reengineering
1 November 2010Operations

Re-engineering Bermudian regulation

The Authority has entered into the next phase of its multi-year regulatory change programme for Bermuda’s insurance sector. As outlined in its 2010 Business Plan, the Authority’s regulatory agenda involves establishing a leading framework for insurance regulation in Bermuda that is risk-based, meets or exceeds international standards, and is recognised as being equivalent by other key regulators around the world.

In common with other financial regulators, the Authority is responding to, and anticipating, the increasing demands of the international regulatory environment, which is undergoing what can be described as a global regulatory re-engineering process, following the financial crisis. The core priorities of global regulatory reform revolve around the issues of capital adequacy, governance and risk management, and transparency and disclosure. However, another significant theme of the change occurring is regulatory equivalence, whereby a jurisdiction deems regimes of other jurisdictions as being on par with their own.

Recognising these trends, the Authority has made significant progress in its workplan to further strengthen Bermuda’s insurance regulations in line with international developments, particularly those promulgated by the International Association of Insurance Supervisors (IAIS) and the technical requirements of Europe’s Solvency II Directive.

Details of this progress are presented in the recently updated publication ‘Bermuda’s Insurance Solvency Framework’, also commonly referred to as the Solvency II Roadmap. The document, which is available on the Authority’s website, also discusses further framework developments that are planned for the remainder of the year and into 2012. These developments include launching the Authority’s formal group-wide supervision process, further advancing its capital adequacy framework, and establishing an enhanced disclosure and transparency regime.

Group-wide supervision

Establishing a group-wide supervision framework is a key element of the Authority’s regulatory change programme for Bermuda re/ insurers, as there are a significant number of such firms that operate within a group structure. A group-wide supervision regime provides regulators with the capacity to form a comprehensive view of an entity’s risk exposures, which the Authority views as critical in its ability to supervise such entities appropriately.

While international standards for group-wide supervision are still undergoing considerable debate due to the complexities surrounding the issue, the Authority has accelerated its work on its framework, basing its approach on the principles and guidance established by the IAIS. After completing two phases of consultation with Bermuda market participants, which spanned the period 2009 and into the early part of 2010, enabling legislation was passed in the first quarter of this year that allows the Authority to become a group-wide supervisor.

The Authority is now focused on establishing the supervisory processes and procedures that are key components of its group-wide supervision framework. These include: assessment of group corporate governance and risk management; group-wide solvency assessments, which include the treatment of intra-group transactions and risk concentration; statutory group financial reporting requirements; and the treatment of unregulated entities that are part of a group. While the Authority progresses with its work, it is taking both the ongoing international developments in this area and the comments received during industry consultations into consideration, to ensure that the changes it implements are consistent with international standards, and are also practical and effective for the Bermuda market. Key milestones relating to the Authority’s group-wide supervision framework, to be implemented by quarter three of 2011, include the publication of group rules, issuing a group code of conduct and a trial run of statutory filings (2010) under the group’s regime for Class 4 and Class 3 firms within a group structure.

Capital adequacy

The changes that the Authority is making to its solvency framework for insurers ensures that capital adequacy is determined and applied in a proportionate manner to all classes of insurers within the sector. The Authority’s future developments with regard to capital adequacy are focused on what it believes are the core components of an equivalent capital adequacy regime: the determination of eligible capital; the determination of regulatory capital; and the ability of firms to clearly demonstrate the link between their capital model, risk governance and decision making—either through a standard or a pre-approved internal model.

With regard to determining eligible capital, the Authority’s developments involve bringing in a number of elements essential to the establishment of eligible capital rules. These consist of classification criteria, which include tiered capital requirements, and off-balancesheet items, which the Authority’s current regime already has in place. In addition, the Authority’s view is that in order to achieve a more realistic representation of an insurer’s solvency position, assets and liabilities should be valued on a consistent economic basis. As such, economic balance sheet rules are being developed as an element of its capital adequacy regime.

