The Bermuda Monetary Authority is moving quickly toward a flexible, risk-based capital model that establishes solvency requirements for many of the island's commercial insurers and reinsurers, as well as for captives writing more than 50 percent in unrelated, third-party business.
Inspired by and based to some degree on the U.S. National Association of Insurance Commissioners risk-based capital model, the United Kingdom's individual capital assessments, as well as the Solvency II requirements proposed for the European Union, the Bermuda Solvency Capital Requirement (or BSCR) is on track to become the new solvency scheme for many (re)insurers doing business on the island.
Prior to the introduction of the BSCR, there were four classes for (re)insurers operating in Bermuda.
o Classes 1 and 2 together comprised single-parent captives and group captives with less than 20 percent in unrelated, third-party business. Their solvency requirements are not affected by the new scheme.
o Class 3 companies included captives with more than 20 percent unrelated business.
o Class 4 companies comprised large commercial entities, including reinsurers.
Class 4 companies had to comply with the BSCR calculations for the 2007 reporting year, but the BMA will not enforce the BSCR capital requirements until year-end 2008.
Class 3 companies have recently been divided into three subclasses–3, 3A and 3B–based on the percentage and dollar amount of unrelated business they write.
Insurers classified as 3A or 3B, both with more than 50 percent in unrelated business, must comply with the BSCR by year-end 2009.
So, what will change when moving from a fixed formula to a risk-based capital model?
Under the old Bermuda solvency scheme, a fixed minimum solvency margin (MSM) was calibrated, based on a company's class and level of business.
o Class 4 companies had an MSM of the greater of $100 million or 50 percent of net written premiums, plus 15 percent of net loss and loss adjustment expense reserves.
o Class 3 companies had an MSM of the greater of $1 million or 20 percent of the first $6 million of net written premiums, decreased to 15 percent for premiums greater than $6 million, plus 15 percent of net loss and loss adjustment expense reserves.
The BMA is replacing the fixed MSM for Classes 3A, 3B and 4 with a risk-based capital model that more accurately accounts for a company's risk profile.
The model generates a capital requirement based on the assessment of risk factors related to credit, liquidity, equity, invested assets, inadequate premiums, inadequate loss reserves and probable maximum loss catastrophe levels.
The model reflects a benefit for diversification of insurance exposures and for independence among the different risk factors listed above.
The BMA introduced the concept of a target capital level (TCL) that is 120 percent of the regulatory capital requirement (RCR), which is calculated by the BSCR model. The intention is to formalize an early warning system for companies that might be falling into financial difficulties.
o Companies with capital levels between 100 percent and 120 percent of the RCR would not be considered insolvent or in breach, but additional reporting requirements or other enhanced oversight may be imposed by the BMA.
o Companies with capital levels between 100 percent of the RCR and the MSM, calculated under the old requirement, would not be considered insolvent from a statutory perspective, but would be in breach of the 2008 Solvency Requirement (the "Order") and could be subject to regulatory actions as promulgated under Section 32 of the Insurance Act 1978.
o Companies with capital levels below the MSM would be considered insolvent from a statutory point of view and could be dissolved or taken over by the BMA.
As part of the BSCR process, companies must prepare additional schedules and complete questionnaires requested at various times throughout the year. Some of these additional reporting requirements include:
o Management discussion and analysis (MD&A).
o Stress and scenario testing.
o Additional schedules to the statutory statement and reporting changes.
o Operational risk assessment questionnaire.
o Make publicly available a company's Generally Accepted Accounting Principles (GAAP) financial statements.
The MD&A is similar to the 10K required by the U.S. Securities and Exchange Commission. These reports will ask management to discuss company operations and key developments, provide an analysis of operating results, list exposures by statutory lines of business and defined territories, and offer pro forma guidance statements with projections extending out one year.
The BMA will require companies to submit standard and company-specific stress tests and scenario tests for both man-made and natural catastrophes.
Additional schedules and disclosures will be required with all statutory returns so that the BSCR model inputs are readily apparent. Reserves will no longer be able to be reported at discounted values, and investments must be reported at market value (except for bonds scheduled to be held to maturity, which can be valued at their amortized cost).
The BMA also will require companies to complete an operational risk assessment questionnaire, designed to prompt the (re)insurer to assess the quality of its risk management function with respect to its operational risk exposures.
The results of this self-assessment will be used to modify the capital requirement, between 1 percent and 10 percent, resulting from the BSCR model.
The BMA will ask Class 4 companies to (voluntary) make publicly available their audited financial statements in accordance with GAAP or International Financial Reporting Standards (IFRS).
The BMA incorporated a great deal of subjectivity and flexibility into the BSCR. The number calculated to establish the 120 percent target ratio for an individual company can be adjusted up or down, depending on several factors.
As indicated above, the BMA will require stress tests with detailed adverse scenarios–such as two significant hurricanes in Miami-Dade County, Fla., concurrent with a significant drop in portfolio value and/or a sudden widening of credit spreads.
If the test reveals excess vulnerabilities to these adverse scenarios, capital requirements could be adjusted upward. Adjustments also can be made for significant premium growth not captured by the model.
Companies will have the right to dispute upward adjustments, and there will be two levels of appeal open to them–at the BMA and, if the company disagrees with that decision and decides to appeal again, to a tribunal pursuant to Section 44A Part VIIIA of the Bermuda Insurance Act 1978.
Beginning in 2009, the BMA will allow companies to apply for its approval to submit their own internal models to be used for the determination of their RCR.
Amendments to the Insurance Act 1978 have been drafted and will most likely be passed by the Bermuda legislature before the end of this year, making the BSCR standards legally mandated for Classes 3A, 3B and 4.
The landscape of the Bermuda insurance industry is not likely to change much as a result of the BSCR, although there may be some short-term disruption as companies become familiar with the new rules. For its part, the BMA has significantly increased staff to ensure a smooth transition.
The island's future as an international off-shore center for insurance, however, is likely to be enhanced in the long run by the addition of its new risk-based capital framework.
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