Diana Bui sits down with industry experts to assess how Solvency II modifications and other regulatory changes affect asset management strategies for captive insurers in Europe
Winston Churchill once remarked: "To improve is to change; to be perfect is to change often."
This philosophy rings true for Europe’s captive insurance sector, as it stands on the brink of significant regulatory changes. While these reforms stop short of revolutionising the industry, they offer a lighter regulatory touch that could unlock new avenues for captives to optimise their investment strategies.
As the industry prepares for these regulatory updates, set to roll out in 2026, EU-domiciled captive entities can expect “a more streamlined, proportionate, and risk-based prudential process,” according to AM Best in its market segment report on European captives. Under the new regulatory landscape, captive insurers will have the opportunity to reassess and potentially diversify their asset portfolios.
Marine Charbonnier, head of captives and facultative underwriting, APAC and Europe, AXA XL, observes: “Recent modifications to Solvency II, aimed at enhancing the proportionality for captives, could potentially improve their efficiency. These changes may lead to reduced reporting requirements and capital charges. However, the long-term impact might require captives to adopt more sophisticated risk management and investment strategies to fully leverage these regulatory relaxations."
Solvency II modifications
On 22 September 2021, the European Commission proposed a directive to amend the Solvency II framework, the EU's comprehensive regulatory regime for insurance companies. The proposed changes, which reached a provisional agreement in April 2024, are set to significantly impact captive insurance companies operating within the European market. Although the exact implementation date remains uncertain, it is anticipated that these amendments will come into effect by early 2026.
The revisions, developed in collaboration with the European Insurance and Occupational Pensions Authority (EIOPA), aim to refine the regulatory environment. The focus is on enhancing stability across the market while introducing greater flexibility for insurers, particularly those with specialised risk profiles, such as captives. The changes seek to address challenges that have emerged since Solvency II was first implemented, ensuring the framework can adapt to new risks and evolving market conditions.
In light of these recent modifications to Solvency II, Simon Grima and Pierpaolo Marano, professors from the University of Malta, highlight several fundamental changes and their specific implications for captive insurers.
Among these is the proposed reduction in the cost-of-capital rate used in risk margin calculations, which is expected to ease the capital reserve requirements for captive insurers with long-term liabilities. By lowering this rate from the current 6 per cent to around 4.75 per cent, the amendments aim to free up significant resources, potentially improving solvency ratios for these specialised insurers.
Additionally, the scope of the matching adjustment is set to expand, allowing captive insurers to invest in a broader range of assets, including infrastructure bonds and high-quality corporate debt.
According to Grima and Marano, this expansion is designed to align investments more closely with long-term liabilities while promoting sustainable, green projects.
They add that another key aspect of the reforms is the simplification of regulations for smaller insurers. The new measures are expected to reduce the reporting and capital calculation burdens for captives classified as ‘small and non-complex’, allowing them to focus more on their core business operations.
The volatility adjustment mechanism is also being overhauled to make it more responsive to real-time market conditions. This change will help captive insurers maintain their solvency during periods of market stress without the need for drastic actions, such as selling off assets at unfavourable prices.
Furthermore, the recalibration of capital requirements based on updated risk assessments may lead captives to adjust their investment portfolios, favouring more stable, lower-cost assets over equities.
Finally, Grima and Marano say that the addition of environmental, social, and governance (ESG) factors to the Solvency II framework will make captive insurers more likely to invest in long-lasting assets.
These investments may benefit from lower capital requirements, aligning with broader sustainability goals, and enhancing the reputational standing of captives within larger corporate groups.
Reassessing investment portfolios
Captive insurance companies in Europe often prioritise underwriting over investment strategies, according to Vittorio Pozzo, director of Europe and Great Britain captive advisory team at WTW. "Captives tend to place little emphasis on investment policy and asset allocation relative to the emphasis placed on underwriting," Pozzo says. He notes that their asset management strategies are usually basic, focusing mainly on cash pooling or short-term investments, driven by the need for flexibility and liquidity. Pozzo explains that structured asset management is often secondary for captives, as their primary role is to challenge the commercial insurance market, retain underwriting profits, and create additional capacity for future claims. "Captives are driven by the liability side of the balance sheet," he adds.
Under Solvency II, Pozzo highlights the importance of diversifying investments across counterparties and focusing on high-rating assets. "With regards to the cash pooling investment, the arbitrage is typically between capital requirements vis-a-vis liquidity," he says.
The recent changes to the regulation, especially concerning the ‘prudent person’ principle, have strengthened the importance of a careful and risk-aligned approach to asset management for captive insurance companies in the European market. According to AXA XL’s Charbonnier, this principle requires captive insurers to invest in assets in a way that ensures the portfolio's security, quality, and liquidity, which directly influences their asset management strategies.
