INTERNATIONAL ASSOCIATION OF
INSURANCE SUPERVISORSAPPLICATION PAPER ON THE
REGULATION AND SUPERVISION OF
CAPTIVE INSURERS
November 2015

About the IAISThe International Association of Insurance Supervisors (IAIS) is a voluntary membershiporganization of insurance supervisors and regulators from more than 200 jurisdictions innearly 140 countries. The mission of the IAIS is to promote effective and globallyconsistent supervision of the insurance industry in order to develop and maintain fair,safe and stable insurance markets for the benefit and protection of policyholders and tocontribute to global financial stability.
Established in 1994, the IAIS is the international standard setting body responsible fordeveloping principles, standards and other supporting material for the supervision of theinsurance sector and assisting in their implementation. The IAIS also provides a forum
for Members to share their experiences and understanding of insurance supervision andinsurance markets.
The IAIS coordinates its work with other international financial policymakers andassociations of supervisors or regulators, and assists in shaping financial systems
globally. In particular, the IAIS is a member of the Financial Stability Board (FSB),
member of the Standards Advisory Council of the International Accounting Standards
Board (IASB) and partner in the Access to Insurance Initiative (A2ii). In recognition of its
collective expertise, the IAIS also is routinely called upon by the G20 leaders and otherinternational standard setting bodies for input on insurance issues as well as on issues
related to the regulation and supervision of the global financial sector.

About IAIS Application Papers
Application Papers provide additional material related to one or more ICPs, ComFrameor G-SII policy measures, including actual examples or case studies that help practicalapplication of supervisory material. Application Papers could be provided incircumstances where the practical application of principles and standards may vary or
where their interpretation and implementation may pose challenges Application Papers
can provide further advice, illustrations, recommendations or examples of good practiceto supervisors on how supervisory material may be implemented.

This document was prepared by the Captive Insurance Task Force (formerly the Captive
Insurance Drafting Group within the Reinsurance Subcommittee).
This publication is available on the IAIS website (www.iaisweb.org).
© International Association of Insurance Supervisors 2015. All rights reserved. Brief excerpts may
be reproduced or translated provided the source is statedApplication Paper on the regulation and supervision of captive insurers

Contents
1.
2.

Introduction ..........................................................................................................................4
Scope of paper .....................................................................................................................4
Ownership and structure .....................................................................................................5Business underwritten.........................................................................................................5
Policyholders and beneficiaries ..........................................................................................5
3. Structure of paper ................................................................................................................6
4. Application of the ICPs and Standards...............................................................................6
4.1 Regulatory system .............................................................................................................6
Supervisory cooperation and information exchange ........................................................7
Licensing ..............................................................................................................................7
Suitability of persons ...........................................................................................................8
Changes in control and portfolio transfers ........................................................................9
Supervisory review and reporting.....................................................................................10
On-site inspections ............................................................................................................10
Group-wide supervision ....................................................................................................11
Reinsurance........................................................................................................................11
Conduct of business ..........................................................................................................12
4.2 Corporate governance .....................................................................................................12
4.3 Risk management and internal controls.........................................................................14
Types of risk .......................................................................................................................14
Internal controls .................................................................................................................16
4.4 Valuation ...........................................................................................................................17
4.5 Investment ........................................................................................................................18
4.6 Enterprise risk management for solvency purposes.....................................................20
4.8 Capital adequacy..............................................................................................................21
4.9 Confidentiality and disclosure ........................................................................................23
4.10 Fraud, anti-money laundering and combating the financing of terrorism (“CFT”) .... 24
Fraud ...................................................................................................................................24
Anti-money laundering and CFT .......................................................................................25
4.11 Macroprudential surveillance ........................................................................................25
5. Protected Cell Companies and other cell company structures ......................................26
6. Insurance managers ..........................................................................................................27
6.1 Supervision ......................................................................................................................27
Licensing ............................................................................................................................28
Suitability ............................................................................................................................28
Reporting requirements .....................................................................................................28
On-site inspections ............................................................................................................29
6.2 Corporate governance and internal control ...................................................................29
Internal control ...................................................................................................................29
6.3 Fraud, AML and CFT ........................................................................................................30
Fraud ...................................................................................................................................30
AML and CFT ......................................................................................................................30

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1.

Introduction

1.
This paper is intended to provide guidance to insurance supervisors on the application of
aspects of regulation and supervision that are specifically relevant to captive insurers or reinsurers(“captives”). For background information about captive insurance, reference can be made to the
IAIS Issues Paper on the Regulation and Supervision of Captive insurance companies – October
2006.
2.
Supervisors should develop an appropriate supervisory approach to captives and theguidance provided in this paper is designed to assist supervisors in doing this. The guidance
follows the IAIS Insurance Core Principles (ICPs) and highlights those matters specifically relevant
to captive supervision.

2.

Scope of paper

3.
There are a number of existing “definitions” of captive insurance used in the insurance
market place; this paper is not based on any particular definition. The IAIS has defined a captive
insurer as “an insurance or reinsurance entity created and owned, directly or indirectly, by one ormore industrial, commercial or financial entities, the purpose of which is to provide insurance orreinsurance cover for risks of the entity or entities to which it belongs, or for entities connected tothose entities and only a small part if any of its risk exposure is related to providing insurance orreinsurance to other parties.”
4.

In practice, supervisors of captive insurers tend to use the following classifications 1:•

Pure captives: “single parent companies writing only the risks of their owner and/or
affiliates”;•

Group and/or association captives: “multi-owned insurance companies writing only therisks of their owners and/or affiliates, usually within a specific trade or activity”;•

Rental captives: “insurers specifically formed to provide captive facilities to unrelatedbodies for a fee. They are used by entities that prefer not to form their own dedicatedcaptive”;•

Diversified captives: “captives writing a limited proportion of unrelated business in
2
addition to the risks of their owner and/or affiliates”.

5.
The use of internal reinsurance vehicles by insurance groups, to reinsure the insurance orreinsurance risks they have underwritten, is outside the scope of this paper. Such vehicles are
sometimes referred to as captives but fall outside the traditional definition of a captive. 3
1

IAIS Issues paper on the regulation and supervision of captive insurance companies, October 2006
Some jurisdictions consider that an insurance company writing unrelated party business cannot be classified as a captive.
3
Captives may be used to insure the operational risks of an insurance or reinsurance group in the same way as they are used by anyother industrial, commercial or financial entity, e.g. to cover risks of group owned property. In that case they may be treated in the same
way as any other captive.
2

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6.
Supervisors should recognise that the regulatory risk inherent in a captive insurer can vary
substantially and therefore the level of supervision that is necessary will vary accordingly. A pure
captive represents the lowest regulatory risk because there are no unrelated party policyholders or
potential third party beneficiaries. Those representing the highest regulatory risk are captives
underwriting risks for unrelated party policyholders or underwriting compulsory third party liability
risks where the third party has direct recourse to the insurer. Such insurers may pose risks similar
to those of commercial insurers and, to that extent, supervisors should consider applying
regulatory requirements similar to those for commercial insurers.
7.
Supervisors should determine an appropriate and proportionate supervisory approach,depending upon the type of captive and the following factors may be taken into account.
Ownership and structure
8.
There are a number of different captive structures. The simplest structure is represented
by single owner captives. Other captives can have more than one owner such as association
captives or risk retention groups.
9.
Some captives may be structured as protected cell companies (PCCs) 4 which maintain alegal separation between the assets and liabilities relating to each policyholder, but in othercaptives, such as rental captives, these may not be kept legally separate.
Business underwritten
10.
There are captives that only underwrite classes of business such as property damage orbusiness interruption for which it is clear that only the parent company has an interest in the policy.
Other captives write liability business or employee benefit risks where there may be third parties or
employees with an indirect interest in the proceeds of the policy. It is important to establish who
the obligation to the third party rests with; in many cases it remains with the captive owner.
11.
In some cases, captives are permitted to underwrite compulsory classes of business, suchas employers’ liability or motor third party liability, directly under the legislation of the jurisdiction
where the risk is situated. In other cases the captive will require the use of a fronting insurer who
will bear the responsibility to third parties.
12.
The business may be directly written or assumed as reinsurance which involves the use ofa fronting insurer.
Policyholders and beneficiaries
13.
Many captives only underwrite risks for their owner or owners, either directly or throughfronting insurers. In other cases, captives write business for connected parties such as othercompanies in the same industry or for commercial customers or suppliers of the owner. Some
captives also underwrite risks for individual consumers or for employees of the owner. Howeversupervisors should bear in mind that captives underwriting such risks on a direct basis may require
heightened regulation or supervision.
14.
Producer owned reinsurance companies (PORCs) reinsure a fronting insurer which
underwrites risks for individual consumers generated by the captive owner. Supervisors should4

See section 5

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have heightened awareness of consumer protection issues, because the sale of the insurance
product could be influenced by the owners of the PORC, and consider carefully whether such
entities should be treated as captives.

