First published in Trading Risk, June 2019
The ILS market has broadly welcomed moves by the Bermuda Monetary Authority (BMA) to create a new collateralised insurance vehicle, but opinions vary on whether the new rules will prove to be onerous.
Questions also remain around what may happen in any transition period.
Bermuda's legislation for Special Purpose Insurers (SPI) was created when most ILS deals were simple cat bond transactions. Since then, so-called "unrestricted" SPIs have been adapted to use for more complex collateralised deals while some managers have also moved to set up commercial insurers of class 3A or above.
The proposed Limited Purpose Insurer (LPI) has been positioned as an interim step between SPIs and commercial insurers – but crucially it does not provide Solvency II equivalency.
Some see this as a benefit, believing the regulation of the class will not be as "stringent" but others have questioned why people would "go through a lot more work than being an SPI or Class 3" without the gain of Solvency II recognition.
Appleby partner Brad Adderley said it was "completely sensible" for the BMA to update the regulation given the evolution in the market.
"How you regulate your standard simple sidecar/cat bond and how you regulate your $2bn collateralised vehicle which has top-ups and clawbacks has to be different," he said. "In some ways you could argue that the horse has already bolted – people have chosen to jump from SPIs to 3As already."
One complication has been that fully collateralised firms registering as Class 3As do not fit neatly with Bermuda Solvency Capital Requirements. This was a point taken up by Horseshoe CEO Andre Perez, who welcomed the move to end regulatory confusion and said that if the BMA brings in the new LPI class he would push for no more exemptions for Class 3As.
"There is a false sense that all 3As are created equal," he said. However he also warned of "over-thinking going on here from a regulatory perspective". "If you are cedant all you care about is that you have a valid reinsurance contract and the money in the collateral account," he said.
"The reality is we are not talking about insuring Mr or Mrs Smith who own a shop. We are talking about sophisticated parties and, to a certain extent, that is not being fully reflected here." Perez also said it was unclear how the transition to the new regulation would work, raising the question of whether existing firms would be forced to reclassify their status.
The general expectation is that LPIs will be introduced for the start of January 2020 and further details will unfold once the BMA has processed responses to its consultation.
Peter Dunlop, partner at law firm Walkers, said the BMA was not in the habit of forcing participants to go from class to class. He doubted there would be a "guillotine" to the transition phase.
Funding standards evolve
The ability of LPIs to use reinsurance as contingent capital or collateral is seen as a key benefit. But more details are required about how it would work in practice. Fully funded is different to fully collateralised, Dunlop noted.
Similarly, on clawback Perez said that while the guidance note stated that it would be allowed, the language was more grey than black and white.
This level of overall uncertainty is reflected in the range of opinions on the proposals: one unnamed ILS fund manager described LPIs as beneficial and not seeming too onerous while another said the regulations would be "very heavy to comply with".
LPIs will also have to have some level of permanent regulatory capital. This will range from a minimum of $250,000 up to 0.88 percent of assets depending on the vehicle's risk score. Views on this ranged from it being "a lot of money" to not "punitive".
The BMA has previously consulted on the need to raise fees and flagged this in the latest consultation. As one participant pointed out, a collateralised reinsurer may pay up to $40,000 whereas SPI fees can be as low as $10,000. There are clearly plenty of details to iron out. However there is no doubt that currently there are plenty of companies falling between available regulatory categories. The sentiment overall is the BMA has attempted to be dynamic and responsive to the ever-evolving environment.
However, it will have to address the concerns it will hear in the consultation feedback to truly deliver the "proportionate" regime that it believes this change will herald.
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