Establishing a european captive

Authored by Marine Charbonnier, Global Programmes and Captives Regional Director for Europe, AXA XL and Maxime Schons, Managing Director for Europe, Strategic Risk Solutions

Over the last two years, there has been more captive formation activity in Continental Europe than since the introduction of Solvency II in 2016. And the indications are that there are many more new captives in the pipeline.

Against this background, Global Captive Podcast (GCP) recently hosted a “GCP Short” to discuss the issues companies need to consider when setting up a new European captive, including the key elements of the process, critical success factors and the roles and expectations for the different participants. The experts GCP spoke with were Marine Charbonnier, AXA XL’s Global Programmes and Captives Regional Director for Europe, and Maxime Schons, Strategic Risk Solutions’ Managing Director for Europe in Finance & Compliance. Following are highlights from the podcast.

What’s behind this surge?

Marine and Maxime cited several factors driving the “unprecedented growth in the captive market”. Foremost of these are the current dynamics of the traditional insurance markets including rate increases, higher deductibles, lower limits, and more stringent terms and conditions in many lines-of-business. They also noted the continuing challenges associated with emerging risks, including cyber-attacks and supply chain disruptions, which are only becoming more pronounced.

According to Maxime, three other “intangible factors” also play a role. First, risk management is becoming more centralised in many organisations, and a centralised organisational structure generally is more conducive to owning and managing a captive. Second, a generational shift is underway with an influx of new corporate risk managers who are more comfortable with solutions that some previously discounted as overly technical or complex. Third, there is more experience in using captives to cover a broader range of risks, e.g., employee benefits, or to implement alternative solutions, e.g., parametric coverages or multi-line/multi-year programs.

Marine also emphasised that in today’s highly uncertain and volatile world, effective risk management and mitigation are more essential than ever, and captives have proved to be flexible, capital-efficient vehicles for managing and mitigating risks.

Creating a solid foundation

Maxime and Marine highlighted the importance of the initial feasibility study in creating a solid foundation for a new captive. They noted that the feasibility study typically begins with assessing the organisation’s risk profile and risk appetite.

As Maxine put it, “We need to get a clear overall picture of the current insured risk, the non-insured risk, and the non-insurable risk to envisage the right mix of lines-of-business underwritten by the captive”. Marine added, “One of the challenges during the feasibility study is finding the adequate threshold between risk retention and risk transfer while also taking into account the risk profile, the subsidiaries’ need for low deductibles, the financial strength of the captive, and current market conditions”.

Maxime noted that setting up a captive is akin to launching a new business. As such, agreeing on the captive’s long-term strategic objectives is another essential element of the feasibility study. Some key questions include: “What are your long-term intentions/goals for the captive? How will the captive fit into your existing risk management programme? What is the underwriting direction? How much volatility can you tolerate”?

Internal buy-in and support are critical

One of the challenges in setting up a new captive is that the organisation’s leaders and managers typically are unfamiliar with captive structures, including what they are, how they operate, and the value they can deliver. At the same time, long-term success heavily depends on broad understanding and support for the captive across the business and its functional areas.

Maxime said that as a new “subsidiary” within an existing enterprise, “it is important for the captive manager to become familiar with the group culture, to identify the key stakeholders that will be intervening in the lifecycle of the captive. To seek a corporate consensus with the final objectives of the captive. To make the captive visible and its benefits well-understood for everyone”.

Marine expanded on this point: “I would highlight that an understanding about how it will work on a daily basis is key. To fully understand the captive process and, with that, the added value. Also, the roles and responsibilities of the stakeholders. Because it has to be understood that there is an advisor, there is a captive manager, there is a broker, there is a fronting company, and perhaps a retrocessionaire. And all internal stakeholders need to understand the roles these different participants, including the external partners, play. It demonstrates the value of strong coordination and the need for that coordination to be defined, shared and controlled.”

In terms of who needs to understand and support the captive, Maxime commented: “It has to include the key directors from the C-suite. The CEO is always a plus. The financial functions, including the tax department, also are key, especially as tax issues become more and more of a consideration in how the captive operates. Finally, having support functions like compliance and legal onboard helps ensure that the captive starts with a robust framework”.

Marine underscored the finance team and CFO’s critical role in setting up and managing a captive. She noted how it could significantly impact the parent company’s short- and long-term financial plans and, more specifically, “because when we ceed a new captive, it needs securing by a collateral. Bearing in mind the wide range of possible collaterals, their selection and their potential impacts on the captive’s design need to be duly explained and understood during the feasibility assessment phase.”

Marine and Maxime concluded this part of the discussion by stressing the long-term value of building an understanding of and securing support for the captive at the outset of the process.

Marine: “Long-term relationships are key to a captive’s success. Having all that right from the beginning makes the whole process, not just at formation but the next five years of the captive’s life, that much easier as well”.

Maxime: “It is a matter of educating people at the start to avoid repetition and to have everyone at the table understand how the captive could benefit the group and the different departments”.

Engaging with the regulators

A common concern among companies considering setting up a captive is having to satisfy regulatory requirements, including Solvency II, which they haven’t encountered before and can be perceived as complex and perhaps daunting. Since this is an area Maxime specialises in, he offered several specific suggestions.

For starters, “it is important to maintain a permanent discussion and contact with the regulator. First, to sell the application project and then to ensure the captive achieves its objectives over time”.

He then outlined the “milestones” the regulator will use “to analyse the solidity of the project”.

“The first is the overall rationale of the project and how it fits within an overall risk management strategy. This includes an analysis of the (parent company’s) shareholding structure. The regulators are looking for transparency and clarity around the shareholding structure. They also want evidence concerning the group’s reputation and stability”.

“Secondly, there are some risk management items the regulator needs to see supported with solid and robust actuarial calculations. That means we need to assess the captive’s long-term solvency picture and, more importantly, how it performs in stress-testing to various adverse scenarios.

“Those are the two main focuses of the regulator when analysing a captive project.

“Once this step is achieved, another milestone focuses on governance. This includes analysing what are called the three lines of defence: 1) the board members; 2) the Solvency II key functions; and 3) the operations and the daily back office”.

Closing comments

Marine: “For new and existing captives, transparency and communication are keys. Those are critical to the overall success. Because if you don’t have those, it could be a nightmare”.

Maxime: I agree that the first year is significant. Because it represents the right moment to build the foundation for the long-term strategy. It is also important to build the right processes and systems, whether it is claims management, financial reporting, internal control, an underwriting dashboard … all are critical for the long-term success of the captive.”