3.

Structure of paper

15.
This paper considers the application of the ICPs and IAIS standards to captives and whereappropriate provides additional guidance and elaboration. The ICPs and the associated Standards
apply to captives subject to the nature, scale and complexity of various forms of captives. There
are separate sections on issues relating to cell company structures and insurance managers
although, for the avoidance of doubt, the ICPs do not apply to insurance managers but to theinsurers for which they act.

4.

Application of the ICPs and Standards

16.
The following ICPs have been considered in respect of their specific application to thesupervision of captives:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•

ICP 3:ICP 4:ICP 5:ICP 6:ICP 7:ICP 8:ICP 9:ICP 13:
ICP 14:
ICP 15:
ICP 16:
ICP 17:
ICP 19:ICP 20:
ICP 21:
ICP 22:
ICP 23:
ICP 24:

Information Exchange and Confidentiality Requirements
LicensingSuitability of Persons
Changes in Control and Portfolio Transfers
Corporate GovernanceRisk Management and Internal Controls
Supervisory Review and Reporting
Reinsurance and Other Forms of Risk Transfer
Valuation
Investment
Enterprise Risk Management for Solvency Purposes
Capital Adequacy
Conduct of Business
Public Disclosure
Countering Fraud in Insurance
Anti-Money Laundering and Combating the Financing of Terrorism
Group-wide Supervision
Macroprudential Surveillance and Insurance Supervision

4.1 Regulatory system
17.
This section covers ICP 3 (Information Exchange and Confidentiality Requirements), ICP 4(Licensing), ICP 5 (Suitability of Persons), ICP 6 (Changes in Control and Portfolio Transfers), ICP
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24 (Macroprudential surveillance and insurance supervision), ICP 9 (Supervisory Review andReporting), ICP 19 (Conduct of Business) and ICP 23 (Group-wide Supervision).
Supervisory cooperation and information exchange
18.
ICP 3 requires the exchange of information amongst relevant supervisors and authorities
subject to confidentiality, purpose and use requirements.
19.
Where appropriate, and subject to confidentiality and use considerations, supervisors of
captives should cooperate fully in sharing information with other supervisors. Examples include;
where captives transfer risks between jurisdictions through reinsurance or portfolio transfers, orwhere a director or controller of a captive or insurance manager located in one jurisdiction applies
to be a director or controller of a regulated entity located in another jurisdiction. The requirement
for supervisors of captives that are part of financial groups to cooperate with supervisors in otherjurisdictions is covered in paragraph 51.
20.
It is also possible for captives to migrate to other jurisdictions. Supervisors in therespective jurisdictions should review the cooperation and confidentiality arrangements andcommunicate with each other in these circumstances to confirm that there are no regulatory
reasons why such a transfer should not take place.
Licensing21.
In accordance with ICP 4: A legal entity that engages in insurance activities must be
licensed before it can operate within a jurisdiction. 5 It is further required that procedures forlicensing must be clear, objective and public, and be consistently applied and therefore this would
apply to the licensing requirements for captive insurers.
22.
A captive is usually an integral part of its owner’s risk management programme.
Supervisors should have a clear understanding of why the captive is being formed and its
particular goals and objectives. Supervisors should ensure that they fully understand the scope,nature and source of the business.
23.
The captive’s owners may not be familiar with the operational and prudential requirementsof an insurer. Supervisors should therefore satisfy themselves that the captive will be managed byexperienced professionals. The day-to-day management is often carried out by an insurance
manager. This is covered further in section 6.
24.
Licence applications should be accompanied by relevant licensing information, whichshould include, at a minimum, details of proposed significant owners, board members, key persons
in control functions, service providers such as insurance managers, auditors and actuaries, and abusiness plan.
25.
Most supervisors of captives require that the business plan also addresses matters, someof which may be obtained from the feasibility study, such as:••
5the capital structure, including how the captive would meet future solvency requirements
a projected balance sheet

See ICP 4 for further information on the exclusion of limited insurance activities from licensing requirements.

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•
•
•
•
•
•
•
•
•
•
•
•
•

•

a profit forecast
cash flow projection
intended classes of business and cover
limits of liability
use of reinsurers and fronting insurers
an organisational chart
any outsourcing arrangements
an outline of the proposed investment and dividend strategies
financial and other resources
rating and pricing methodologies
claims management process
prior loss experience
information on the actuarial function where appropriate, depending on the nature of thebusiness, for example if the captive is to write life insurance, pensions or long-tail non-life
insurance risks
confirmation that the legislation of the jurisdictions where the insurance risks are locatedsupports and is consistent with the captive's business plan

