Big changes on a small island

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By Karl Goring, Christine K. Kogut | 08 September 2008

The Bermuda Monetary Authority (BMA) is moving quickly toward a flexible, risk-based capital model that establishes solvency requirements for many of the island's commercial reinsurers and for those captives writing more than 50% in unrelated, third-party business.

Inspired by and based to some degree on the U.S. National Association of Insurance Commissioners (NAIC) risk-based capital model, the U.K.'s individual capital assessments, and the Solvency II requirements currently being proposed for the European Union, the Bermuda Solvency Capital Requirement (BSCR) is on track to become the new solvency scheme for many reinsurers doing business on the island.

Prior to the introduction of the BSCR, there were four classes for reinsurers operating in Bermuda. Classes 1 and 2 together comprised single-parent captives and group captives with less than 20% in unrelated, third-party business. Their solvency requirements are not affected by the new scheme.

Class 3 companies included captives with more than 20% unrelated business, and Class 4 companies included 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% in unrelated business, must comply with the BSCR by year-end 2009.

1. The BSCR: What will change?
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. Class 4 companies had a MSM of either the greater of $100 million or 50% of net written premiums plus 15% of net loss and loss adjustment expense reserves. Class 3 companies had a MSM of either the greater of $1 million or 20% of the first $6 million of net written premiums, decreased to 15% for premiums greater than $6 million, plus 15% 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 (PML) catastrophe levels. The model reflects a benefit for diversification of insurance exposures and for independence among the different risk factors listed above.1

2. The target
The BMA introduced the concept of a target capital level (TCL) that is 120% 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.

  • Companies with capital levels between 100% and 120% 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.
  • Companies with capital levels between 100% 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.
  • 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.

3. Enhanced reporting requirements
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:

  1. Management discussion and analysis (MD&A)
  2. Stress and scenario testing
  3. Additional schedules to the statutory statement and reporting changes
  4. Operational risk assessment questionnaire
  5. 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 will also require companies to complete an operational risk assessment questionnaire, which is designed to prompt the reinsurer 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% and 10%, resulting from the BSCR model.

The BMA will ask (voluntary) Class 4 companies to make publicly available their audited financial statements in accordance with GAAP or International Financial Reporting Standards (IFRS).

4. Greater subjectivity
The BMA incorporated a great deal of subjectivity and flexibility into the BSCR. The number calculated to establish the 120% 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 (e.g., two significant hurricanes in Miami-Dade County, Florida, 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 can also 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 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.

1 Using the square root of the sum of the squares for each risk factor.