A report released by the Bermuda Monetary Authority found thatwhile Bermudian insurers exhibit sophistication in their use ofmodels--particularly with catastrophic risk--there is room forimprovement in other areas, including governance.

Only 45 percent of surveyed models have been reviewed by outsideexperts, with the extent of external review varying significantly,the report found.

The Authority's first comprehensive survey for research andanalysis of capital modeling practices within the Bermuda market,released earlier this week, examined economic capital modelingtools and techniques being used by (Class 4) large insurers andreinsurers in the Bermuda market. The survey returns were thenaugmented by discussions with companies.

Matthew Elderfield, chief executive officer of the Authority,said in a statement that while the survey results show that theBermuda market as a whole demonstrates sophistication in itseconomic modeling capability, particularly in the modeling ofcatastrophic risk, "documentation and governance procedures appearto be underdeveloped across the Bermuda market, and there is morework to be done in a number of areas as we move into the next phaseof adopting models as the basis for regulatory solvencypurposes."

Mr. Elderfield said the Authority is using a "phased approach tointroduce this new framework, taking the results of this survey andrecent lessons learned from the use of modeling to develop prudentminimum criteria for the use of internal models that address theseweaknesses, while still encouraging innovation in risk managementpractices."

According to the report, available on the BMA Web site, economiccapital modeling is central to the underwriting process for manyBermuda reinsurers, particularly in catastrophe lines ofbusiness.

Many companies use their capital model as an input into a rangeof management decisions, including capital allocation, reinsurancepurchase, pricing decisions, performance measurement and investmentstrategy.

The study found that the technical sophistication of the Bermudamarket is not matched by supporting documentation and governanceprocesses--sound risk management.

The report concluded:

o Some companies have a lack of adequate documentation on themodel itself.

o There are commonly inadequate process controls surroundingprocedures for making revisions to or updating the model.

o There is a lack of record of validation or justification ofmodel methodologies and assumptions.

o There is often no substantive documentation supporting theselection of key model assumptions or processes.

According to the report, governance processes around datavalidation, underwriting controls and model parameterization areoften informal. Lack of procedure and documentation can tend tomake companies overly reliant on key individuals.

The report noted that Bermuda companies tend to have internalreview and validation processes in place for model methodologiesand parameterization. There is a high level of peer review andchallenge of model inputs and outputs internally, with nearly allcompanies' models subject to some degree of review by the board ofdirectors.

The proposed internal models framework is being developed tooperate parallel to the Bermuda Solvency Capital Requirement(BSCR), a standardized risk-based capital model the Authorityimplemented earlier this year to determine regulatory capitalrequirements for Class 4 insurers and reinsurers.

The BSCR has been set as a standard model that reflects theaverage inherent business risk of the Class 4 market. Under theproposed internal models framework, if an insurer can demonstratethat its own model better reflects the inherent risk to itsbusiness, it may apply to the Authority to use its model todetermine regulatory capital.

Mr. Elderfield said information about current modeling practicesin the Bermuda market derived from the survey provides theAuthority with a good platform for establishing appropriatecriteria and regulatory requirements for the next phase ofdevelopment in the internal models initiative.

"An insurer's internal model will have to satisfy certaincriteria to be approved for determining regulatory capital.Therefore the next phase of our work will involve developingstandards, and the application and review process, for assessingand approving internal capital models as the basis for calculatingregulatory capital," Mr. Elderfield explained.

He noted the Authority will base the assessment on criteria suchas:

o How well the internal model is integrated into an insurer'srisk management program.

o What type of governance processes and controls the companyapplies to its model.

o How appropriate the model is for determining regulatorycapital requirements.

The intention is to have a pilot model approval processpublished by the second quarter of 2009.

A copy of the report can be found on the Authority's Web site,www.bma.bm.