26.
Supervisors should be satisfied that the operations of captives, domiciled in theirjurisdiction, are sufficient to demonstrate that management and control resides within theirjurisdiction.
27.
Prior to issuing a licence, supervisors should be satisfied with proof of the captive’s
incorporation and capitalisation. Where the captive and its owner are based in different
jurisdictions, performing due diligence on the owners may involve the exchange of information
between authorities in those jurisdictions.
28.
Standards within ICP 4 require supervisors to have the authority to impose additional
requirements, conditions or restrictions on an applicant where appropriate. This is important in the
supervision of captives since supervisors need to have the flexibility to deal with a wide range oftypes and structures of captive. Examples of restrictions are limiting business strictly to relatedparty risks, permission to conduct business only through a fronting insurer, requirements to havestop-loss reinsurance in place, or limiting the captive to writing certain lines of business.
29.
The Standard requiring the suitability of board members, senior management, significant
owners and key persons in control functions, as specified in ICP 5 (Suitability of Persons), to beassessed prior to licensing is equally applicable for captives even though the owner and thepolicyholder may be one and the same.
30.
The owner’s location may also be considered in the licensing decision because
transparency and reliability of financial information can vary between jurisdictions and differencesin accounting practices can complicate assessment of on-going financial strength. Further, somejurisdictions may restrict outward investment through exchange and other controls, potentiallyinhibiting cash flows or financial support to the captive.
Suitability of persons
31.
ICP 5 addresses the suitability of board members, senior management, key persons incontrol functions and significant owners of an insurer.
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32.
Owners of captives must have financial soundness and integrity, therefore inquiries should
be undertaken to satisfy supervisors of an applicant’s suitability. Where a captive is part of acomplex organisational structure, the ultimate parent company and major shareholders, together
with any intermediate structure should be identified and assessed to the extent judged necessary
by the supervisor.
33.
Supervisors usually require captives to have a representative and/or manager in thejurisdiction (or country) in which the captive is licensed. To meet this requirement, many captives
use the services of insurance managers, which should have the necessary insurance knowledge,
skills and resources. In the case of a captive that does not employ the services of an insurance
manager, supervisors should require the board members and senior management of the captive todemonstrate that they have the required skills and experience to effectively carry out their roles,
including appropriate underwriting and accounting skills.
34.
Supervisors should require that the captive’s board of directors collectively possesses the
skills, experience and knowledge to oversee effectively the insurance managers and any otheroutsourced service providers. The board should also demonstrate that it has a broad knowledge ofthe business being written and that the directors can individually properly exercise their
responsibilities.
35.
When assessing the suitability of captive owners the supervisor may take into account thatthe insurance expertise is often provided by other parties such as the insurance manager or the
insurance/reinsurance broker as well as by the owner’s risk management or insurance functions.
Therefore it is not necessary for the captive owner to be an expert in all aspects of running acaptive insurer.
36.
Captives sometimes use service providers located outside their jurisdiction. In such cases,
supervisors should require the board to be satisfied that the service providers have an appropriate
level of knowledge of the legislation applicable to the captive’s location.
Changes in control and portfolio transfers
37.
ICP 6 requires that proposals to acquire significant ownership or an interest in an insurer,
portfolio transfers and merger of insurers should all be subject to supervisory approval.
38.
Changes in control may occur when the captive, and/or its parent, is purchased by, or
merged with another entity, thus changing the direct or ultimate owner of the captive. In thesecircumstances, if they have concerns over the new owner, supervisors need to be able to takeappropriate action such as preventing the captive from accepting further new business. Changes
in control often take place within the group so that the ultimate owner of the captive is unchanged
and the supervisor will need to be notified of it, and if necessary, the supervisor will inquire further
to, for example, satisfy themselves of the reason for the change.
39.
The purchase or merger of a captive’s parent is sometimes the precursor to a change of
domicile (migration) of the captive in order to allow for it to be amalgamated with other risk
management operations of the enlarged group. Supervisors may have the power to restrict or
impose conditions relating to an outward transfer of a captive or a portfolio transfer to protect thepolicyholders’ interests. Inward migrations will usually be subject to the normal licensing
application criteria.
40.
When a captive undergoes a change in control through a direct sale to an unrelated party,
supervisors need to take appropriate action as the captive could then be writing unrelated party
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risks. There is a market for the purchase of captives that are in run-off. This may be attractive fora parent that has no further use for its captive since it removes potential liabilities from the group.
The supervisor should consider the type of business that was written by the captive whenassessing the prospective purchaser and should assess whether the purchaser has the financial
resources to deal with any future deterioration in long-tailed claims reserves prior to approving thechange in control.
41.
Similarly, when a related entity insured by the captive is sold to an unrelated entity orgroup, the captive could then be exposed to unrelated party risks. In this respect, supervisory
actions could include imposing conditions requiring the captive to cease accepting new business or
to transfer out existing business, or to review its level of capital and/or restrict the making of
distributions to shareholders. Supervisors should consider whether it remains appropriate todesignate the entity as a captive insurer and hence whether it is necessary to amend its
supervisory approach accordingly.
42.
Where a captive proposes to carry out a portfolio transfer of its business to another insurer,
supervisors should ascertain in advance that the receiving or transferring insurer is of suitable
standing to enter into the transaction, and should evaluate the risks of the transaction to thepolicyholders and to unrelated parties.
Supervisory review and reporting43.
ICP 9 describes a risk based approach to supervision, requiring the supervisor to use bothoff-site monitoring and on-site inspections to examine the business of each insurer, evaluate its
condition, risk profile and conduct, the quality and effectiveness of its corporate governance and its
compliance with relevant legislation and supervisory requirements.
Off-site monitoring
44.
Reports to supervisors are as important in relation to captives as for any other insurer.
Whilst captives typically pose reduced risk to external stakeholders or to the financial stability of
the insurance market, supervisors should nevertheless receive sufficient and timely reporting tomonitor solvency, assess compliance with the applicable legislation and to identify potential
problems.
45.
Standard ICP 9 requires supervisors to set the requirements for supervisory reporting. In
defining the scope, content and frequency of the information to be provided, supervisors may take
into account the captive’s particular risks, size and the amount of third party and/or unrelated party
insurance exposures, if any.
46.
Taking a risk based approach, supervisors should regularly monitor a captive’s adherence
to its agreed business plan, particularly as regards dividend policy, the extent of any unrelated
party business and risk management strategies.
On-site inspections
47.
It is important that the risk profile of a captive, including the amount of any potential
liabilities to third parties and/or unrelated party business, be considered in establishing the extent
and focus of the inspection, and especially when considering the frequency of inspections.
Supervisors should recognise that captives frequently pose less risk to external stakeholders andto markets than do commercial insurers or reinsurers, so supervisors should have the ability to
tailor inspections, where appropriate.
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48.

Supervisors may specifically focus on:
•
•
•
•
•

connected party transactions
the amount of unrelated party businessthird party liabilities
capital and solvency
corporate governance and control, including board oversight49.
Where an insurance manager has been appointed, on-site inspections of captives may be
carried out in conjunction with an inspection of the insurance manager. This is covered further insection 6.
Group-wide supervision50.
ICP 23 requires supervisors to identify the scope of the group to be subject to group-wide
supervision.
51.
Supervisors should consider the need to communicate with other financial sector
supervisors responsible for other companies in the group. For example, a global group may havemultiple captives, in different jurisdictions, involved in the group’s risk finance programme.
52.
Supervisors should consider the overall structure of a group and use risk-assessment
techniques to determine whether further supervision is necessary, for example if the captive holds
significant related-party assets or relies upon unpaid share capital for solvency purposes. The
group structure should be explained in sufficiently transparent terms such that the supervisor canassess the risks involved in such related party assets.
53.
Many captives, being owned by industrial or commercial organisations, will be the only legal
entity within their group that is subject to financial regulation. Supervisors may not find it practicalor have the authority to undertake group supervision in those circumstances. The focus should beon the legal entity but with appropriate analysis of the potential for the activities of group entities to
impact on the captive and on the controls in place to prevent the group from removing assets fromthe captive without the approval of the board and the supervisor.
Reinsurance
54.
In accordance with ICP 13 supervisors should require that cedants are transparent in theirreinsurance arrangements and the associated risks, allowing the supervisor to understand theeconomic impact of reinsurance and other forms of risk transfer arrangements in place.
55.
Supervisors should require that the board has assessed the proposed reinsurance strategy,
both assumed and ceded/retroceded, to confirm that it provides adequate protection and has
considered the financial standing of both fronting insurers and reinsurers as well as the domicile inwhich they are located. The supervisor should consider the level of supervisory review of thereinsurance programme based on the type of captive and the extent of reliance upon the reinsurer.
56.
Captives are often reliant upon one reinsurer and the supervisor should require that theboard has adequate procedures, which may involve some delegation to the captive manager, tomonitor this significant counterparty exposure.

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Conduct of business57.
ICP 19 deals with requirements for the conduct of the business of insurance in order toensure that customers are treated fairly throughout the duration of the contract.
58.
The criteria of ICP 19 have limited applicability to captives, since requirements for fairtreatment of customers, assessing insurance needs before advising customers and dealing withcomplaints are less pertinent to a captive because a captive’s customer is normally its owner.
59.
In the case of a group or rental captive, supervisors should require that, if applicable, thecaptive’s business plan explains its marketing programme and the information to be provided toprospective owners or users.
60.
Guidance notes to ICP 19 allow for supervisory requirements to distinguish between
particular types of customers. Therefore, since policyholders of most captives will fall into thecategory of sophisticated customers, detailed conduct of business rules may not be appropriate 6.
In the event that a captive has retail customers the supervisor may consider whether to apply
conduct of business rules in the same way they would be applied to commercial insurers.
61.
The risk characteristics and services arising from the different captive types are varied. In
the case of group captives, a major feature may be risk sharing or one captive member’s accountbeing charged for the losses of another captive member. Where unrelated parties are involved,
supervisors should be satisfied that the board of the captive and, where relevant, the captive
manager is aware of any consumer protection requirements applying in the jurisdiction.
62.
When a captive underwrites liability risk, in particular compulsory liability, supervisors may
recognise and take account of the fact that claims may arise from unconnected third parties andthat these claims may be made against the parent or, in certain cases, directly against the captive.
If a captive, under the applicable legislation, is permitted to insure compulsory classes of businessin its own or in another jurisdiction, supervisors should be satisfied that the rights of third parties
are appropriately recognised.
4.2 Corporate governance
63.

This section covers ICP 7 (Corporate Governance).

64.
The aim of the corporate governance framework is to provide for sound and prudent
management and oversight of the insurer’s business and it should adequately recognise andprotects the interests of policyholders.
65.
The principles of corporate governance, as outlined in this ICP, apply to captives, bearing in
mind that the application of corporate governance standards should take account of the size,
nature and complexity of the business of the insurer. Corporate governance issues specifically
relevant to captives may include unrelated party issues, related party transactions or perceived or
actual conflicts of interest.
66.
Where a captive is managed by an insurance manager, a distinction can be made between
corporate governance as it applies to the captive and its board of directors and corporate
6

Sophisticated customers can be defined as knowledgeable, ‘professional’, customers, as in the case of a major enterprise, who would
have in-depth knowledge concerning all major aspects of the transaction, including associated risks.

