The Federation of European Risk Management Associations is encouraging national jurisdictions to adopt a consistent framework to implement the Organization for Economic Co-operation and Development’s recommendations on base erosion and profit shifting in evaluating captive owners’ decision-making processes and motivations.

In June, FERMA released a set of guidelines covering three key areas: commercial rationale, substance and governance, and the transfer pricing/ premium-setting process. For example, documentation to justify the commercial rationale for the captive could include the total cost of risk analysis showing how the captive reduces the total cost of risk for its parent, and a total premium statement showing how the captive can save costs for its parent group by reducing total premiums paid outside the group, avoiding numerous local policies and potential duplications and accessing reinsurance or specialty capacity more directly, according to the guidelines.

On the substance and governance side, the documentation should demonstrate elements like the captive board of directors meeting in person and within the captive jurisdiction at least twice a year, and the board comprising least three people, including a resident of the captive domicile.

These first two prongs should not be difficult to comply with, as many of these steps are obvious to captive owners and experts, but the third prong, the transfer pricing/premium-setting process, may be a bit more challenging, said Gilbert Canaméras, FERMA’s secretary general.

Documentation that would justify the appropriateness of the pricing for a captive acting as an insurer includes a documented and transparent premium-setting process, market quotes from third-party insurers or reinsurers, or a benchmarking analysis and a model-based technical premium using standard actuarial methodologies based on loss history, exposure measures or cost of capital, according to the guidelines.

For a captive acting as a reinsurer, the documentation to support the captive decisions further includes evidence that reinsurance pricing follows the fronting insurer’s pricing.

“We can explain very clearly the premium-setting process,” he said. “After that, it’s the fiscal regulator’s decision.” European captives are already dealing with Solvency II requirements and will likely be sufficiently compliant, Mr. Canaméras said. “The sole problem could be captives that are not able to explain the premium transfer,” he said.