1 November 2011Life

Bermuda strides ahead on equivalency

Bermudian interests were generally pleased with the European Insurance and Occupational Pensions Authority’s (EIOPA) preliminary assessment of Bermuda’s regulatory framework in relation to Solvency II, published on 17 August, 2011. The assessment indicates that Bermuda’s regime for its major non-life commercial insurers (class 4) has been found to be largely equivalent. Other commercial classes (3A and 3B) were generally found to be partially equivalent, and authorities in Bermuda are confident in addressing the caveats raised by the EIOPA.

"Bermuda's efforts to be at the front of the queue on equivalence may well hinge on the success of enhancing its long-term business regulatory framework."

The report clearly calls attention to the lack of equivalence for the captive sector (classes 1, 2 and 3). Bermuda is a leading captive jurisdiction and as such provided considerable input to the International Association of Insurance Supervisors’ (IAIS) draft guidance on the regulation of captives. The IAIS is the international standards-setting body for insurance, similar to the Basel Committee on Bank Supervision which sets international bank standards. However, significant differences exist with EIOPA concerning various aspects of the regulation of captives. This raises the question of whether Bermuda, or any other jurisdiction, can achieve equivalence for a subset of specifically licensed insurers. The format of the report addressing classes of licence implies that this topic may be considered, but granting equivalence for such subsectors was not originally contemplated and may require EU legislative amendments.

The Bermuda Monetary Authority’s (BMA) plans to achieve equivalence have always focused on all classes because that was previously believed to be the only option available (and may still be). So with the door perhaps being opened to achieve equivalence only for commercial classes, we expect equivalency efforts to be prioritised to that effect. This does not mean that planned enhancements to captive regulation will cease. Far from it: no sector is immune from stakeholder expectations of regulators in response to the economic turmoil since 2008.

We currently do not expect increases to capital and solvency requirements for captives, but risk governance and certain regulatory risk disclosures are expected to be enhanced in line with IAIS standards for the regulation of captives. The report highlights inconsistencies between EIOPA’s perspectives on captive regulation and those draftedby the IAIS, and this is likely to frustrate jurisdictions that have large captive sectors such as Bermuda and the US.

The report also cites numerous areas where either changes are needed to meet the equivalency test or where additional evaluations are needed after the BMA completes the implementation of additional regulatory requirements. Many of these additional requirements are in the process of development or implementation and therefore it is not surprising that the report raised a number of points. For example, a proposed economic balance sheet framework, a key principle under Solvency II, has been through an internal development process at the BMA and further consultation is planned. In this regard, it would make sense for the BMA to closely monitor the work of the International Accounting Standards Board (IASB) on valuation of insurance contracts.

The IASB plans to issue a final accounting standard on insurance contracts in the first half of 2012, and the US Financial Accounting Standards Board (FASB) is expected to amend insurance contract accounting requirements under US Generally Accepted Accounting Principles to closely align with international financial reporting standards. Both boards are targeting a framework that is economic in substance and are working closely together with the aim of converging requirements, consistent with their approach on other major accounting projects. If, as expected, the IASB and FASB achieve consistency in approach on the valuation of insurance contracts, and such valuation methodology is deemed to be equivalent with Solvency II valuation requirements (which should be true) then it would make considerable sense for regulatory valuation requirements also to conform with IASB and/or FASB standards. This would enable companies to streamline accounting production between financial and regulatory reporting, with potentially significant cost savings.

The report reflects the fact that Bermuda’s new requirements for the long-term business sector are at a much earlier stage of development and will need to be revisited by EIOPA. This is largely because Bermuda is principally a property and casualty market and equivalency plans and related resources focussed on general business regulations first. While the BMA has already embarked on a factor-based solvency framework for long-term business, considerable enhancements are expected to continue to be rolled out for long-term licences and these will likely be subject to a relatively aggressive implementation timeline. Bermuda’s efforts to be at the front of the queue on equivalence may well hinge on the success of enhancing its long-term business regulatory framework. For various reasons there is no expectation that long-term classes will be carved out of equivalence; the most notable reason being the existence of many composites (dual-licensed entities) in the market.

Another consequence of equivalence is that BMA practice will continue to evolve. The report implies a need for the BMA to be more prescriptive in how it addresses various situations and so the use of discretion will be more challenging. The report also highlighted the need for the BMA to recruit additional actuarial resources, a matter which is already being addressed.

Some observers commented on the level of granularity of the report which, although in line with the methodology published by EIOPA in September 2010 (known as CP 82), was surprising because third party countries are expected to be predominantly judged and assessed on principles. Terri Vaughan, CEO of the US National Association of Insurance Commissioners (NAIC) gave testimony before a Senate subcommittee in Washington on September 14, 2011, which shed light on a US perspective. She commented that “we must remember thatthere are different regulatory systems and approaches around the globe, so regulatory convergence must involve arriving at common outcomes and not necessarily at universal standards or structures”.

She further stated “We do believe that our system of supervision is at least equivalent to Solvency II on an outcomes basis. The IMF assessment of our system and the performance of our market relative to other sectors during the financial crisis reinforce this view. We strongly encourage our European colleagues to review our system on an outcomes basis and find our system equivalent to avoid any disruptions in the transatlantic insurance market.” Of course, Vaughan’s comments were not intended to represent a Bermudian perspective, but many in Bermuda would agree that the equivalence assessment is expected to be, and should be, predominantly judged and assessed on principles and outcomes.

Overall the conclusion of ‘equivalence subject to caveats’ appears to have been positively presented by EIOPA and positively received in the Bermuda market. The conclusion is consistent with the ongoing development of the prudential regime in Bermuda. EIOPA is expected to revisit Bermuda’s equivalence assessment in mid-2012 after finalising the Solvency II Level 2 implementing measures and publication of the Omnibus II directive. A final decision on equivalence by the European Commission is expected in the fourth quarter of 2012. In the interim period there is much work to do, but the authorities in Bermuda are confident.

The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young.

Jonathan Reiss is a partner in the Financial Services Office of Ernst & Young Ltd in Bermuda. He can be contacted at: