Widening the Focus
London & Bermuda Newsletter
Described by its Chief Executive as “probably [its] most critical objective” for the year, the Bermuda Monetary Authority (the “BMA”) plan for group-wide supervision of insurers advanced a step forward in February 2010. The proposal furthers its objective of meeting Solvency II requirements, the regulatory framework rolled out by the European Union.
The BMA’s “Consultation Paper on Proposed Insurance Groups Regulatory Framework” succeeds a Discussion Paper on the same topic published in 2009.
Group-wide supervision takes account of exposure that local insurers have to risks affecting affiliates (including affiliates overseas) as a result of intra-group arrangements or other factors. A narrow supervisory focus at the individual entity level, at the expense of oversight of the group, is regarded by many as a factor underlying the recent financial crisis.
When and which insurers?
The BMA plans to implement a group-wide regime by the third quarter of 2010, with a transitional period applying until full implementation in 2012. The regime will apply to Class 4 insurers (insurers carrying on excess liability or property catastrophe business with capital and surplus of at least $100 million) and Class 3B insurers (large commercial insurers writing at least 50% “unrelated” (roughly, not captive business) and total net premium income of at least $50 million). However, in the more distant future, the BMA anticipates rolling the regime out to other commercial insurers.
What specific risks?
Under the proposal, the BMA will assess the group's corporate governance, risk management and solvency. This includes a focus for the first time on intra-group transactions and risk concentrations, including exposure of insurers to unregulated entities that are a part of the same group. In a recent interview, the Chief Executive commented, "We need to cover all the bases. We need to cover a scenario like the AIG scenario, where you had an unregulated entity that effectively had a significant impact on the survival of the group as a whole" (Source: Advisen.)
How does group-wide supervision work?
Identifying the group-wide supervisor
Where a Bermuda insurer is part of a group of insurance companies, including entities located overseas, the BMA’s proposal is that one supervisor should be responsible for overseeing supervision at the group level. Identifying the group-wide supervisor must be a consensual process. However, the BMA proposes that, for any group, the group-wide supervisor should be the authority of the jurisdiction where the parent or head office of the group is located, or from where the insurance group “directs its business”, or where the largest gross liabilities reside.
The system is premised on co-operation between supervisors in different jurisdictions. Through its agreement to memoranda of understanding, and active participation in supervisory “colleges”, the BMA has played a significant role in the development of a network of cross-jurisdictional information channels.
The regime is also dependent upon mutual confidence among supervisors in the “equivalence” of applicable supervisory standards and principles with their own.
Where the BMA deems the supervisory regime or skills or experience of a candidate group-wide supervisor to be not equivalent with its own, it will either (a) consent to group-wide supervision in the hands of the overseas supervisor but apply its own super-equivalence requirements locally, or (b) request the Bermudian entities to incorporate a local parent, creating a local insurance sub-group, over which the BMA may exercise group-wide-supervisory control.
What risks? Who must identify them?
In some respects, the group-wide approach simply transposes at group level operational and governance requirements (of a type familiar in the European Union with the roll-out of Solvency II) already prevailing at the individual entity level. Thus, the BMA’s proposals require embedding internal controls and risk management procedures, and place the responsibility for doing this at board or senior management level.
Under group-wide supervision, the board and senior management in question are those at the parent company level.
What distinguishes the position at the group level is the particular attention required to intra-group transactions and exposures. For example, internal reinsurances, group concentration risks, intra-group loans, and exposure to unregulated entities in the group.
Identification of these risks has a knock-on effect on the assessment of group capital requirements.
Because responsibility for implementing structures that can be relied on to identify these types of group risks lies with the board of the parent, sound reporting lines must be established, providing accurate and adequate detail, with clear delegation of duties. Risk management will need to be a rolling process. The BMA intends to check the frequency with which internal controls are reviewed.
Where the BMA is the supervisor for a group, it will request overseas supervisors to share information concerning group members, including changes in the board or senior management, withdrawals or grants of licenses, significant changes in the financial position of group members, significant operational risks, significant financial risks, etc.
The BMA also proposes to extend the “Own Risk and Solvency Assessment” (“ORSA”), currently between the Discussion Paper and Consultation Paper stage, at group level. The completed ORSA will report on non-financial risks not currently captured under the Bermudian regime and will indicate whether internal controls and risk management procedures are embedded.
Insurance groups will have to hold eligible capital necessary to meet group solvency and which is adequate to the risk profile of the group. The group capital requirements build on the current solvency regime already applicable at the entity level to Class 4 (and shortly Class 3B) insurers. This is the Bermuda Solvency Capital Requirement (“BSCR”).
Individual insurer entities must currently hold capital equal to their Minimum Margin of Solvency (“MSM”) and Enhanced Capital Requirement (“ECR”). The MSM is the minimum level of capital and surplus required to meet the entity’s obligations.
The ECR reflects additional capital charges required by the BMA based on the assessment of further risks such as investment, equity, credit, premium, and reserve risks, as well as a built-in stress test for interest rate and liquidity risks. Breach of this may occasion restrictions on new business.
The MSM for the group will equal the sum of all individual entity MSMs across all jurisdictions in which the group has member entities. The BMA may augment a MSM where it does not regard the relevant overseas supervisory regime as equivalent with its own.
The group will need to hold an ECR based on investment, equity, liquidity, premium, reserve, credit, catastrophe and operational risks affecting the group. The existence of intra-group arrangements with unregulated entities within the group will require a more detailed approach.
In “exceptional circumstances”, the outcome of an ORSA may occasion add-ons to the ECR.
The BMA will begin its assessment of group ECR and MSMs upon submission of regulatory filings for the 2010 year-end.
Disclosure of material intra-group transactions
Internal transactions (reinsurances, loans, guarantees) can maximize efficient use of capital, but are subject to risks that the affiliate obligor may fail to perform, that overseas regulatory provisions may impede performance, or that capital is subject to double-gearing. Accordingly, the BMA will communicate closely with overseas supervisors and will require disclosure of material transactions above a threshold value along with the group statutory filing.
The BMA will also be attentive to any risks affecting the insurance group where it is part of a financial conglomerate participating in other industry sectors. It will communicate with overseas supervisors on these matters.
Further proposals, concerning eligible capital and reporting, are beyond the scope of this paper.
The BMA has proposed implementation of the group-wide regime as follows:
Q1 2010 enactment and enforcement of the group-wide supervisory legislation
Q2 2011 statutory filing for 2010 year-end (except solvency filings)
Q3 2011 trial run for solvency filing for 2010 year-end
Followed by transition period of 12 months for the insurance group to comply with the provisions for group solvency and eligible capital, until...
Q3 2012 enforcement of group solvency and group eligible capital requirements