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governance as it applies to the insurance manager. The board remains responsible for the
corporate governance of the captive despite outsourcing the management. Corporate governanceissues specifically relating to insurance managers are dealt with later in section 6.
67.
The areas in which the application of good corporate governance, as it applies to captives,
could differ from those applicable to commercial insurers and reinsurers include requirements that
may vary, for example, because:
•
•

•

•
•
•
•

Separation of the oversight function from the management responsibilities may become
blurred.
Many of the functions of the captive may be outsourced, either to the insurance manager
or, for example, to investment managers, specialist claims administrators or firms ofactuaries.
The captive is often domiciled in a different jurisdiction from its owners. In these cases,
supervisors should be satisfied that supervision is not impeded in any way by crossborder issues. Supervisors should take account of any known potential conflicts
between corporate governance requirements applying in the home jurisdiction and theparent company’s jurisdiction.
There is a need to formalise the arrangements between captive owners, directors andinsurance managers to ensure effective governance.
There are different conduct of business considerations for owners, related parties andunrelated third parties.
Any remuneration policy is likely to be limited solely to the directors since the majority of
captives do not employ their own staff.
A captive may be required to adopt policies or procedures developed at group level but itshould still ensure that these are appropriate and meet the requirements of the insurance
supervisor.

68.
The following are specific guidelines relating to corporate governance of captives.
Supervisors may wish to consider:
•

•

•

69.

Satisfying themselves that operational control of the captive and access to its books andrecords are within the jurisdiction of supervision. Considerations include the location ofsenior management and clerical/administrative processes.
When approving non-executive directors, seeking confirmation that they are able toexercise independent judgement and objectivity in making decisions and able tochallenge sensibly the views of the directors who are appointed by the parent group.
Be satisfying themselves with the composition of the board of directors, including any
requirement for locally resident directors and the balance between executive and nonexecutive directors.

Supervisors may wish to be satisfied that the board of directors:•••

Has sufficient balance such that no one individual has unfettered powers of decision.
Has the proper balance to ensure the proper management of the captive.
Have put in place transparent, effective ways to identify any conflicts of interest andensure that they are managed and satisfactorily dealt with.

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•
•
•
•

Takes into account the interests of stakeholders, like possible claimants on the parent
policyholder e.g. employer’s liability or motor third party liability.
Collectively have the skills and experience necessary to manage effectively any
outsourced operations including outsourced insurance management functions.
has clearly defined and agreed the responsibilities of the insurance manager
have adequate controls in place so that transactions, payments or charges on assets
initiated by the owner (dividends, reinsurance agreements with related entities, loans,
expenses or guarantees) do not financially impair the captive’s ability to meet its
liabilities.

70.
In the case of captives established as association captives, multi-owner captives or rental
captives, the supervisor should be satisfied that the board consider their responsibilities to multiple
owners of the captive.
4.3 Risk management and internal controls
71.

This section covers ICP 8 (Risk Management and Internal Controls).

72.
Effective systems of risk management and internal controls, including effective functions forrisk management, compliance, actuarial matters and internal audit are an essential part of theoverall corporate governance framework and the supervisor should require an insurer to have suchfunctions. The systems and controls should be adequate for the nature, scale and complexity of
the insurer’s business and risks.
Types of risk
73.
The nature of the risks to which captives are exposed is similar to that of commercial
insurers but the degree and diversity of exposure may differ. The following risks may differ as
between captives and commercial insurers and the supervisor may take into account the resourcesof the parent and the nature of the captive when considering such risks (this list is not exhaustive
nor in any particular order of priority):•

Control of outsourced insurance management function
Supervisors should require that the captive’s board of directors has sufficient skills
and experience to effectively control the outsourcing arrangements and that asuitable management agreement is in place. The directors should be aware of thepotential for additional operational risks arising from the outsourcing arrangements.

•

Management risk
Supervisors should take account of the risks posed to a captive by poor
management, whether or not the management is outsourced to an insurance
manager. A lack of technical knowledge is particularly significant as it can pose athreat to the solvency of the captive through inadequate premiums levels or
insufficient technical provisions or solvency.

•

Location of owners and captives in different jurisdictions
Supervisors should be aware of the additional risks arising if a captive is located in adifferent location from its parent. For example, the impact of the applicablelegislation to be used for settling disputes and there may also be exposure of thecaptive to claims from third parties that may not arise under its local legislation.

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•Legislative developments affecting captives
Supervisors should be aware that legislative developments, particularly in thejurisdiction of the parent of a captive, can adversely impact captives; for example,
by imposing a requirement for fronting insurers or restricting the payment ofpremiums or claims.

•

Concentration of assets
Asset concentration risk and credit risk should be monitored, managed andmitigated by a captive, especially if it holds relatively low levels of assets andtechnical provisions and have low solvency capital requirements.

•

Failure of a fronting insurer
Supervisors should be aware that the failure of a fronting insurer could adversely
impact a captive if, for example, the fronting insurer had collected premiums which
had not been paid over to the captive, or, fronting was required to meet local
regulatory requirements in certain jurisdictions. Supervisors may take account of
this when considering a captive’s fronting arrangements.

•

Lack of risk diversification/retention
Supervisors should take account of the lack of risk diversification or risk retention
inherent in many captives when setting capital requirements. Supervisors shouldhave the power to require the captive to hold sufficient funds to meet the maximum
potential claim level in a given period.

•

High claims volatility
Supervisors should take account of the potential for a captive, particularly one
writing a single line of business, to experience high claims volatility. This should bereflected in the methods employed for setting technical provisions and solvency
requirements.

•

High liquidity risk
Since captives can potentially have high liquidity requirements resulting from a highlevel of claims volatility or high collateral requirements, for example from fronting
insurers, supervisors should take account of the liquidity of the assets held by thecaptive.

•

Exposure to related parties
Captives sometimes provide loans to their parent companies. Supervisors of
captive insurers should consider whether, and under what circumstances, it isappropriate to include these as admissible for solvency purposes. If loans are to be
acceptable, supervisors should assess the financial position of the parent company
and consider the impact of the terms of the loans on the captive’s solvency understress.

•Potential risk of money laundering, terrorist financing and fraudulent activities
Supervisors should be aware of the risks of captives being utilised for money
laundering, terrorism financing or fraudulent purposes. The payment of excessive
levels of premium can be an indicator of the possibility of this type of activity.

•

Dependency on the financial strength of the parent

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Even if no loans are made from a captive to its parent, supervisors should be awareof the risks posed by the insolvency of the parent, particularly if there areoutstanding premiums. Supervisors should be aware of the need for the rights ofthird party claimants or unrelated policyholders to be protected in the event of aliquidation of a captive following the insolvency of its parent.
•

Reinsurance risk
Since there is often significant, sometimes total, reliance on reinsurance,
supervisors should require that the terms of reinsurance contracts are promptly
documented and clearly expressed and that the credit standings of reinsurers havebeen prudently assessed. Supervisors may wish to consider whether there is anappropriate level of risk retention within the captive, whilst recognising that there
may be valid reasons why no risk is retained.

•

Taxation issues
Supervisors should be aware of the risks arising from potential tax changes, both in
the home jurisdiction and in the parent’s jurisdiction.

•

Counterparty risk resulting from reliance on contingent capitalSupervisors should be aware of the risks involved if a captive relies on support fromcontingent capital such as letters of credit or unpaid share capital. Supervisors
should be satisfied that additional capital will be available if required.

•

Currency risk
Since captives often underwrite risks in multiple jurisdictions and hold assets in adifferent currency to their liabilities, supervisors should be aware of the potential
impact of changes in exchange rates.

74.
Many risks normally associated with a commercial insurer are mitigated or are of less
impact in a captive. For example:•

Legal risk: the risk of being sued by a policyholder is generally quite low since thecaptive frequently insures just its owner although there may remain a risk of beingsued by a third party claimant. If necessary, confirmation should be sought thatlegal advice has been obtained by the captive in this regard. Legal risk may also
exist in relation to the relationship with the fronting insurer.

•

Operational risk: such risk may be low if the captive has few transactions or alimited number of policies and thus does not conduct activity every day; this iscommon in many captives. Many captives are reliant upon an insurance manager
for operational matters and can be run remotely if necessary.