Other rules relating to determining eligible capital include the Commercial Insurers’ Solvency Self Assessment (CISSA), which is comparable to the Own Risk and Solvency Assessment (ORSA) being developed by the IAIS under Solvency II. The CISSA will allow the Authority to obtain a re/insurer’s view of the capital resources required to achieve its business objectives, and the governance, risk management and controls surrounding this process. To supplement the CISSA, the Authority is also proposing to establish 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.

"The Authority's proposed enhanced disclosure regime uses a risk-based approach that will be applied proportionally and in a phased manner to Bermuda's insurance sector."

In the arena of determining regulatory capital, the Authority is continuing with the process of rolling out the Bermuda Solvency Capital Requirement (BSCR), its standard risk-based capital adequacy model. The BSCR was implemented for Class 4 firms in 2008 and the Authority is currently conducting analysis from a trial run of the BSCR with Class 3B firms, based on voluntary filings from firms for the 2009 year end. Also in development is a modified BSCR for small and medium-sized firms (BSCR-SME) and a standard model for longterm firms (BSCR-LT). For the remainder of 2010, the Authority will conduct further market consultation on the BSCR-SME and BSCR-LT. Its goal is to conduct a trial run using test submissions from the BSCRSME with select Class 3A firms early in 2011, with a view to facilitate full implementation by the end of that year. The implementation of the BSCR-LT will be conducted in a similar phased approach.

The Authority recognises that the BSCR may not appropriately reflect the risks inherent to a particular firm and is therefore establishing an internal capital models (ICM) framework. After completing extensive market consultation on its ICM proposals, the Authority formally established in June 2009 its model review standards and the application process for permitting the use of insurers’ internal capital models to determine regulatory capital. The elements of the Authority’s ICM framework are in line with emerging international best practice for reviewing internal models and are also consistent with the conditions of Solvency II.

As a next step in its ICM development, the Authority is currently conducting a pilot assessment with selected Class 4 companies, which will continue through to the end of 2010. The pilot will allow the Authority to validate its pre-application process and assist in the further development of the necessary analytical tools required to conduct reviews. The Authority expects to complete this pilot at the end of 2010 and to have its ICM framework fully implemented in 2011. A similar pilot will be conducted for the long-term sector during 2011.

The Authority intends to apply rigorous scrutiny to models submitted for approval, given that approval may result in reduced capital requirements for some insurers. Approval for a model for regulatory purposes will only be granted to an insurer if all the relevant minimum standards are met, and if it can clearly demonstrate an established and effective track record of risk management.

Disclosure and transparency

The Authority regards disclosure and transparency as core elements of an effective regulatory framework and continues to make steady progress with enhancing its regime in this regard against a backdrop of evolving international standards. The Authority’s proposed enhanced disclosure regime uses a risk-based approach that will be applied proportionally and in a phased manner to Bermuda’s insurance sector. The Authority believes that having a phased approach to implementation allows for proper consideration of developing global standards and effective application of these changes to its regime.

The Authority has already embarked on the first phase, which began in 2009, with enhancements designed to provide a more complete understanding of an insurer’s risk profile. This involved standardising regulatory disclosures on risk management, governance and related financial information. The Authority enhanced its regime based on existing international public disclosure regimes, which comprised a requirement for Class 4 firms to publish general-purpose financial statements that already provide a comprehensive range of risks and other disclosures required by account standards. This requirement will be extended to Class 3B firms for 2010 year-end filings. Phase one also addresses disclosures for group-wide supervision; Commercial Insurer Solvency Self Assessment Requirements for phase 2, which encompass reporting periods 2012 to 2014; and phase 3, which encompasses reporting periods from 2015 and beyond—all of which will be based on prevailing international standards and market consultation in place at the time. This approach will allow necessary consideration in line with the dynamic nature of international developments on disclosure, and how they are to be adapted appropriately to the Bermuda market.

Conclusion

While the Authority has made significant progress with its regulatory change programme, it continues to develop its frameworks further with a view to establishing a leading risk-based supervisory regime for Bermuda’s insurance market. The current phase of development builds upon the work completed to date and places Bermuda among the leading group of jurisdictions preparing for regulatory equivalence.

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