With a plethora of legal and regulatory changes on the horizon, Ian Morris of BWCI Group takes a look ahead to what 2013 holds for the captive industry.

Famously there is a curse, often attributed to the Chinese, which says "may you live in interesting times".

Anyone involved in finance or the economy over recent years will recognise that times have been not only interesting but very challenging as well. In this article I look at why 2013 will remain interesting for the insurance sector.

Incidentally, the 'curse' relating to interesting times was thought to be the first of three. The second was "may you come to the attention of those in authority". There are a number of senior finance staff in recent years (albeit perhaps more in banking than insurance) who might wish that they had avoided the 'curse' of attention from those in authority. I will return to the third 'curse' at the end of this article.

UK legal changes

Several UK legal changes are likely to have an impact in 2013 and beyond. The Legal Aid, Sentencing and Punishment of Offenders (Laspo) Act 2012 will introduce key reforms including the abolition of referral fees and limits on fees. These changes could have a major impact on future claims costs, but it remains to be seen how the legal profession will evolve around the changes. The Ministry of Justice (or Jackson) reforms to the claims process for small claims continues and its scope may be increased. There is some limited evidence that the process has reduced the level of damages, costs and delays. However, to date the impact looks modest.

Other potential legal changes may arise from a review of whiplash claims and a review of the Ogden discount rate.

In assessing premiums and reserves it remains challenging to assess the potential impact of legal changes. While the aim of these changes is to limit claims costs, their effectiveness is as yet largely untested.

UK CFC changes

The UK has introduced a new regime for controlled foreign companies (CFCs) with effect from 1 January 2013. This will alter how UK parents of captive insurance companies will be taxed. As often with tax changes, the new CFC rules restrict certain aspects while introducing new issues and possible opportunities. Cells of protected cell companies (PCCs) will now be treated as companies for tax purposes, even if the parent does not fully control the core entity. There is also a potential tax charge on the UK parent if the captive is deemed to have excess capital.

The basis for this assessment is under review. It is anticipated that the changes will largely be beneficial for captive insurance companies controlled by a UK company. Nevertheless, the detailed tax rules are complex and assistance may be needed with certain areas (such as demonstrating that the capital held is not more that an independent company might hold).

Gender neutrality

Since 21 December 2012, rating premiums by gender has been outlawed within the EU. In 2013 it is likely that companies will be reassessing their regulatory position, to see how their gender neutral rates compare to the market. I expect most companies to keep rates under review on a regular basis as they develop an understanding of the approaches adopted by their competitors.

Solvency II

Progress with Solvency II has been a focus for the European industry for several years and was originally intended to be adopted from November 2012. However, there have been a number of delays! On 19 December 2012, the European Insurance and Occupational Pensions Authority (Eiopa) announced a long-term guarantees assessment (LTGA) to be launched on 28 January 2013. The purpose of the LTGA is to test several approaches to long-term guarantee measures. Participants in the LTGA are to report by the end of March and Eiopa is to publish a report in June 2013 for the benefit of the trilogue parties (the European Commission, the European Parliament and the Council of the EU).

The current schedule is for the trilogue parties to vote on the Omnibus II Directive on 10 June 2013. However, I expect this to be delayed until September 2013, to enable sufficient time for review of the LTGA report. It has been suggested that Solvency II will go live from perhaps 1 January 2014 or 2015 but 1 January 2016 seems more likely. Whatever the final effective date, much of the detail of the new regime has yet to be finalised.

Insurers will need to remain alert to manage the impact of the new details when established. Furthermore, there will be a lengthy period prior to the full adoption of the new regime. Each EU country will have to decide how to monitor solvency pending the full adoption of Solvency II and insurers will have to adapt accordingly.

Outside Solvency II

The developments in Solvency II do not have a direct impact on jurisdictions such as Guernsey and the Isle of Man. Nevertheless, I anticipate that regulatory authorities in both of these jurisdictions will continue to review their approaches relative to the International Association of Insurance Supervisors (IAIS) core principles and may evolve their approaches to supervision. In particular, both may consider to what extent their current arrangements for looking at solvency can be made more risk based. However, both are likely to seek a practical approach that should be manageable for the captives based in those regimes.

IFRS Phase 4

Revised accounting standards for insurance have been under review for many years. As with Solvency II, the need to seek international agreement in a technically challenging area has proved difficult. The International Accounting Standards Board (IASB) expects to publish a revised exposure draft (ED) on insurance contracts in the first half of 2013. The ED will contain a restricted set of questions focusing on the presentation proposals, measurement proposals and the approach to transition. Issues that have been already deliberated and decided since the first ED in 2010 will not be re-exposed.

The IASB expects to publish the final IFRS 4 in the second half of 2014 and the proposed effective date is 1 January 2018. Early adoption will be permitted. There may not be a final conclusion to this work in 2013. However, insurers would be advised to monitor the requirements, as much work on systems and accounting reporting may be needed to give effect to the new regime.

Low interest rates

While there may be a few green shoots of recovery, most Western economies look sluggish, struggling with high levels of debt, banks with capital challenges, significant problems in the eurozone and the fiscal cliff in the US. In these circumstances investment earnings are likely to remain low and insurers will have to rely on good quality underwriting to remain profitable, rather than relying on investment income on assets to offset any underwriting losses.

May your wishes be granted

The third curse attributed to the Chinese says "may your wishes be granted". This might seem a relatively innocuous goodwill statement rather than a 'curse' but perhaps relates to the saying "be careful what you wish for". In any event, I wish you all the best for 2013 and hope that life remains interesting but perhaps not too interesting or attracting undue attention from the regulatory authorities!

Originally published by Captive Review, February 2013

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

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.