Internal controls
75.
Outsourced functions are addressed within the standards of ICP 8. At least the same
degree of oversight of and accountability for any outsourced material activity or function (such as acontrol function) should be applied as to non-outsourced activities or functions and thus remains
the ultimate responsibility of the captive.
76.
In common with other insurers, the board of directors of a captive should exercise its
judgment in determining the nature and scope of the risk management and internal control systems
and practices that are necessary, including internal controls operated by the insurance manager,
which should be documented. Most captives are not complex operations which require extensive
control functions and some captives are subject to the internal audit disciplines and/or risk
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management functions of the parent company. This may be taken into account when supervisors
assess the internal control requirements for captives.
77.
Supervisors should require captives to have effective control functions in place. In practicemany functions are provided by the insurance manager, the parent company or outsourced to
specialist firms. The following issues are of specific relevance when considering the control
functions of a captive:•

Risk Management Function
Captives are an integral part of their parent’s enterprise risk management function with thehead of the risk function often being appointed as a director of the captive. The captive’s
attitude to risk will therefore be heavily influenced by its parent but it is important that thewhole board is engaged in the process and is able to challenge the parent if required.

•

Compliance Function
The compliance function is often outsourced; usually to the insurance manager since they
have the expertise relevant to local legislation and will be familiar with the regulatory
requirements set by the supervisor. This also provides economies of scale for the captive
as the costs of the compliance function can be shared amongst all of the captive clients of
the insurance manager. The parent company may also have oversight of the compliancefunction from a group perspective.

•

Actuarial Function
A captive board may have a number of sources of actuarial advice such as the insurance
manager, the insurance or reinsurance broker, and, external actuarial consultants which
are often used by larger captives writing liability risks. Depending upon the type of
insurance being underwritten a fronting insurer may also be a source of actuarial
information in relation to the setting of technical provisions. In practice captives mainly
make use of actuarial resources to calculate technical provisions and advise on the ORSA.
Captives generally do not use actuarial techniques to calculate premiums or to match
assets and liabilities.

•

Internal Audit Function
Insurance Managers often work to a set of generic control procedures that are applied to all
captives under their management. Individual captives will therefore modify these controls
to suit their circumstances. The insurance manager’s internal audit function will therefore
have some oversight of each captive. The internal audit function of the parent company willoften also be responsible for oversight of the captive to ensure that group controls are
effectively applied.
Whilst some self-managed captives may be of sufficient size and complexity to support
their own control functions most will not and therefore the supervisor should take into
account the nature, scale and complexity of a captive’s business when considering theadequacy of the control functions.

4.4 Valuation
78.

This section covers ICP 14 (Valuation).

79.

The valuation of assets and liabilities for solvency purposes is addressed in ICP 14.

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80.
The underlying principles behind ICP 14 are as relevant to captives as to commercial
insurers. They require the solvency regime to address the recognition, de-recognition andmeasurement of assets and liabilities so that they are valued on a consistent basis in a reliable,
decision useful and transparent manner. This is partly to allow comparison across insurers
worldwide but this is not such an important consideration for captives which do not have to comply
with ICP 20 on Public Disclosure.
81.
The Standards require that the valuation of assets and liabilities is an economic valuation
and reflects the risk adjusted present values of future cash flows. In practice many captives are
inherently conservative in their valuation of liabilities and do not take into account the time value ofmoney. To the extent that this results in higher capital requirements this should not pose a difficulty
for the supervisor, however, the supervisor should be satisfied that there is no inherent optimism in
the valuation of liabilities.
82.
Captives have some unique characteristics such as having higher potential claims volatility.
This volatility may be managed by the imposition of annual aggregate limits or by the purchase ofreinsurance. These characteristics may be incorporated into a review of liabilities by supervisors
or when creating regulations regarding captive liabilities.
83.
Captives may reinsure a portion of their risks and some captives are formed with the sole
purpose of accessing the reinsurance market. Supervisors may take this into account whenestablishing whether to give full credit for reinsurance in the calculation of technical provisions,subject to satisfactory reinsurance creditworthiness.
84.
In some cases, pure captives may already have knowledge of all reported claims, because
their owner is the only claimant. In those cases, the incurred but not reported (“IBNR”) componentof the technical provisions may justifiably be zero where there is a sufficiently strong reporting
procedure in place such that the captive is immediately aware when an insured event occurs.
Adequate provision must however be made for the potential for adverse loss development, such asa reserve for claims incurred but not enough reported (“IBNER”).
4.5 Investment
85.

This section covers ICP 15 (Investment).

86.
ICP 15 deals with requirements for solvency purposes on the investment activities of
insurers.
87.
Because of the nature of their business, many captives have very straightforward
investment strategies, which may be tied to the investment and risk management goals of theirowner.
88.
The processes and systems required in each case should be proportionate to the nature,scale and complexity of each captive's activities. Supervisors could, for example, consider thefollowing factors when establishing requirements for solvency purposes on the investment activities
of captives.
•

Liquidity issues may have a higher profile than is normal for a commercial insurer orreinsurer. Supervisors should be satisfied that a captive has in place adequate internal
procedures to make sure that it is able to meet its obligations as they fall due or can do

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•

•

•

•

•

so without incurring excessive cost. A captive should hold sufficient liquidity to ensurethat it can be considered to be conducting its business in a prudent manner.
Some captive’s investment portfolios are less well diversified than that of larger
commercial insurers since they will have a smaller portfolio. Diversification is often
achieved by the use of collective investment schemes.
A captive’s investment portfolio may reflect a lower risk profile, as often captives do nothave a material exposure to investments in equities, property (or other illiquid assets) or
derivatives and similar commitments.
Supervisors should require that the board of a captive has adequately assessed its
exposure to counterparty risk including exposure to banks and to related parties and hastaken steps to limit or mitigate this.
Supervisors should assess whether a captive has taken adequate account of assetliability matching and that the captive has made active decisions about the extent of any
mismatch in relation to its business plan including holding an appropriate amount ofadditional capital to cover asset-liability mismatching.
Supervisors may consider a captive's investment policy as part of their review of its
business plan. The supervisor should consider whether it wishes to be advised of any
change to the original investment policy.

89.
Supervisors should require that any related party transactions by a captive, such as loans to
the parent company, loans to related entities, loans to directors/owners or investments in otherrelated entities and reinsurance agreements with related entities are approved by the captive's
board of directors. Supervisors may consider, in the context of the regulations applying to solvency
and liquidity in their jurisdiction, the extent to which to give credit for assets held in related party
transactions. Supervisors may also consider whether it is appropriate to make any specificrequirements regarding transferability of capital or protection of funds in the event of a material
adverse change in financial circumstances affecting the captive and/or the parent company or otherrelated entity.
90.
Supervisors should consider whether loans to any connected parties should be admissible tocover technical reserves or for solvency purposes depending upon the terms and conditions of theloan. The written formal loan agreement should form part of the captive’s books and records.
91.

Supervisors should be satisfied that a captive’s board of directors is able to:••••

set the captive's investment policy, including periodic review of its continued suitability
implement and review the investment mandates or other instructions issued to implementthat policy
direct and oversee any investment activities of the insurance managers, including areview as to whether they possess appropriate competence in this area
direct and oversee the activities of any outsourced investment managers

92.
Supervisors should be satisfied that a captive’s board of directors is able to ensure that any
investment activities undertaken on behalf of a captive by its parent or other related entity
treasury/finance departments or functions are scrutinised by the directors in the same way as anyother outsourcing arrangement to third parties.

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4.6 Enterprise risk management for solvency purposes
93.

This section covers ICP 16 (Enterprise Risk Management for Solvency Purposes).

