The Ever-Changing European Captive Landscape
Alex Gedge | April 17, 2023
Editor's Note: Hylant Global Captive Solutions contributes this Thought Leadership article examining developments in European captive insurance markets.
Interest in the use of captives as a risk management tool continues to become increasingly widespread as European owners seek to gain both the economies of captives and better mitigation for their business and market risks.
Additionally, climbing commercial insurance rates and coverage limitations are driving more companies to seek alternative strategies. Reinsurance providers predict a tightening market, driving premiums higher, although we're seeing signs the rate of increase is slowing. Standard & Poor's has forecasted continuing hikes, and Moody's has projected a 4-percentage-point underwriting improvement for reinsurers during 2023.
As companies look to fine-tune coverages and reduce the burden of higher insurance costs, captives are available to provide both capacity and cost controls.
One of the biggest changes comes on the regulatory front, as the new financial reporting standard known as International Financial Reporting Standard (IFRS) 17 takes effect within the European Union. The standard, which represents the most significant change in accounting for insurance in many years, has operational and reporting consequences—especially for multiyear policies. It replaces IFRS 4, which was issued in 2004.
IFRS is meant to create more accurate and timely assessments of captive and other insurance contracts by better-evaluating cash flows and making it easier to compare financial statements to those of other insurers. Replacing the nation-by-nation approach of IFRS 4, the new standard provides a global approach to accounting for insurance. It changes the valuation of insurance liabilities, affecting the amount of capital captives must devote to reserves.
Data management and transparency play key roles, and familiar financial statements and charts of accounts have been replaced with new versions. Captive insurers are required to make major changes to their financial processes and strengthen the connections between finance and the actuarial role. There are new disclosure requirements, necessary controls, and audit processes, too.
While the changes required under IFRS 17 are complicated and extensive, they do provide an opportunity for captive insurers to improve forward-looking management and take a fresh view of the structure of the organization, internal processes, and controls.
Another area of change in Europe centers on opportunities for choices of captive domicile. Both France and Italy have enacted new captive legislation, and Lloyd's of London introduced more captive facilities. As new domiciles become available, it's important to remember not every domicile is appropriate for every captive; some are available only to highly specialized types of captives.
The global focus on environmental, social, and governance (ESG) investing may also affect the operations of captives in Europe and elsewhere. Companies are increasingly paying attention to their impact on environmental, social, and governance issues in response to investor demands. When developing a captive insurer, a company needs to take steps to ensure its operations complement and support its own philosophy and attitudes about ESG investing. The heightened transparency triggered by IFRS 17 reinforces the importance of considering the ESG-related effects of a captive.
The growing complexity of risks such as cyber security and catastrophic events has led insurers to raise premiums, reduce coverages and impose strict limitations. As companies step up management of these risks, captives offer a proven way to fill coverage gaps and address specific risk areas. Not only does the use of captives enhance a company's ability to address unique areas of concern, but it also provides financial incentives for improving the management of these risks through loss control and similar strategies.
While it's heartening to see European authorities expanding access to captive strategies, the complexity of country-specific laws and the commercial insurance marketplace as a whole underscore the importance of working with an experienced partner that is familiar with managing every aspect of operating a captive and handling the transition to that strategy. That way, companies and organizations are assured of realizing the many benefits of creating a captive in less time and with fewer headaches.
Alex Gedge | April 17, 2023