NU Online News Service, May 12, 1:51 p.m. EDT 

European Union captive insurers most likely will see higher costs, increased capital requirements and tightened enterprise risk management standards with Solvency II implementation, says rating agency A.M. Best Co.

In a special report, A.M. Best says captives' current market environment is bound to change dramatically with the increased requirements the European risk-based regulatory regime represents. It will lead parent companies to re-evaluate the role of their captives and the value they add to their organizations while it appears inevitable that capital requirements for captives operating within the EU will increase dramatically.

The latest indications, it says, point to a three- to fourfold increase in minimum capital requirements for EU-domiciled captives. The small size of most captives, their lack of diversifica­tion of risks, and their high counterparty exposures seem to be the main drivers for this regulatory capital increase as captives move from Solvency I to Solvency II.

It has been argued that the Solvency II stan­dard formula to calculate solvency capital requirements is not appropriate for captives, says A.M. Best, adding it believes captive insurers are likely to be among the hardest hit in terms of addi­tional capital requirements upon implemen­tation of Solvency II due to their generally small size and highly vola­tile claims.

A.M. Best says captives that are able to obtain a secure financial strength rating should not have major difficulties adapting to Sol­vency II. Strong risk-based capital, robust risk management and governance, close integration with a securely rated parent and effective reporting systems will leave captives well positioned for the demands of the new regime, the ratings agency says.

Because many captives operate as reinsurers, A.M. Best says equivalence could be a major consideration, as some reinsurance business is already supported by collateral or deposits of reserves with a fronting company.

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