94.
There is a requirement for the supervisor to establish enterprise risk management (ERM)
requirements for solvency purposes that require insurers to address all relevant and material risks.
95.
The IAIS recognises, within the guidance, that this ICP may not be fully achievable by someinsurers and some markets in the near future. Further, it emphasises that this ICP does notprescribe a specific aspect of solvency requirements which is to be applied compulsorily by IAIS
Members. The supervisor may take this into account when setting the requirements for captives.
96.
A captive is an integral part of its parent company’s ERM framework. It is not necessary fora captive to duplicate work that has already been carried out at a group level. The board of thecaptive should focus on risks that are specific to the captive.
97.
Risk tolerance limits for a captive will, to a large extent, be guided by the willingness of theparent company to provide capital and by the risks that are offered to the captive; a captive does not
generally seek out risk but rather waits until it is offered a risk by its parent.
98.
Asset-liability matching (ALM) is not always practised by captives since their investment
priorities are often simplicity and capital preservation and this prevents them from taking longer term
investment risk to match with their potentially long tail liabilities. Of course some more complex
captives may practice ALM.
99.
ICP 16 requires supervisors to ensure that insurers have a risk management policy which
includes explicit policies in relation to underwriting risk. For captives it is particularly important thatthe underwriting policy addresses the levels of risk retention that the board is willing to accept
given the relative lack of diversification within a captive portfolio. The captive’s board should
consider setting a retention policy which incorporates caps, such as an aggregate limit on its
exposure, or the use of reinsurance.
100. The simplicity of a captive’s operational and reporting structure means that it can readily
respond to changes in its risk profile and it is likely to be a part of a wider group feedback loop
since one rationale for operating a captive is to enable better reporting on insured risks and claims.
101. An insurer is required to perform its own risk and solvency assessment (ORSA) in order todetermine the economic capital requirement. The ORSA output should proportionally account for thenature, scale and complexity of the insurer and may be a concise, simple high level assessment
given the characteristics of a captive
102. The ORSA process for a captive may focus on those areas which may not be adequately
captured in the standardised approach determined by the supervisor. A basic qualitative andquantitative assessment of the risks, without analysing sophisticated modelling, may be sufficient fora captive. Supervisors may wish to consider the following points which are of specific relevance to a
captive’s ORSA:•

Underwriting risk – the aggregate limits applicable to a captive’s insurance
programme should be considered when setting economic capital requirements.

•

Credit risk – the level of reliance upon reinsurers is likely to be the most significant
risk for many captives.

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Page 20 of 31•Market risk – Given the low risk approach to investments this is unlikely to be asignificant risk for most captives.

•

Operational risk – this is best dealt with on a qualitative basis since the captive isreliant upon the insurance manager who will be obliged to provide a service
regardless of operational risk events. The board should satisfy itself with thebusiness continuity arrangements of the insurance manager.

•

Liquidity risk – this can pose an issue for captives if they have been required to tie up
significant assets in collateral arrangements for fronting insurers.

•

Group risk – the extent to which the captive is reliant upon the parent forrecapitalisation or repayment of group loans should be addressed.

103. The ORSA time horizon for a captive may be much shorter than that of a commercial insurer
and will be influenced by the parent company. Most captive parent companies prefer to recapitaliseon a regular basis rather than maintain capital in the captive for a long-term time horizon. Given
that the risks offered to a captive may vary from year to year, depending on the terms offered by the
insurance market, the captive cannot look beyond a fairly short time horizon – often not beyond thenext renewal cycle.
4.8 Capital adequacy
104.

This section covers ICP 17 (Capital Adequacy).

105. The capital adequacy requirements for solvency purposes, set by the supervisor, areintended to ensure that insurers can absorb significant unforeseen losses whilst also providing forvarying degrees of supervisory intervention.
106. The supervisor should ensure that the standardised approach to solvency is appropriate to
the nature, scale and complexity of the risks that captives face and feasible in practice for captives
taking into account the technical capacity required to manage their business effectively.
107. The supervisor is required to set solvency control levels that trigger different degrees ofintervention. The level at which these control levels are set, and the intervention actions that are
triggered will be influenced by the risk tolerance of the supervisor. The risk tolerance of thesupervisor may be different for a captive insurer compared with a commercial insurer and therefore
the solvency control levels and the intervention actions that are triggered will reflect this. The
supervisor may consider that triggers are not necessary for some types of captive.
108. The standards on regulatory capital requirements require the supervisor to establish a
Prescribed Capital Requirement (PCR) and a Minimum Capital Requirement (MCR). The
supervisor should consider whether, in the interests of simplicity, the MCR for captives may be set
by means of a simple formula or an absolute monetary amount. The underlying calibration of the
PCR for the standardised approach will reflect the risk tolerance of the supervisor and therefore the
PCR may be lower for captives than for other types of insurer.
109. For the sake of transparency the supervisor should make public the solvency framework
which applies to captives including where they differ from the requirements applicable tocommercial insurers in the jurisdiction.
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110. Group-wide capital adequacy assessment is also addressed in the standards but it would
be unlikely that a captive supervisor would wish to apply solvency controls on a group-wide basis,
particularly where the group is undertaking business of which the supervisor has no relevant
experience or expertise.
111. The supervisor is required to address all relevant and material categories of risk withintechnical provisions and/or regulatory capital requirements. These include, at a minimum,
underwriting risk, credit risk, market risk and operational risk.
•

Underwriting risk – special considerations for captives include relatively
unsophisticated premium setting methods and a lack of diversification comparedwith commercial insurers. However, captives can have an advantage in theaccuracy of their claims reporting because they will be alerted to any significant
incidents quickly by their parent company.

•

Credit risk – the main risk for a captive is often its exposure to reinsurers but there isoften a concentration on a small number of significant counterparties.

•

Market risk – captives vary in their exposure to market risk but there is often a lackof diversification in the asset base.

•

Operational risk is best addressed for captives on a qualitative rather thanquantitative basis. Captives rarely have their own staff or premises but are reliant
upon the business continuity arrangements of the insurance manager.

•

All of these risks can be addressed in a relatively simple manner within astandardised approach that is suitable for the nature, scale and complexity of
captives.

112. It is unlikely that a captive would seek to utilise an internal model due to the cost involved
and the limited nature of the data available to captives. The Supervisor should carefully consider
whether to permit internal models for captives and should only do so if it is confident that is has theresources to review and assess those models.
4.9 Capital Resources
113.

This section covers Standard 17.11.

114. The standard addresses the establishment of criteria for assessing the quality andsuitability of capital resources, having regard to their ability to absorb losses on both a going
concern and wind-up basis.
115. A number of captives meet capital requirements through alternative forms of capital, forexample:• letters of credit• partly paid share capital• trust funds or• subordinated debt.
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116. Supervisors should consider whether a distinction should be drawn between the forms ofcapital permitted in respect of the Minimum Capital Requirement (MCR) as opposed to additional
capital required to support the Prescribed Capital Requirement (PCR) or the economic capitalrequirement established in the ORSA.
117. Supervisors should be satisfied that the terms of the capital instruments confirm that funds
will be made available when required. It is particularly important to ensure that funds will beavailable in situations of significant stress for the captive as well as for normal ongoing operations.
This is particularly important in relation to unpaid share capital and the supervisor should consider
whether events which adversely impact the captive could also impact the parent such that it will be
unable to pay up the unpaid capital.
118. If retained earnings are used to support a captive’s capital requirements, supervisors
should review the permanence of this capital in the light of any legal requirements to pay dividends
e.g. if a certain level of distribution is required to maintain the taxation status of the owner. The
captive owner often considers these taxation issues when selecting a domicile, as prior approval ofany dividend may be required by the supervisor.
119. Depending upon the financial and legal status of the owner, they may be required toprovide a greater proportion of contributed ordinary share capital in cash rather than other types ofcapital instrument such as a mix of ordinary shares and redeemable preference shares andsubordinated debt.
120.
Supervisors may also consider permitting captives to hold a portion of their capitalrequirement in the form of a contingent guarantee to invest further monies if required, such as aletter of credit issued by a recognised financial institution acceptable to the supervisors, provided
that they are satisfied with the financial status of the owner.
4.10 Confidentiality and disclosure
121.

This section covers ICP 20 (Public Disclosure).

