Bermuda Monetary Authority Proposes Enhancements to its Regulatory Regime

In our latest installment of “The Standard Formula” podcast, partner Rob Chaplin and associate Ilianna Kotini discuss the proposals made in the Bermuda Monetary Authority's (BMA) latest consultation paper, which are focused on the BMA’s plan to enhance the regulatory and supervisory regime for commercial insurers and insurance groups.

The proposals cover four main areas: changes to the calculations of insurers’ technical provisions, amendments to the computation of the Bermuda Solvency Capital Requirement (BSCR), enhancements to the prudential rules and reporting forms set out in the BMA's section 6(d) framework and revisions to the fees charged to life insurers regulated by the BMA.

The BMA's proposals aim to bring the Bermuda regime closer to Solvency II, and are of interest to the entire insurance market, given the amount of business that is reinsured into Bermuda.

Key Takeaways

• Technical Provisions Changes: The BMA's proposed enhancements to technical provisions fall into three categories: adjusting the risk margin calculation of insurance groups to be on an unconsolidated basis, changing its scenario-based approach and adjusting the euro-denominated discount curves for the standard approach. These changes aim to update the technical provisions framework to suit today's market environment.
• BSCR Enhancements: The BMA's proposals to enhance the BSCR framework include the introduction of increased risk sensitivity to lapse and expense risks and amendments to property and casualty catastrophe risk charges to better capture man-made risks. These changes will improve risk sensitivity, enhance transparency and encourage good risk management practices.
• Amendments to Section 6(d) Framework: The BMA proposes revisions to the application process insurers and reinsurers must follow to modify specific parameters concerning their BSCR. The revised framework aims to be more clearly defined, standardized and transparent, while allowing insurers to better understand when adjustments to their BSCR may be allowed if the existing framework does not fully reflect their risk profile.
• Fee Increases for Long-term Commercial Insurers: The BMA proposes increasing fees charged to long-term commercial insurers to cover the increased cost of supervision and ensure it has the appropriate level of resources for effective supervisory activities. This is driven by an increase in new market entrants and the growth in size and complexity of existing authorized entities.

Voiceover (00:01):
From Skadden, The Standard Formula is a Solvency II podcast for UK and European insurance professionals. Join us as Grand Park Law Group partner, Robert Chaplin, leads conversations with industry practitioners and explores Solvency II developments that matter to you.

Rob Chaplin (00:18):
Welcome to the fourth episode of our Standard Formula podcast. In our previous episode, we discussed the Bermuda Monetary Authority's Solvency Capital Requirement and contrasted it with US risk-based capital, Solvency II and Solvency UK. In today's episode, we'll be covering the proposals set out in the consultation paper, published by the Bermuda Monetary Authority or BMA, which relate to the BMA's plan to make certain enhancements to the regulatory and supervisory regime for commercial insurers and insurance groups. I'm Rob Chaplin, one of the insurance Skadden Partnersat Grand Park Law Group based in London. With me today is Ilianna Kotini, one of the insurance associates in our team.

(01:03):
The BMA's proposals are intended to ensure that the regulatory regime for commercial insurers, regulated in Bermuda, continues to be sound and that the rules in place serve the dual purpose of protecting policyholders while also contributing to financial stability. These changes bring the Bermuda regime closer to Solvency II. The changes are of interest to the entire insurance market, given the amount of business which is reinsured into Bermuda. Clearly, any strengthening of the regime may have consequences for insurers and reinsurers worldwide, particularly as to pricing. So, moving on to the reforms.

(01:44):
The proposed enhancements cover four main areas. These are: changes to the calculation of insurers and insurance groups technical provisions, amendments to the computation and flexibility of the Bermuda Solvency Capital Requirement or the BSCR, enhancements to the prudential rules and reporting forms set out in the BMA's section 6(d) framework to modify capital requirements, and revisions to the fees charged to life insurers regulated by the BMA. We'll take each of the BMA's proposed changes in turn and briefly summarize the changes being considered. Ilianna, what is the first enhancement that the BMA is proposing?

Ilianna Kotini (02:29):
The BMA's first proposed enhancement relates the technical provisions. These proposals all appear to be driven by the need to update the technical provisions framework to better suit today's market environment and developments in insurer practices. The proposals fall into three main categories.

