Captive managers have admitted that improved governance and control need to be considered in addition to supplementary capital requirements under the second pillar of Solvency II, according to audit firm Towers Watson.
Towers Watson explained in a release that Solvency II’s second pillar requires captive managers to demonstrate “robust governance and risk management”.
Mark Cook, director at Towers Watson, said: “Until now the greatest concern for captive managers about Solvency II has been the solvency capital requirement and the implications of the solvency margin standard formula for the balance between risk retention, capital and reinsurance.”
“Now, captive owners realise that improved governance and control also matter, especially when those captives are writing employee benefit risks … One note of caution that has not been clarified as of yet is that the long-term reserving requirements for benefits paid out as annuities are still an area under debate.”
Cook added that despite the additional requirements, the improved framework “should” enhance the long-term success of captive programmes if well thought through.
According to Towers Watson, Solvency II governance requirements will create additional work for captive management. However, additional employee benefit programme governance and risk management shouldn’t add too much to the existing costs of Solvency II and compliance for existing captives.
Cook said: “We see many captives that write employee benefits risks having governance frameworks in place already. For example, many will have a captive board sub-committee that has specialist employee benefits knowledge. This committee will focus on the employee benefit risks and advise on a variety of topics such as underwriting, pricing, reporting and provider service levels. So this area under Solvency II will be an extension or formalisation of current best practice.”
Towers Watson explained that under Solvency II, captive board members have to understand the business they are writing, as well as the associated operating and investment risks. The firm suggested that risk management of employee benefit risks is different from property and casualty (P&C) risks.
Mark Cook said: “In the case of a captive’s typical P&C risk exposure, the risks are often highly unpredictable and potentially very volatile, whereas employee benefit risks are somewhat more predictable, higher frequency and lower volatility in comparison.”
“Captives writing employee benefit risks should therefore seek to understand the risks of their employee benefit business, determine how they may adversely affect the captive and then take the appropriate risk management steps.”
Cook concluded that while risk management and employee benefit programmes in captives will require specialised knowledge, the introduction of employee benefit risks could reduce the risk of the captive becoming insolvent through the addition of an essentially “uncorrelated line of business”.