“Captives, smaller and more specialised than traditional insurers, may find it challenging to adhere to these strict requirements while maintaining flexibility in their investment strategies. They need to prioritise low-risk, highly liquid assets, limiting their ability to pursue higher-yield investments,” she remarks.
Meanwhile, William Gibbons, principal in insurance investment at Mercer, explains that the prudent person principle dictates that insurers should invest in a manner that a prudent person would — meaning investments should be sensible, measured, and aligned with the ability to identify, monitor, manage, and control associated risks.
“Insurers must be comfortable with the risks involved in their investment strategies and manage them appropriately. Regulators and supervisors often use this principle as a benchmark. If there's any concern about an insurer's investment strategy, they may reference the prudent person principle to ensure that the strategy aligns with best practices."
EIOPA has provided specific guidance for captive insurers, covering areas such as cash pooling, security, asset quality, availability, and asset-liability management. Gibbons notes that the purpose of these guidelines is to assist insurers in adhering to the prudent person principle by carefully weighing these aspects in their investment decisions.
Looking at the recent modifications in Solvency II from an investment standpoint, Shadrack Kwasa, executive director at London and Capital, remarks that the most significant benefit for captives is this newfound flexibility." With reduced regulatory burdens, captives can now allocate more time and resources towards refining their investment strategies. This shift allows them to maximise market opportunities, making their capital work more efficiently."
Kwasa explains: “For captives dealing with long-tail businesses, such as life insurance or pension-related products, these changes bring material benefits to asset management. The reforms make assets like infrastructure equity, private equity, and private debt more attractive to captives, who are now better positioned to explore these markets. Additionally, changes in the treatment of assets that match liabilities, especially in terms of volatility, enable captives to manage these assets with reduced risk, thereby reducing their susceptibility to interest rate fluctuations."
To help captive insurers balance the liquidity, security, and profitability in their investment portfolios under Solvency II, Charbonnier recommends a multifaceted strategy. She advises captives to invest in high-quality liquid assets (HQLA) to cover short-term obligations, while strategically allocating a reasonable portion of their portfolios to higher-yield investments that maintain a reasonable level of safety. "Additionally, to improve the solvency ratio, captives might explore reinsurance arrangements that provide capital allocation optimisation."
Managing asset allocation
Kwasa says that the capital charges under Solvency II have significantly impacted the asset allocation strategies of captive insurers. These regulations have compelled captives to reevaluate their investment portfolio management strategies, aiming to optimise them not only for economic returns but also from a regulatory standpoint.
"The challenge lies in balancing investment-efficient and Solvency II-efficient portfolios, which means captives need to hold the least capital while maximising returns."
Historically, captives have often opted for simpler asset classes like cash or loans, focussing more on supporting their parent companies' insurance programmes rather than chasing high investment returns. With the recent changes, there is now a greater opportunity for captives to rethink their investment strategies.
"They can now consider factors such as risk appetite, market conditions, and available capital more carefully when structuring portfolios to make the most of the opportunities available, ultimately achieving greater efficiency in their investment approach," Kwasa notes.
Grima and Marano reiterate Kwasa's remarks on capital charges, stating that Solvency II assigns capital charges to asset classes according to their risk profiles. Higher-risk assets like equities and real estate attract higher charges, while lower-risk assets like government bonds and high-quality corporate debt are subject to lower charges. These capital charges have a direct impact on how captives allocate their assets, as they seek to optimise capital efficiency while managing risk.
The professors from the University of Malta explain that the recent recalibration of capital charges includes more favourable treatment for certain asset classes, such as infrastructure bonds, as well as a renewed focus on sustainable investments. This provides captives with new opportunities to enhance returns without significantly increasing their capital requirements. As a result, captives may shift their portfolios towards these newly favoured assets, reducing their exposure to higher-charge investments to maintain strong solvency ratios and capital efficiency."
In order to minimise capital charges while ensuring profitability, Charbonnier recommends captives to “optimise the allocation towards low-risk investments by exploring less capital-intensive alternative investments.
“The group CFO and/or treasury manager must align the captive asset management strategy with Solvency II by focussing on capital efficiency, ensuring the portfolio is balanced to meet liquidity needs without compromising solvency."
As the market and the regulatory landscape evolve, so do captives. Pozzo observes a trend among some sizable and well-established captives to try and structure a more sophisticated asset management strategy with their available cash in excess of what they have to commit for insurance and regulatory purposes. "Captives may choose to accept a higher level of investment risk in exchange for higher returns," he says. However, Pozzo advises carefully evaluating the combined impact of all risk factors when assuming greater-than-normal underwriting risk to prevent stressing the captive's financial stability.
When it comes to fund administration, Gibbons notes that when selecting investments, it is crucial for captive insurers to consider the adequacy of reporting — particularly through the Tripartite Template (TPT), which ensures compliance with regulatory reporting requirements. He also emphasises the importance of targeting a specific Solvency Capital Requirement (SCR) level, which directly correlates with the risk profile of the investments.
