An evolving ORSA in the post-COVID-19 world: what are the implications for captives?

What learnings should captives take from COVID-19 and incorporate into their ORSAs going forward, whilst maintaining adherence to the related supervisory requirements?

COVID-19 took the world by surprise at the end of 2019 and has had significant and far-reaching social and economic impacts. The extent of the impact on an insurer depends on the types of policies it writes and the levels of coverage offered: the most obvious example of this being the adverse impact on insurers writing policies with disease claims, due to the lack of pandemic exclusions in policy wordings.

Insurers have had to adapt to changes in their risk landscape, and those that were well prepared for crisis events and had robust business continuity plans in place will have fared better than those without. Within the Solvency II regulatory framework, the Own Risk and Solvency Assessment (ORSA) is an essential tool for insurers to assess the full range of risks they are exposed to. In times of turmoil, such as the COVID-19 pandemic, an insurer’s ORSA should have helped the boards of directors, captive owners, and captive managers respond to the challenges and quantify the potential financial impact.

So what learnings should captives take from COVID-19 and incorporate into their ORSAs going forward, whilst maintaining adherence to the related supervisory requirements?

EIOPA’s Supervisory Statement

A captive’s ORSA plays an important role in the system of governance and contains a well thought out set of possible future risks. On the 16 June 2021, the European Insurance and Occupational Pensions Authority (EIOPA) issued a supervisory statement outlining how it expects insurers to allow for the future impact of COVID-19 in the ORSA. This will apply to all captives regulated under Solvency II.

EIOPA’s supervisory statement is not intended to impose additional requirements on insurers (including captives), but aims to clarify how they should reflect the material impact of COVID-19 in their ORSA. It explains how COVID-19 requires an assessment of changes in risk profile, followed by a forward-looking stress testing and scenario analysis exercise.

Key Considerations for Captive Owners

Depending on the size, risk profile, and nature of a captive’s business, the proportionality principle as defined in Solvency II can be applied when performing an assessment of these supervisory expectations. Captive Boards should consider the following steps when assessing the supervisory expectations outlined by EIOPA.

Step 1 – Review the impact of COVID-19 on the captive’s risk profile.

Consider the following:

  • Changes in business plans and strategies.
  • Impact on underwriting results – such as, the adverse claims experience from policies underwriting business interruption cover; the impact on household and motor claims; and the unknown (but quantifiable) impact on employers’ liability policies.
  • Impact on capital requirements and available capital – such as, changes in market risk, credit risk, or operational risk exposures. 
  • Impact on the captive’s reinsurance arrangements – a change in the reinsurance strategy and/or reinsurance programme could significantly affect the captive’s risk profile and the overall cost of reinsurance.

Step 2 – Consider whether COVID-19 impact is sufficiently material to require an ‘ad hoc ORSA’[1].

In this case, the captive board, with support from their captive manager, should follow the requirements for an ad hoc ORSA, as outlined in Article 45 of the Solvency II Directive.

Step 3 – Include the COVID-19 impact in the ORSA forward-looking assessment and assess the impact through scenario analysis.

The forward-looking assessment should take into account the following:

  • The uncertainty of the duration and economic impact of COVID-19. Consider the present conditions and the expected stress on the captive, such as claims development.
  • The degree of COVID-19 uncertainty on the captive, which should then be documented.
  • The impact of COVID-19 on the captive’s future business model, including any material changes (positive and negative) on the captive’s portfolio of business written.
  • Any impacts or changes to claim development patterns and the potential impact on estimated ultimate claims – including consideration of time lags and delays in claim notification; the cost and time of additional claims assessment; or any claims in dispute.

Having accounted for the above in the assessment, captive boards should be sufficiently equipped to select and design appropriate scenarios for analysis, which should at least consider a three-year future period. Scenario analysis should then be carried out to assess the impact of each scenario on the Solvency Capital Requirement and eligible Own Funds. Where relevant, the ORSA should include the risk mitigating measures and/or management actions that can improve the solvency position. The above should be documented in the ORSA process.

Step 4 – Consider Appropriateness of Current Risk Management Metrics

As a result of the material impact of COVID-19, captive boards should assess if the risk management metrics applied by the captive (including, risk appetite or risk tolerance limits) are adequate and sufficient.

If the assessment performed in step 1 concludes that the impact is not expected to be material, the ORSA should contain a description of the assessment performed and the outcome of the assessment.

Where an assessment against EIOPA’s supervisory expectations concludes that COVID-19 is expected to have a material impact on the ORSA, steps 2 to 4 above should be performed.

The Way Forward

Ultimately, captive owners should use this assessment against EIOPA’s expectations as an opportunity to perform a more holistic horizon scanning exercise. This will enhance their understanding of further or emerging risks surrounding their captive’s business that may presently be under-accounted for. The inclusion of thorough and imaginative scenario analysis will help make sure that the captive’s board and management are best prepared to deal with future unexpected events.

[1] The EIOPA supervisory statement on ORSA in the context of COVID-19 defines an ad hoc ORSA as a non-regular ORSA which is needed based on the analysis of any material changes to the risk profile.