(02:47):
First, the BMA is proposing to change the risk margin calculation of insurance groups to be on an unconsolidated basis. This is intended to align the risk margin calculation with the principles behind risk margin construction with a transfer scenario on which the risk margin determination is conceptually based, assumes a separate transfer of the insurance group's liabilities on a carrier-by-carrier basis. In the transfer scenario, no diversification of benefits between the entities exist. This brings this element of the BSCR into line with Solvency II.

(03:24):
Second, the BMA is proposing changes to its scenario-based approach, also referred to as the SBA, which is similar in concept to the matching adjustment under Solvency II. The SBA reflects their liquidity premium embedded in an insurer's asset yields in discounting liabilities. If the liabilities can be demonstrated to have predictable and stable cash flows across a range of scenarios and are matched with suitable fixed-income assets that also produce predictable and stable cash flows, the SBA assumes a high degree of matching between the asset and liability flows. To the extent it is not possible to match liability cash flows with asset cash flows, the BMA will apply a mismatching cost by running the calculation through eight alternative interest rate scenarios and picking the worst scenario to determine the best estimate liability or BEL.

(04:20):
The SBA is therefore a highly tailored and dynamic approach and requires significant investment from the insurer to ensure adequate governance, risk management, and modeling systems are in place. The BMA's proposals to enhance the SBA are driven by its observation that insurers will benefit from having greater clarity and guidance on the SBA requirements.

(04:43):
While the changes do not conform the BSCR with Solvency II matching adjustment, they do bring it materially closer to it. The SBA enhancement proposals set out in the BMA's consultation paper are quite detailed, but in summary, they include the following:

(05:00):
The introduction of an approval requirement prior to insurers using the SBA in relation to new business written after the enhanced rules will come into effect.

(05:10):
The requirement for insurers to implement a liquidity risk management program.

(05:14):
New requirements for demonstrating that lapse risk is not significant.

(05:19):
Enhanced modeling of assets that have optionalities or behavioral components to allow for a more granular view of such assets.

(05:27):
Changes in relation to unsellable assets, focusing on ensuring that unsellable assets should not be sold to meet cash flow shortfalls, and that SBA projections should end with no assets left in the portfolio.

(05:40):
Changes to default and downgrade cost assumptions and guidance on liquidity and transaction costs.

(05:45):
Increased governance and internal control requirements, enhanced reporting requirements, and updated guidance on model risk management.

(05:54):
The most significant remaining difference between the SBA and matching adjustment remains the ability to rely on modeling. In terms of implementing the SBA enhancements, the BMA recognizes that the proposed changes, which may be amended further, will have a material financial impact on life insurers in Bermuda. Most metrics and triggers of the current SBA regime are locked into the reinsurance treaties that insurers already have in place. Therefore, the BMA proposes to grandfather the treatment of existing portfolio liabilities until runoff. However, the changes will apply to all new business written after the proposed enhancements come into effect early next year.

(06:37):
Third, the BMA is considering adjusting the euro-denominated discount curves for the standard approach akin to The Standard Formula. The adjustment would eliminate differences between the euro-denominated rate curves provided by the European Insurance and Occupational Pensions Authority, or EIOPA, and those provided by the BMA. This is driven by the BMA's observation that Bermuda insurers with euro-denominated liabilities often carry out internal calculations using the EIOPA curve. The BMA is of the view that the two curves produce similar results, and so it proposes to allow insurers to use the EIOPA euro-denominated discount curve without seeking separate approval from the BMA. So Rob, this is the BMA's first proposal. What's next?

Rob Chaplin (07:24):
Thanks, Ilianna. The second proposal involves more general enhancements to be made to the BSCR framework. There are two sets of enhancements being proposed here. The first relates to the introduction of increased risk sensitivity in relation to lapse and expense risks in relation to the BSCR framework. And the second relates to amendments being made to property and casualty catastrophe risk charges to better capture manmade risks. Lapse and expense risks currently fall within the long-term other insurance risk charge of the BSCR framework. There is no explicit identification of these two risk components.

(08:07):
The BMA proposes that the other insurance risk charge be broken down into separate lapses and expense risk components. This change will better reflect these risks and enhance the transparency of the BSCR standard approach.