“The insurer must hold more capital due to the higher capital charge associated with riskier investments. By controlling capital requirements, asset managers help provide stability for captives, allowing them to know precisely how much additional capital they need to hold against investment risks. This approach supports better business management and future planning."
For captives governed by Solvency II, Gibbons warns against investment strategies that incur excessive capital charges. "Simply pursuing high-yield or securitised investments without considering their capital implications can be counterproductive," he says, highlighting that such strategies can lead to increased capital requirements and ultimately lower profitability.
Instead, he advocates for a balanced approach that aligns investment returns with prudent capital use, ensuring compliance with regulations while maintaining financial stability.
Racing to attract captives in Europe
European jurisdictions are increasingly vying for a share of the captive insurance market and are starting to reap the benefits, according to Best’s Review published in August. While Europe hosts a fraction of the world’s 6,000 captives, inconsistent reporting across jurisdictions makes tracking growth challenging. However, more captives were licensed in Europe in 2022 than were dissolved.
Guernsey reclaimed the top spot among European captive domiciles, followed by Luxembourg and the Isle of Man, driven by a vigorous market push. Larger European countries like France, Italy, and the UK, which historically overlooked this business, are now seeking ways to attract captives. London, in particular, is exploring a captive insurance framework as part of efforts to enhance the UK’s risk transfer environment. Gibbons highlights the competitive landscape among domiciles, noting that some jurisdictions provide distinct regulatory frameworks tailored to the specific needs of captive insurers. "Whether a group is looking to establish a reinsurance captive, a direct writing captive, or an offshore captive, the choice of domicile can be influenced by these unique regulatory offerings," he explains.
To stay competitive in the industry, Gibbons advises: “European captive insurance companies may wish to adjust their strategies in response to recent changes in financial markets, particularly the rise in interest rates. For many years, interest rates remained exceptionally low, from the period following the global financial crisis up until the COVID-19 pandemic. However, with rates now elevated, there are greater opportunities to generate returns from investment strategies. Captive insurers are now re-evaluating their investment strategies, focussing on balancing risk while maximising returns. For instance, rather than keeping funds in low-yield cash accounts, insurers might consider investing in bonds or funds offering higher yields. Failing to adapt could mean missing out on significant income opportunities."
He predicts that the European captive insurance market is poised for growth, driven by regulatory changes that could increase the amount of capital held within captives. "As more assets flow into these structures, there will be a stronger emphasis on investment strategies. Captives will need to refine their approaches to remain competitive, with a focus on generating higher investment returns.
“Strategies may include loaning cash back to the parent company or exploring bond-based investments to maximise income. I think the trend suggests a growing importance of investment strategy within captives as they seek to optimise returns on their increased capital reserves."
Gibbons points out that while Solvency II imposes stringent requirements on captives domiciled within the EU, these captives benefit from the ability to conduct business directly across the EU. "Captives within the EU can write business on a direct basis without the need for fronting relationships or the guarantees typically required by fronting insurers," he says.
Meanwhile, Grima and Marano forecast that the European captive insurance industry would move towards capital efficiency in response to Solvency II and recent regulatory changes. They say that captives would invest more in low-capital charge assets like infrastructure projects and ESG-compliant investments. "This shift will be driven by the adjusted capital requirements and broader eligibility for matching adjustments introduced by the Solvency II modifications."
The professors also highlight a growing emphasis on sustainability as captives integrate ESG factors into their investment and risk management strategies. Digital transformation is expected to accelerate, with captives adopting advanced technologies for risk management and compliance to enhance efficiency and quickly adapt to regulatory changes. Smaller captives may also seek collaborations to scale up and navigate the complex regulatory environment.
“These trends collectively point towards a more innovative, resilient, and strategically focused European captive insurance market,” Grima and Marano add, noting the sector’s enhanced position to thrive under the evolving Solvency II framework.
On the other hand, Kwasa believes that European captives can turn the regulatory and reporting burdens imposed by Solvency II into a competitive advantage. "Solvency II mandates that European captives be well capitalised, well managed, and rigorously overseen,” Kwasa notes. "This robust framework positions them to better withstand market shocks and underwrite riskier lines, such as cyber risks or climate-related risks. European captives, with their deeper awareness of ESG factors, are well-suited to address these emerging challenges." He observes a shift in European captives' approach, in which risk and investment strategies are increasingly considered in the early stages of formation. "The goal is to make the captive as efficient and self-sufficient as possible, supported by a robust investment portfolio. This proactive approach allows European captives to shine relative to their peers, particularly in handling uncertainty and risk,” he adds.
As the landscape for European captives evolves, the challenging market is pushing more companies to consider captives as a viable option. For European captives, the key lies in leveraging their strengths, capitalising on their inherent advantages, and solidifying their position in the market. "The captive is returning home, and there's clear momentum in the right direction,” Kwasa says. The outlook is promising, but the industry will be watching closely to see how this development unfolds.
