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"As Solvency II is designed to cater for an "average" insurer, it poses challenges for captives due to their unique characteristics compared with other insurance entities", Fitch said.
The agency expects Solvency II to have varied implications for the EU captive industry. Owners that retain captives in the EU will have to strengthen risk management and governance functions, and in some cases additional capital injections may be necessary, it said.
As an alternative, captives could be re-domiciled to a non-Solvency II jurisdiction and write EU-based business through a fronting entity. In this case, Fitch believes that obtaining a credit rating on the captive could lower the overall capital cost.
"According to Fitch's analysis, obtaining a credit rating on an off-shore captive could, under the standard model, significantly lower the counterparty risk capital requirements levied on the fronting entity under Solvency II, and thereby reduce the overall capital requirements on an off-shore structure", says Bjorn Norrman, associate director in Fitch's insurance team.
How proportionality is applied under Solvency II will be critical for the attractiveness of EU captive centres. Fitch expects proportionality to be applied by individual regulators in a way that makes the majority of EU-based captives viable under Solvency II.
However, the agency predicts that in certain cases, in particular for small captives with limited financial strength and expertise, the new compliance requirements are likely to prove too burdensome, resulting in a limited outflow of captive entities from the EU.