Originally published in Captive Review, Guernsey Report, 2009-10, October 2009

Michael Poulding of the Guernsey Financial Services Commission believes both the insurance and reinsurance industry in Guernsey can benefit from Solvency II

Guernsey is a British Crown Dependency situated 50 kilometres from the French Coast in the bay of St Malo. It is fiscally independent from the UK and is responsible for setting its own legislation, including financial services legislation. It is not a member of the European Union (EU).

The insurance market in Guernsey consists of over 700 individual insurance entities including captive insurance companies, reinsurance companies, protected cell companies and their cells. Captive insurance companies and cells account for approximately 60% of the market. The total gross premium income in 2008 was £3.3bn while total assets at 31 December 2008 amounted to £21bn, an increase of 13% over the previous year. Currently the areas of greatest growth are protected and incorporated cell companies and this trend is expected to continue.

Captives licensed in Guernsey often utilise the services of commercial insurance companies, to front certain classes of risk, normally to comply with legislation in some jurisdictions that require certain classes of business such as employers' or motor liability to be insured either by locally licensed companies or by companies licensed in an EU member state. In these circumstances, the captive acts as a reinsurer of the fronting company and as a consequence, the fronting company has to consider the admissibility of the reinsurance in its own solvency calculations.

Under the Solvency II regime, EU insurance or reinsurance companies ceding reinsurance to a company situated in a third country outside the EU will not be able to take credit for the ceded reinsurance unless the third country regulatory and supervisory regime can be considered equivalent to Solvency II. Criteria for assessing equivalence are expected to be established by Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) by July 2010.

The Guernsey system of regulation

The current solvency capital requirements for Guernsey insurers, including captives, are based on a percentage of premium income or total claims provisions. In practice companies are required to hold solvency capital equal to at least 150% of the MCR (minimum capital requirement). The supervisor is able to impose higher capital requirements if justified by the nature of the business.

The approach adopted for simple captive insurance companies where account cannot be taken of diversification or pooling of risk is to consider the 'risk gap', in other words the difference between the maximum total claim amount in any one year and the expected premium income. The risk gap should be more than covered by available capital.

In 2008, Guernsey introduced a requirement for all companies, including captives, to produce an 'OSCA', in other words, an 'Own Solvency Capital Assessment'. A guidance paper was issued detailing the risk factors that should be taken into account. The introduction of the OSCA was intended to ensure that the boards of insurers considered their own specific risk profile in determining the appropriate level of capital to be held in excess of the statutory minimum requirement. An analysis of the first OSCA reports has shown that considerable thought has been given by insurance managers and boards to the specific risks applicable to each company which provided valuable confirmation of the adequacy of the capital position.

Guernsey is an active member of the International Association of Insurance Supervisors (IAIS) and sits on most of the IAIS committees and subcommittees including the key Solvency Subcommittee. Guernsey represents the Offshore Region of Insurance Supervisors on the IAIS Executive Committee. The Guernsey system of regulation is based on the IAIS Insurance Core Principles together with the associated standards and guidance. This includes the IAIS guidance paper on captive insurers which was prepared by a group of both captive and non-captive supervisors chaired by Guernsey.

The insurance laws and regulations in Guernsey are regularly reviewed in line with changes to the IAIS standards and in particular, changes will be made to ensure that solvency requirements are consistent with developing requirements.

Solvency II equivalence

Since Guernsey is outside the EU, it is not required to adopt EU Directives and is therefore not required to implement the Solvency II regime. It will, however, take account of Solvency II when developing its own solvency and other regulatory and supervisory requirements in line with international standards, particularly as the Solvency II regime is likely to be considered as a benchmark for evolving international best practice.

In order to achieve equivalence under the Solvency II Directive, Guernsey will, under the expected equivalence criteria, have to be able to demonstrate that its regime is compatible with the Solvency II requirements, although the full extent of the compatibility requirements will only be known when the equivalence criteria are finalised.

Under Solvency II, supervisors will be able to approve the use of internal models by insurers to establish their solvency capital requirements as an alternative to the standard methodology specified by the Qualitative Impact Studies. The use of internal models is expected to be limited to certain larger life insurance companies and reinsurers although it may also be an option for the larger captive insurers. Regulatory guidance will be developed to cover the appropriate use of internal models.

An important component of the Solvency II regime will be the application of the principle of proportionality. In view of the nature of the Guernsey market, which has a number of small commercial insurers and in particular captive insurers, many of which insure a single type of risk, the ability to apply proportionality principles realistically in determining the methodology for determining solvency requirements is a particularly significant aspect of the regime.

As the largest captive domicile in the European geographical region, Guernsey is particularly well placed to focus on the application of Solvency II to captives. We are in active discussion with both insurance supervisors and insurance management companies in the EU captive domiciles of Dublin, Luxembourg and Malta to establish the impact of Solvency II on the European captive insurance industry. We are also holding discussions with bodies representing captive owners such as the Association of Insurance and Risk Managers (AIRMIC) in the UK and the European Captive Insurance and Reinsurance Owners Association (ECIROA) in Europe.

A number of insurance entities in both Guernsey and the EU are established as protected cell companies or incorporated cell companies. Consideration needs to be given to the application of the Solvency II requirements to protected cell companies and in particular to situations where cells each have recourse to core capital for solvency purposes.

Impact of Solvency II on Guernsey

Guernsey currently has a major captive insurance sector as well as an international life insurance sector. It is also home to an increasing number of both life and general reinsurance companies.

The impact of Solvency II on the Guernsey market depends on the achievement of equivalence under the Solvency II Directive.

If equivalence is achieved, Guernsey captive insurance companies will still be able to utilise the services of EU fronting companies at an economic cost and the reinsurance sector is expected to expand as it will be able to accept ceded reinsurance from EU insurance and reinsurance companies. If the achievement of equivalence is not achieved or is delayed, there is a risk that the attraction of Guernsey as a captive insurance centre will diminish as the cost of fronting will increase and EU captive owners will increasingly look towards EU domiciles to establish their captives. The expansion of the reinsurance sector would also be adversely impacted by the reduced attractiveness to EU companies of ceding reinsurance to Guernsey reinsurers.

Companies in the international life insurance sector would be less impacted if equivalence is not achieved as they are less reliant on ceded reinsurance, although there could be an adverse impact where they participate in a pooling arrangement for mortality or morbidity risks that includes EU life insurance companies.

Guernsey is well placed to benefit from the introduction of the Solvency II regime in Europe, provided it can achieve equivalence status under the Directive. This will benefit both the captive insurance and the reinsurance sectors.

Achieving the equivalence status will involve further development of the Guernsey regulatory and supervisory regime in line with the latest international standards while ensuring compatibility with the requirements of Solvency II. An important consideration will be the application the requirements of the Directive to smaller insurers and captives of the IAIS and the Offshore Group.

For more information about Guernsey's finance industry please visit www.guernseyfinance.com.

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