Bermuda's House of Assembly passed the Insurance Amendment Bill 2008 (the "Insurance Amendment Act 2008") in July 2008. This legislation has far-reaching implications for the Bermuda (re)insurance market, particularly in the context of the BMA's ongoing development of risk-based supervision.
The enhancement of the risk-based supervisory approach to capital adequacy and solvency margin requirements, as set out in the Insurance Amendment Act 2008, reflects Bermuda's development of, and commitment to achieving equivalency with key regulatory regimes, including the European Union's Solvency II.
The BMA's primary objectives of insurance supervision are policyholder protection and development of the Bermuda (re)insurance market; the implementation of a risk-based approach contributes towards to achieving these objectives. This has particular resonance in light of the market volatility of the past months.
The risk-based approach in determining solvency means that material risks that are inherent to (re)insurers' business models are identified, allowing the Regulatory Capital Requirement ("RCR") to be determined. The change from prior regulation is therefore to establish a risk-based capital model as a tool to assist the BMA both in measuring risk and in determining appropriate levels of capitalisation (termed the Bermuda Solvency Capital Requirement ("BSCR") or an in-house (re)insurer solvency capital model approved by the BMA). The BSCR employs a standard mathematical model that can relate more accurately the risks underwritten by (re)insurers to the capital that is dedicated to their business. The particular framework that has been developed seeks to apply a standard measurement format to the risk associated with an insurer's assets, liabilities and premiums, including a formula to take account of catastrophe risk exposure.
However, where the (re)insurer believes that its own internal model for measuring risk and determining appropriate levels of capital better reflects the inherent risk of its business, it may make application to the BMA for approval of its internal model to be considered in the determination of its RCR as opposed to BSCR. The BMA may approve a (re)insurer's internal model provided certain conditions have been established1.
In order to minimise the risk of a shortfall in capital arising from an unexpected adverse deviation and in moving towards the implementation of a risk-based capital approach, the BMA proposes that (re)insurers operate at or above a threshold capital level (termed the Target Capital Level ("TCL")), which exceeds the BSCR or approved internal models minimum amounts.
Under the Insurance Amendment Act 2008 the BMA proposes to introduce prudential standards in relation to the Enhanced Capital Requirement ("ECR") and Capital and Solvency Return ("CSR")2. The ECR is determined using the BSCR or an approved internal model. The CSR is the return setting out the (re)insurers risk management practises and other information used by the (re)insurer to calculate its approved internal model ECR.
The new capital requirements will require (re)insurers to hold available statutory capital and surplus equal to or exceeding ECR, and set TCL at 120% of ECR.
While the product of the risk-based capital test is mechanistic, the BMA also believes it necessary to provide some limited degree of discretion for it to impose ECR on insurers in particular cases, for instance where a (re)insurer falls below the TCL. In those cases, the new risk-based capital model should be supplemented by a requirement for the affected (re)insurers to conduct certain stress and scenario testing in order to assess their potential vulnerability to defined extreme events. Where the results of scenario and stress-testing indicated potential capital vulnerability, the BMA would be able to require a higher solvency 'cushion' by increasing the 120% TCL figure.
Section 6A Orders
The enhancement of the new risk-based supervisory approach allows the BMA to analyse the impact and probability of failures among regulated (re)insurers and target those (re)insurers, (re)insurer classes, situations and/or activities that the BMA identifies as being at risk. In such cases, the BMA would issue a Section 6A Order prescribing additional capital and surplus requirements to be met by (re)insurer(s).
In determining whether a (re)insurer conducts its business in a prudential manner, the BMA will consider whether it maintains sufficient capital to enable it to meet its obligations in light of the size, business mix and risk-profile of the (re)insurer's business. Thus, the reclassification of Class 3 (re)insurers will have a direct impact upon how reclassified and new Class 3, Class 3A and Class 3B (re)insurers are supervised in relation to prudential standards (bearing in mind the BMA's focus on protecting unsophisticated policyholders).
Principal Representatives
The development of the risk-based approach also impacts upon the BMA notification responsibilities of principal representatives. In addition to the existing list of events that a principal representative is obliged to notify to the BMA (and to take the steps listed) in relation to a (re)insurer for which he/she acts as principal representative, are the following events, namely:
- a significant loss that is likely to render the (re)insurer unable to comply with its ECR, and within 45 days following notification to lodge with the BMA a capital and solvency return reflecting ECR prepared using post-loss data;
- in relation to a Class 4 (re)insurer, a material change to the nature of the business it underwrites, and within 30 days following notification to lodge with the BMA unaudited interim statutory financial statements together with a general business solvency certificate in relation to those financials; or
- in relation to a Class 3A (re)insurer, where the limit (less than $50 million) on unrelated business is exceeded.
Effect of the risk-based supervisory approach
The Bermuda (re)insurance market is already extremely well capitalised and the BMA has for many years operated arrangements for monitoring, managing and mitigating the risks that are taken on by Bermuda (re)insurers and ensuring that adequate capital is held against them. As a result, the incidence of problem situations in the Bermuda market has been low (even in light of recent market volatility), with policyholder losses extremely rare. The overwhelming majority of registered (re)insurers already operate at capital levels that are well in excess of the legal minimum.
Accordingly, for the most part, in developing the risk-based solvency tests, the BMA has stated it sees no need to alter the overall relationship between aggregate capital held and risks underwritten in the Bermuda market.
Conclusion
The enhancement and development of the Bermuda regulatory environment achieved under the Insurance Amendment Act 2008 is to be welcomed by all Bermuda market participants and stakeholders.
While the changes and developments proposed will, inevitably in the short-term, lead to a phase of adjustment, the long-term benefits to this jurisdiction, in ensuring that it stays in line with, and sometimes ahead of, global supervisory trends should not be discounted.
Footnote
1. The ability of Bermuda (re)insurers to adopt their own internal models in determining RCR as opposed to adopting BSCR, reflects a similar approach to that adopted by the European Commission and its working group under the draft Solvency II provisions in respect of Solvency Capital Requirements ("SCR"). Solvency II sets out two methods for the calculation of the SCR, namely the European Standard Formula or EU (re)insurance firms' own internal models. SCR is proposed to cover all quantifiable risks a (re)insurer faces and takes into account any risk mitigation techniques adopted by such EU (re)insurance firms.
2. These standards will be introduced by the BMA through Orders issued by it pursuant to Section 6A ("Section 6A Orders") of the Insurance Act 1978, as amended by, inter alia, the Insurance Amendment Act 2008 (together hereinafter referred to as the "Insurance Act"). The BMA is given broad powers to vary or proscribe specific prudential standards for a particular registered (re)insurer or a class of (re)insurers.
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