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The ratings agency believes that many captives may find Own Risk and Solvency Assessment compliance particularly difficult under Pillar II as there is no specific ORSA model to follow. Meanwhile, Pillar III's further disclosures, increased transparency and improved benchmarking are generally welcome though difficult for captives, it said.
The report states that while some captives will struggle to comply with the new directive, others will find opportunities. Companies that focus on risk and capital management and maintain well-diversified or defensible niche strategies are well-prepared for Solvency II. "By maintaining sufficient capital levels, they will be able to take advantage of opportunities to expand their roles, should they arise," AM Best said.
Anandi Nangy-Kotecha, associate director, analytics, commented: "Direct captives are likely to be more heavily impacted by the current form of Solvency II than reinsurance captives. Small captives, which lack risk diversification and have high counterparty exposures, are expected to need capital increases to meet regulatory requirements. Given the more onerous regulatory environment and the costs involved, some parents may close dormant captives and run off existing vehicles."
In terms of exposure to sovereign debt, a captive's exposure is generally lower compared with a conventional insurer, although the captive may come under pressure to increase loans back to a parent that has been negatively affected by the financial uncertainty, according to AM Best.
Yvette Essen, report author and director of industry research, Europe & emerging markets, added: "Parent companies continue to have a wide choice of jurisdictions for their captives. Cells are being formed, although the soft market and uncertainties regarding Solvency II's final specifications and implementation date could result in delayed decisions to form captives in onshore jurisdictions."