiny

What has delivered success?

Sound management practices
Robust and objective regulation
Creativity with a focus on risk management
PCC and ICC legislation
Corporate governance codes
Direct writing throughout the EU
Concerns for insurance market stability
Desire to access reinsurance markets

Where do we go now?

If you accept the market is counter cyclical, then now is the time to see development
Regulation has developed during times of the soft market and this should be used to assist corporate development not to stifle it
Use of the captive concept stands to deliver greater benefit now than at any time in the last twenty years

And why do we go there?

PCC and ICC structures allow effective ring-fencing of self-insured risks without reliance on the external market
Domiciles are introducing new thinking including Takaful insurance and direct writing
The strategy worked in spite of a soft market
Creative development during the soft market has positioned the captive concept so it can beat the present credit crunch

What makes a good domicile for Captives?

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Protected Cell Companies

By George Mangion, Senior Partner - PKF Malta

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Overview

Attractions of a good PCC domicile
Protected Cell Company Regulation
Characteristics of a PCC
Main Advantages of PCCs
Recourse
Transfer
PCC Formation
Payment of Cellular Dividends
Incorporated Cell Companies
Taxation

What makes a good PCC domicile?

EU member membership guarantees access to all European Markets
Single passport regulations
Re-domiciliation regulations: captives operating in other jurisdictions are allowed to transfer their seat in the domicile
Taxation – OECD recognised tax environment; Double taxation relief
Moderate and competitive operating costs
Local pool of expertise, skilled workforce
Protected Cell Legislation

Characteristics of a PCC 1/2

A regular trading company which is constituted as a Cell Company is called PCC
The Cellular Structure is for the purpose to segregate and protect the cellular assets of the company
A PCC is a single legal entity. Cells within a PCC have NO OWN legal personality
Cells are represented by a class of shares
Monetary Streams, Liabilities and assets are kept SEPERATE
Non-cellular assets are assets of the PCC which are not attributable to a cell

Characteristics of a PCC 2/2

Collective management is permitted as long as identification is possible at any time
Management of cells may be delegated, but ultimate responsibility remains with directors of the PCC.
The PCC is exclusively for Insurance Companies, but Jurisdiction adopts the principles of the PCC also for funds
Solvency requirements must be satisfied by each cell individually
Solvency is not calculated on a consolidated base

Main Advantages of PCCs

Cells and their owners can write EU based risk with lower capital, own funds or other requirements
Segregation and protection of cellular assets from any liabilities of the PCCs core or other cells.
Thus, a PCC structure enables promoters to share overhead costs with other promoters without losing protection from the insolvency of others.
Easier access to captive market: Expenses of a captive can be shared between the owners of each of the cells, thus it is cheaper; especially for small firms
Due to its flexibility a PCC can provide a means of entry into captive insurance market to entities for which it was previously uneconomic to do so.

Recourse

Cellular assets attributable to a cell only available to satisfy liabilities of that certain cell
No recourse by any creditor of another cell
Creditors of a cell have right of secondary recourse to non-cellular assets of the PCC but only once cellular assets of the particular cell have been fully exhausted
Creditors of PCC but not of a certain cell have right of recourse against non-cellular assets

Transfer

Transfer of cellular assets to third parties possible
Approval of regulator necessary
Allowance only given if creditors of the certain cell have been informed of the transfer and consent to it
Approval NOT required for transfers made in the course of ordinary administration (invest cellular assets, claim settlement, payments, … )

The PCC Formation

The Memorandum and Articles of a PCC have to cover following conditions:

the expression PCC / Protected Cell Company has to be included in the company name
the memorandum has to provide that the company is a cell company
every cell must have a distinct name or designation
the M&A must distinguish between cell shares and non-cellular shares

PCC Statement

a cell company must indicate in its business forms and letters that it is a cell company

The PCC

In the first step a company has to be empowered to convert into a PCC in its M&A
The promotion, creation, management and administration of cells has to be included in the Objects of the company
To achieve these Objects and to be able to trade and deal in respect of the various cells the Powers of the company have to be extended
The cellular structure has to be applied to the company and the shares and assets of the cell companies must be named

Payment of Cellular Dividend

Dividends are payable by a PCC in respect of cells shares
Cellular dividends may be paid by reference only to cellular assets (including reserves) and liabilities or the profits attributable to the cell
Issue of cellular dividends independently of the core or other cells
Determination by the Board and approved by the members

Incorporated Cell Companies 1/2

Incorporated Cell Companies Ordinance 1st May 2006, Guernsey
Companies (Jersey) Law (Amendment No. 8) 2006, Jersey
Same principle as Protected Cell Companies
Differences:

Each cell is a separately registered legal entity!
Each incorporated cell has a separate Board, its own share capital, its own memorandum & articles, produces own accounts

Incorporated Cell Companies 2/2

Consequences:

Company can be converted into a incorporated cell of an ICC and vice versa
Incorporated cells can be sold of to a third party as a separate company
Incorporated cells can merge with other companies or incorporated cells and can migrate to other jurisdictions

Nevertheless, PCCs retain following advantages:

Quick formation by Board resolution, because cells are not separately registered
Slightly lower administration costs
PCC as single legal entity can avoid reaches of certain tax avoidance legislation

Taxation - Malta

There are a number of fiscal incentives applicable

A non-resident shareholder of company carrying on affiliated insurance is taxable at the effective rate of 5%
Technical provisions and equalisation reserves are allowed as a deduction in the computation of taxable income
Duty is not chargeable under the Duty on Documents and Transfers Act 1993 in respect of any contract of insurance relating to a risk situated outside Malta
A company is assessed and pays tax in the currency in which its share capital is denominated. Any refund of tax is made in the same currency
Captive Management Services have the further benefit of being zero rated for VAT purposes under the VAT Act

Taxation - Guernsey

With effect from 1st January 2008, Guernsey introduced a new ‘0/10’ corporate tax regime: regular companies pay no tax, companies regulated by the Financial Services Commission pay 10% tax
New trust legislation (the Trusts (Guernsey) Law, 2007) was approved in July 2007 and came into force on 17th March 2008

more flexible framework for local trust industry, ensures that Guernsey remains well-placed and competitive

Third Comparative Captives Seminar

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Rules and Regulations

Conferences, Seminars

EU Regulatory Changes and Developments affecting captives

Treatment of Captives - Solvency II

Captive Insurance and the Credit Crunch

What makes a good domicile for Captives?

Protected Cell Companies