(08:23):
In relation to lapse risk, the capital requirement will be equal to the change in net asset value resulting from the applied shocks. This would involve calculating the post shock BEL and comparing it to the before shock BEL to determine the impact of the shock. The BMA stated in its consultation paper that breaking down and replacing the long-term other insurance risk charge necessitates a new dedicated charge for expense risk. As with the lapse risk proposals, the aim is to increase risk sensitivity and transparency of the charges. The proposal involves taking into account a combination of the following two shocks: a relative increase in all unit expense assumptions, and absolute increase in expense inflation rates per annum. These shocks will be applied to the capital requirement and recalculation of the BEL. The difference between the pre-shock and post-shock values will be the capital requirement.

(09:29):
The BMA proposes applying a 10-year transitional period to the new lapse and expenses risk charges. For property and casualty catastrophe risks, the BMA wishes to enhance the BSCR catastrophe risk module by including a dedicated man-made catastrophe risk submodule. This submodule will comprise of catastrophe scenarios for: terrorism, credit and surety, marine and aviation, reflecting market developments. The BMA expects that the introduction of this submodule will enable it to adopt the approach followed by other internationally recognized insurance capital models of a greater industry certainty as it reduces the need for ad hoc capital adjustments for non-modeled catastrophe perils, and promote good risk management as the scenarios are all risk sensitive. Over to you Ilianna for the third proposal.

Ilianna Kotini (10:26):
Thanks, Rob. The third proposal relates to amendments to the BMA's section 60 framework, the references to section 60 of the Bermuda Insurance Act 1978. This refers to the adjustments that regulated entities can apply to make to their BSCR. The aim of the proposed enhancements here is to allow the BMA to revise its framework regarding the application process that insurers and reinsurers have to follow to modify specific parameters in relation to their BSCR. Particularly in situations where the BSCR framework may not adequately reflect the insurer's risk profile, the revised section 60 regime will allow for certain predefined set of adjustments that fall under one of three different routes, ranging from the simplest to the most complex adjustments.

(11:20):
The BMA states that the proposed revisions will ensure that the section 60 framework is more clearly defined, standardized, and transparent in terms of its scope and requirements. In addition, the BMA hopes that the revised framework will help insurers gain a better understanding of the areas and circumstances where an application for adjustment to their BSCR may be allowed if the existing BSCR framework does not fully reflect their risk profile. This will then be possible without requiring approval of a full or partial internal model for regulatory capital purposes.

Rob Chaplin (11:57):
The BMA's fourth and final proposal is to increase the fees it charges to long-term commercial insurers. The proposed increase in fees is justified by the BMA as necessary in order to meet the necessary cost of supervision and to enable it to have the appropriate level of resources to conduct its supervisory activities effectively. The BMA cites an increase in new market entrance as well as increases in the size and complexity of existing authorized entities as the driving factors behind the increased cost of supervision. So Ilianna, how have these proposals been received by the insurers and reinsurers that are supervised by the BMA?

Ilianna Kotini (12:39):
It is too soon to tell. The consultation paper was published on February 24th, 2023, and the deadline for industry participants and other interested persons to respond to the consultation is April 30th, 2023. Generally however, the BMA's consultation paper comes at a time when other insurance supervisory authorities are also revisiting their frameworks and considering how to enhance them to better serve the insurance and reinsurance sector. One such example being the reform of the UK Solvency II regime, which was covered in the first episode of The Standard Formula. The Bermuda International Long Term Insurers and Reinsurers Association has welcomed the proposals. It'll be interesting to see what other industry participants have to say in their responses to the BMA. What comes next Rob?

Rob Chaplin (13:31):
Well, following the end of the consultation period on April 30th, the BMA has said that it will issue a second version of the consultation paper in Q3 2023, along with the associated draft bill, revised draft rules and guidance notes. The BMA intends that the enhanced regime will enter into force on January 1st, 2024. Overall, what do we think?

(13:58):
Well, the BSCR is sometimes referred to as an economic framework rather than a set of prescriptive regulatory rules, and that's its attraction. In our view, that still remains the case, but less so than was the case before. Although that's a price still worth paying for the BSCR to retain its Solvency II equivalence, which has clearly been a worry. What will happen to reinsurance pricing? It's hard to tell, but particularly for life business, it will be logical to conclude that the reforms will play an incremental role in further hardening of life reinsurance pricing, and there will be knock-on effects for non-life reinsurance pricing too.

(14:41):
We hope you found this episode of The Standard Formula podcast useful. We look forward to you joining us next time.

Voiceover (14:48):
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(15:01):
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(15:14):
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