Solvency II: ready and willing

The regulatory change to be imposed by Europe’s Solvency II Directive embodies some of the most demanding requirements yet of an insurance regime. Both the Bermuda Monetary Authority and Bermuda market participants understand and appreciate the rigour of this impending new standard. The Authority is committed to implementing a regime that can be deemed as being broadly equivalent to Solvency II standards.

The benefits of obtaining equivalence are significant for Bermuda and for firms operating from within the domicile, given the considerable levels of insurance-related business conducted between Bermuda and Europe. Equivalency will allow Bermuda-based firms to compete in the EU market on a non-discriminatory basis; minimise the need for multiple capital requirements and eliminate the requirement for group solvency calculations on a number of different regulatory bases; and improve the ability of firms to optimise group capital.

The impetus for seeking Solvency II equivalence stems from the importance of the European market to Bermuda-based re/insurers. Europe represents a substantial amount of the Bermuda market’s volume of business. In addition, it is likely that Solvency II will become the global standard for insurance or, at the very least, it will significantly inform the development of international standards for this sector.

Since a key objective for the Authority is to develop a leading insurance framework that meets or exceeds international standards, gaining equivalence with Solvency II is a priority. The Authority stated its intention to pursue equivalence two years ago and, since that time, has completed a number of significant enhancements to its insurance framework, including the implementation of a more robust solvency regime for Bermuda’s commercial insurance sector. The Authority has now entered the next phase of its work geared towards meeting this key objective. In the first quarter of 2010, it met several milestones outlined in its equivalence work plan, some of which, including development of its group-wide supervisory framework, have been accelerated and are ahead of schedule. As the Authority enters this new phase, the focus of its work will be on continuing development of its policy andlegislative framework, along with implementing the new supervisory programmes that are in line with Solvency II requirements.

While being the most advanced of the international insurance standards in development, Solvency II is not expected to become law until October 2012. However, indications from the Commission of European Insurance and Occupational Pensions Supervisors (CEIOPS), the body developing the new rules on behalf of the European Union, are that equivalency assessments of third countries’ frameworks (i.e. countries outside of the European Economic Area) will begin in late 2010. In March of this year, CEIOPS provided the EU with its final advice on the technical criteria for assessing third-country equivalence, clarifying for countries such as Bermuda what will be required.

The Authority is confident that given the work already completed and the additional framework enhancements planned, it will be technically ready for its assessment in the timeframe established by CEIOPS. Along with the intended changes to the framework, the Authority is focused on ensuring that it has the appropriate resources to successfully implement the new supervisory programmes that will result from this work, such as its group-wide supervisory regime. To meet its resourcing objective, the Authority has embarked on an aggressive recruitment effort, with particular focus on attracting seniorlevel professionals with strong technical skills who will complement its existing team of supervisors, actuaries and risk analysts.

The Authority’s approach to equivalence

While the Authority is fully committed to achieving equivalence, its approach is not to duplicate the directive verbatim, but instead, it will adapt the new standards intelligently for the Bermuda market. A major driver of this approach is to preserve a regulatory environment in Bermuda that is risk-based, highly compliant with international standards and appropriate to the unique nature of the Bermuda market. The Authority’s risk-based approach to regulation has been endorsed by such international regulatory bodies as the International Monetary Fund as being both practical and effective. The approach has served the jurisdiction well over the years, and the Authority believes it is appropriate to continue in this manner.

To maintain a framework that is both practical and effective, the Authority is in constant dialogue with Bermuda market participants through a thorough and comprehensive consultation process related to policy development. This process has proven to be crucial to the smooth implementation of regime enhancements. It aids the Authority in understanding what practices are currently being used in the market and how they will be impacted by its proposals. It also ensures that enhancements to the framework, while being compliant with international best practice, are not unduly burdensome on firms.

The Authority’s work on establishing its internal capital models (ICM) framework is an example of the effectiveness of this approach. Prior to publishing the guidelines and standards for the internal framework application process, the Authority conducted a detailed analysis of the current use of modelling within Class 4 firms to determine the level of sophistication of models in use. This exercise proved valuable in determining appropriate standards and guidance for the application process of the ICM. The Authority is continuing with the development of its ICM framework and will be conducting a pilot implementationof the application and review process with selected Class 4 re/insurers throughout 2010.

Upcoming initiatives

As part of the next phase of its equivalency assessment preparations, the Authority is currently consulting with industry stakeholders on issues including the Commercial Insurer’s Solvency Self Assessment Return (CISSA), an equivalent to Solvency II’s Own Risk Solvency Assessment (ORSA) requirement. Consultation is also in progress on an enhanced solvency regime for Class 3A firms; consideration of an economic balance sheet; and additions to disclosure and transparency requirements for re/insurers.

The Authority’s proposed enhanced capital adequacy regime for Class 3A firms is a modified version of the Bermuda Solvency Capital Requirement (BSCR), the standard capital adequacy model implemented for Class 4 and Class 3B firms in 2009. This modified capital adequacy regime for Class 3A firms (BSCR-SME) is in line with the Authority’s risk-based approach to regulation and will be applied in accordance with the proportionality principle. The Authority is currently consulting with Class 3A firms on its proposals, which along with the BSCR-SME, includes a CISSA without the Cat Return.A consultation paper on the Authority’s proposed CISSA is planned for publication in quarter two of 2010. The CISSA is another example of the Authority’s approach to adapting Solvency II requirements to the nature of the Bermuda market, while maintaining consistency with the European requirement. Like Solvency II’s ORSA, the CISSA will allow the Authority to obtain the re/insurer’s view of the capital resources required to achieve its business objectives and assess the governance, risk management and controls surrounding this process. The Authority is proposing to supplement the CISSA with a Catastrophe Return (Cat Return) for Class 4 and Class 3B firms. The Cat Return will allow the Authority to better assess the composition of the Probable Maximum Loss submissions and the quality of modelling generally in the Bermuda market, as well as introduce new stress scenarios for terrorism risks. The consultation paper will also build on the Authority’s proposals for enhanced disclosures, as outlined in its previously published Disclosures and Transparency consultation paper, which was issued in 2009.

A task force assembled by the Authority will consider issues surrounding the introduction of an economic balance sheet and the replacement of statutory financial statements with general-purpose financial statements. The findings will assist the Authority in forming its proposals with regard to the economic balance sheet, which it will outline in a discussion paper for industry comment in the second quarter of 2010.

The Authority continues to work diligently and with acute focus on its planned framework enhancements to Bermuda’s commercial insurance regime. As the window of time for equivalence assessment preparations narrows, the Authority remains confident that it will satisfy the criteria for third-country equivalence outlined by CEIOPS and that there will be no technical impediment to achieving equivalency for Bermuda’s insurance regulations.

Craig Swan is director of policy, research and risk assessment at the Bermuda Monetary Authority. He can be contacted at: cswan@bma.bm