122. ICP 20 addresses the comprehensive, timely and relevant disclosure of information topolicyholders and market participants.
123. According to the guidance supervisors can decide not to apply public disclosure standards
to captives provided there is no potential threat to the financial system, no public interest need fordisclosure and no legitimately interested party is prevented from receiving information.
124. “Legitimately interested parties” includes, for example, related policyholders, third party
claimants, fronting insurers, reinsurers, unrelated party policyholders, owners, and parent
companies.
125. In certain instances, public availability would be detrimental to the parent group and to thecaptive, for example if a parent had to disclose that it had liability insurance in force or its loss
reserves could be identified by claimants or third parties. Public availability would also be
detrimental in the case of kidnap and ransom insurance. The detail of risks underwritten and thepricing methodology would not be disclosed if the risk was insured directly with a commercial
insurer rather than placed through a captive. Supervisors should consider the protection of

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proprietary or confidential information, information should however be made available tosupervisors.
126. ICP 20 is concerned with providing reliable and timely information to stakeholders including
policyholders. In establishing disclosure requirements applicable to captives, supervisors should
consider who the users or stakeholders of the captives are and might be, whether the captive’s
results are consolidated into the parent’s figures, whether the parent is quoted and the financial
statements are publicly available, as well as the company law disclosure requirements applicablein the captive’s jurisdiction of incorporation.
127. Standard ICP 20 provides various criteria to determine the type of information that aninsurer should disclose which is not otherwise required to disclose by law. Some of those items
are not applicable or have limited applicability to captives, notably:••

Decision useful to decisions made by market participants - as noted above theparticipants in a captive already have means of ensuring that the captive discloses
information adequate to their needs.
Comparable between different insurers - captives write specific lines of business fortheir owners. Loss histories are specific to the owner and are not necessarily reflectiveof trends in the insurance sector. Pricing, retention levels and investment strategies
are also in the control of the owner, limiting the usefulness of comparing captives with
one another.

128. Fronting companies or reinsurers have their own requirements for disclosure, in order tomake business decisions, before they conduct business with a captive. Consequently, supervisors
should not need to take steps to monitor the information disclosed to the other parties.
129. Supervisors should appropriately consider the needs of third party claimants undercompulsory classes of liability insurance when establishment is through different disclosure
requirements.
4.11 Fraud, anti-money laundering and combating the financing of terrorism (“CFT”)
130. This section covers ICPs 21 (Countering Fraud in Insurance) and 22 (Anti-money
Laundering and Combating the Financing of Terrorism).
Fraud
131. ICP 21 is concerned with deterring, preventing, detecting, reporting and remedying fraud ininsurance.
132. Despite the nature of their risks, supervisors of captives, especially those underwriting
unrelated party risks should be aware of possible fraudulent activity. Supervisors should beconcerned about intrinsic illegal activity a captive or captive owner may conduct, which may bemonitored by a variety of means such as examination powers, audited and unaudited annual
statement filings, and pre-approval of any parental loan activity. However, pure captives will nottend to write unrelated, uncontrolled risk and therefore intrinsic fraud is unlikely.
133. Supervisors should take into account the nature of the captive when implementing
regulations regarding fraud, as some regulations applicable to commercial insurers may beinappropriate for captives. In particular, the risk of claims fraud by policyholders is lower.
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Supervisors should also be aware of the risks posed by the payment of an excessive level ofpremiums relative to the actual risk as the excess premiums could potentially be used to fundfraudulent claims or commission payments.
Anti-money laundering and CFT134. ICP 22 is concerned with effective measures to combat money laundering and the financing
of terrorism.
135. The criteria listed under ICP 22 deal primarily with ensuring that a jurisdiction has adequate
and appropriate anti-money laundering (AML) regulations in place and that the supervisory
authority has adequate powers and resources to enforce those regulations. At a minimum, such
regulations should apply to insurers and intermediaries offering life insurance products or otherinvestment-related insurance although there is also a risk of money laundering in non-life
insurance companies. Supervisors should take these regulations into account when assessing theoverall acceptability of any licence application and the on-going adequacy of corporate governanceand other risk management systems put in place within a captive.
136.
Supervisors should consider the legitimacy of the source of funds used to capitalise or pay
premiums to the captive. Supervisors should require that there are appropriate controls to preventthe use of a captive for money laundering or other illicit activities.
137. Supervisors should keep in mind the importance of having a clear understanding of theobjectives of any proposed captive and of the nature and reasonableness of the risks beingtransferred. Supervisors should also be satisfied that the ownership and management structure isappropriate and reasonable for what is proposed.
138. Supervisors should consider whether the business conducted by a captive warrants thecaptive or its manager maintaining an anti-money laundering function.
139. It is important that supervisors in different jurisdictions cooperate with each other to preventthe use of captives for illicit purposes, such as fraud, money laundering or terrorist financing
activities.
4.12 Macroprudential surveillance
140.

This section covers ICP 24 (Macroprudential Surveillance and Insurance Supervision).

141. ICP 24 covers the use of macroprudential surveillance by supervisors in order to inform thesupervision of individual insurers.
142. A captive sector may be material to a small jurisdiction in providing employment and in
introducing business to service providers such as banks, lawyers, investment advisers etc. Where
the captive sector is material to the jurisdiction, supervisors should undertake quantitative andqualitative analysis of factors that may impact the financial soundness of captives and, in turn,contribute to the stability of the insurance market in the jurisdiction.
143. In undertaking this analysis, supervisors should recognise that the general and market
developments that may have a significant impact on captives could originate in the jurisdiction
where the captive’s parent is located, which normally is a different jurisdiction to where the captive
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is located. Similarly, supervisors should be aware of significant legislative, regulatory, economic orother market developments in locations where there are large concentrations of risks written, or
ceded, by captives.
144. The captive sector is unlikely to pose any systemic risk to the financial sector in ajurisdiction for a number of reasons, including the following:••••

The risks insured are not located in that jurisdiction
The shareholders are not located in that jurisdiction
Captive risks are unlikely to be correlated with each other so they are not collectively
vulnerable to the same risks
Shareholders come from a wide variety of industries and are therefore not collectively
vulnerable to the same risks.

145. The supervisor should take steps to be aware of any concentration in the use of a small
number of fronting insurers or reinsurers such that the failure of one could impact on a significant
proportion of captives in the jurisdiction.

5. Protected Cell Companies and other cell company structures7

146. A proportion of captives are established using Protected Cell Companies (PCCs) . In
jurisdictions where PCCs are allowed it is important to consider the specific supervisory issues thatarise from the use of this company structure.
147. A Protected Cell Company is a single company incorporated under company legislationconsisting of a core and an indefinite number of cells. The structure enables different risks to be
written in separate cells. Each cell has assets and liabilities attributed to it and under the PCC
legislation, its assets cannot be used to meet the liabilities of any other cell. The company will also
have non-cellular (core) assets, which may be available to meet liabilities of the PCC as a whole.
A PCC can create and issue shares (“cell shares”) in respect of any of its cells but the company
has a single board of directors. The board of directors of a PCC has a duty under the PCC
legislation to ensure that assets and liabilities of individual cells are strictly segregated.
148. In the event of the insolvency of a cell, the creditors only have recourse to the assets of thatcell and not to those of other cells. In some circumstances, there may be access to assets held in
the core.
149. The licensed entity is the PCC which should be subject to formal supervisory approval. The
creation by the PCC of a new cell will not create a separate legal entity. Supervisors should
nevertheless consider whether the addition of new cells to a PCC should be subject to formal
supervisory approval or authorisation because in many respects a cell may have similar
characteristics to a stand-alone captive. PCCs can be used as rental captives with the core
typically being owned by an insurance manager and the cells owned by or rented to individualcompanies.
150.
A consolidated solvency calculation may mask problems in certain cells if the deficit in one
or more cells is less than the combined surplus in others. When assessing the solvency position
7

Also known as a Segregated Account Company (SAC) or a Segregated Portfolio Company (SPC)

