A report released by the Bermuda Monetary Authority found that while Bermudian insurers exhibit sophistication in their use of models--particularly with catastrophic risk--there is room for improvement in other areas, including governance.

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

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

Matthew Elderfield, chief executive officer of the Authority, said in a statement that while the survey results show that the Bermuda market as a whole demonstrates sophistication in its economic modeling capability, particularly in the modeling of catastrophic risk, "documentation and governance procedures appear to be underdeveloped across the Bermuda market, and there is more work to be done in a number of areas as we move into the next phase of adopting models as the basis for regulatory solvency purposes."

Mr. Elderfield said the Authority is using a "phased approach to introduce this new framework, taking the results of this survey and recent lessons learned from the use of modeling to develop prudent minimum criteria for the use of internal models that address these weaknesses, while still encouraging innovation in risk management practices."

According to the report, available on the BMA Web site, economic capital modeling is central to the underwriting process for many Bermuda reinsurers, particularly in catastrophe lines of business.

Many companies use their capital model as an input into a range of management decisions, including capital allocation, reinsurance purchase, pricing decisions, performance measurement and investment strategy.

The study found that the technical sophistication of the Bermuda market is not matched by supporting documentation and governance processes--sound risk management.

The report concluded:

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

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

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

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

According to the report, governance processes around data validation, underwriting controls and model parameterization are often informal. Lack of procedure and documentation can tend to make companies overly reliant on key individuals.

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

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

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

Mr. Elderfield said information about current modeling practices in the Bermuda market derived from the survey provides the Authority with a good platform for establishing appropriate criteria and regulatory requirements for the next phase of development in the internal models initiative.

"An insurer's internal model will have to satisfy certain criteria to be approved for determining regulatory capital. Therefore the next phase of our work will involve developing standards, and the application and review process, for assessing and approving internal capital models as the basis for calculating regulatory capital," Mr. Elderfield explained.

He noted the Authority will base the assessment on criteria such as:

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

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

o How appropriate the model is for determining regulatory capital requirements.

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

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

Special Reports /

Bermuda Survey Finds Governance Lacking In Insurer Modeling

Related Stories

Recommended For You