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of a PCC, supervisors should consider both the consolidated position and the solvency of
individual cells. Supervisors should require that sufficient information is provided to identify if there
are any cells in deficit.
151. Supervisors should consider the adequacy of the capital within a PCC in both the core andthe individual cells. If a PCC is established with individual cells being created and offered to clientsto operate as captives, supervisors should consider the funding of each cell separately as well as
the PCC as a whole. If individual cells rely on capital in the core for solvency support, supervisors
should seek confirmation that appropriate contractual agreements exist to permit the core capital to
be used for this purpose.
152.
In addition to the risks set out in the earlier section on types of risk, supervisors should
consider certain risks that apply specifically to PCCs. PCC legislation does not exist in every
jurisdiction and accordingly there remains potential uncertainty whether the courts outside the
PCC’s home jurisdiction would support the segregation provisions of that jurisdiction’s PCC
legislation. The PCC may mitigate this risk by, inter alia, retaining some or all of its assets within
its home jurisdiction or other jurisdictions having equivalent PCC legislation. Supervisors should
be satisfied that the board of the PCC has adequate measures in place to assess and manage thisrisk, and should require that the legal status of the PCC and cells is clearly explained to any
contracting party.
153. The board of a PCC has overall responsibility for all aspects of its business, including
actions taken by the owners and management of cells. There can potentially be a large number ofcells that are unrelated to the core, a wide geographical spread of cell owners and a diverse rangeof business written across different cells, all of which may lead to an increased risk that the board
may be unable to adequately monitor and control all of the business activities of the PCC.
Supervisors should be satisfied that the board has sufficient skills and experience, and has put inplace appropriate systems and controls, to allow it to exercise proper control over all aspects of thebusiness. Supervisors should also be satisfied that the board has put in place suitable corporate
governance procedures to ensure that potential conflicts of interest that may exist between theowners/management of the PCC and that of its cells can be identified and managed.
154. There are variations to the PCC structure, with each domicile having developed legislationin which the degree of legal separation of cells and the level of licensing/authorisation andsupervision of the individual cells varies. Examples include; the Incorporated Cell Company(“ICC”), the Portfolio Insurance Company (“PIC”), the Series Captive Insurance Company, theSegregated Accounts Company, the Segregated Portfolio Company. In some structures, individual
cells are distinct legal entities. In others, a separate company is established underlying therelevant cell, rather than a cell itself taking the incorporated status. The benefits of incorporation
are then granted to each cell including the ability to enter contracts and appoint their own directors.
This provides a further degree of legal separation of assets and liabilities and flexibility as to theactivities undertaken.

6. Insurance Managers
6.1 Supervision
155. Insurance managers play a critical role in the management of many captives. This section
considers how the role of the insurance manager may impact upon the specific application of the
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ICPs to captives which utilise insurance managers. A captive will often be managed in the captive
jurisdiction by an insurance manager that may be a regulated entity or an approved entity. Thissection is based on the assumption that the manager is regulated although the ICPs contain noreference to insurance managers and there is no requirement that they be licensed; additional
considerations that apply if the manager is not regulated are given in paragraph 165.
Licensing156. If licensing an insurance manager, supervisors should assess whether the insurance
manager is fit and proper to carry out functions on behalf of a licensed insurer. An insurance
manager should have sufficient financial and skilled human resources in relation to the number andcomplexity of the captives it manages and the necessary insurance protection in cases ofnegligence and fraud. The captive manager must be very familiar with local regulations andsupervisory practices.
157. A regulatory regime for insurance managers could address, inter alia, licensing, suitabilityof persons, reporting requirements, on-site inspections, corporate governance, internal controls,
fraud, anti-money laundering and combating the financing of terrorism.
158. Licence applications from insurance managers should be accompanied by relevant
information including a business plan showing the sources of business and details of the owners,
directors, officers and other functionaries and resources, including underwriting and accounting
skills. Applications should also include details of the applicable professional indemnity covers.
Suitability
159. ICP 5 addresses the suitability of Board Members, Senior Management, Key Persons inControl Functions and Significant Owners of an insurer.
160. Where an insurance manager represents the captive’s Senior Management and Key
Persons in Control Functions, notwithstanding the supervisor’s oversight of the insurance
manager, supervisors should be satisfied that the captive’s board undertakes appropriate steps toensure that the insurance manager is suitably qualified, has sufficient experience and resources
and is able to perform its obligations in that capacity. In addition, as insurance management
represents an outsourced activity, supervisors should require the captive to conduct appropriate
due diligence and consider all the risks of outsourcing in selecting an insurance manager.
161. A supervisory regime for insurance managers should include an approval process forchanges in Board Members, Senior Management, Key Persons in Control Functions andSignificant Owners as well as the receipt of information regarding financial resources and a
programme of regular on-site inspections.
Reporting requirements
162. Supervisors should require that the insurance manager provides information to supervisorson an annual basis which, as a minimum, includes the financial statements of the insurance
manager at its year end, any material changes to its business plan or resources which haveoccurred during the year, changes to compliance policy and details of any complaints or pending
litigation. Notwithstanding the involvement of the insurance manager the ultimate responsibility forsupervisory reporting remains with the captive undertaking. Supervisors must be satisfied that theinsurance manager has, and will continue to have, financial and human resources that are
adequate for the nature and scale of the business.

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On-site inspections
163. Insurance managers may be subject to on-site inspections by supervisors both in their own
capacity and as managers of captives, however, the captive remains responsible for any issues
identified during an inspection.
164. The on-site inspections are a primary tool for supervisors as the insurance managers’
systems, procedures and level of controls are often common to the captives they manage. The
inspection should provide an effective means of testing the compliance of the captives under the
insurance manager’s control with the applicable legislation and include an overview of thecorporate governance procedures that have been adopted.
165. In respect of insurance managers which are not regulated entities, supervisors should havethe power to carry out on-site inspections of the insurance manager through its power to supervise
outsourcing arrangements or through information gathering powers.
6.2 Corporate governance and internal control
Corporate governance166. The aim of the corporate governance framework is to provide for sound and prudent
management and oversight of the insurer’s business and to protect the interests of policyholders.
167. When assessing a captive’s corporate governance framework, supervisors should
recognise that an insurance manager is an outsourced service provider. At the same time, it will
form part of the captive’s corporate governance framework. Supervisors should recognise thatconflict of interests may arise in respect of corporate governance areas such as independence andaccountability, when for example, a director or employee of the insurance manager is also a
director of the captive engaging its services. Where insurance managers are part of the samegroups as the producing brokers or reinsurance brokers, appropriate procedures should be inplace to ensure that any conflicts of interest are managed fairly. There may be reporting
requirements on the insurance manager such as a whistle blowing requirement, which create apotential conflict if the insurance manager is also acting as a director of the captive.
168. Supervisors should be satisfied that there are management agreements in place reflecting
the division of responsibilities between the insurance manager and the captive’s board andmanagement, and that these agreements clearly reflect the relative obligations of both parties.
169. Supervisors should be satisfied that the boards of insurance managers have a clear
understanding of their obligations in respect of the captives that they manage. The board of a
captive must however recognise that it cannot delegate its responsibilities for good corporate
governance to the insurance manager and must satisfy itself of the adequacy of its governancearrangements as well as the governance arrangements within the insurance manager.
Internal control
170. Effective systems of risk management and internal controls, including effective functions forrisk management, compliance, actuarial matters and internal audit are an essential part of the

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overall corporate governance framework and the supervisor should require a captive to have suchfunctions.
171. When assessing the captive’s internal control procedures, supervisors should bear in mind
that many of the day-to-day activities of a captive are outsourced to the insurance manager,
including for example, compliance, asset management, financial reporting, certain underwriting
functions and claims handling. In such case, insurance managers may themselves undertakemany of the captive’s internal control activities and should be subject to oversight by the captive’sboard. Supervisors should also recognise that the insurance manager’s internal control
procedures, which should be separate from those of the captives they manage, may overlap withthose of the captive.
172. Supervisors may require the appointment of a compliance officer function by insurance
managers which will oversee the provision of the outsourced compliance function to the captives.
6.3 Fraud, AML and CFT
Fraud
173. Supervisors should be satisfied that the insurance manager has in place the necessary
measures to prevent, detect and remedy insurance fraud in respect of its own business and that of
the captives it manages.
AML and CFT
174. Supervisors should be satisfied that the insurance manager has in place appropriate
procedures in respect of AML and CFT.
175. Supervisors should be satisfied that the insurance manager operates an appropriate“customer due diligence” procedure, which ensures it has a sound knowledge of its customer’sbusiness and pattern of financial transactions and commitments. Since the insurance manager’s
customer is the captive, the manager should carry out appropriate due diligence checks on thecaptive owner, both at the start of the relationship and on an on-going basis.
176. Supervisors should also be satisfied that the captive performs AML/CFT checks, as
appropriate, on policyholders or others with whom it conducts relevant financial business. In
practice, a captive may often delegate the operation of its AML/CFT procedures to the insurance
manager servicing the captive.
177. As part of the AML regime, supervisors should be satisfied that the insurance manager has
appointed a suitably qualified and experienced Money Laundering Reporting Officer and that the
manager’s staff regularly undertake appropriate AML training.
178. Where the insurance manager is not a regulated entity, supervisors should also be satisfied
that the captive’s board has ensured that measures are in place to prevent, detect and remedy
insurance fraud and that procedures in respect of AML and CFT are in place as part of theoperations of the insurance manager.

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