The Bermuda Monetary Authority (BMA) is seeking feedback on a newly proposed class of insurer for use in collateralised reinsurance underwriting, as it seeks to create a new, regulated home for the multi-use and more innovative applications of collateralised and capital markets backed protection.
The BMA says in its consultation document, which is available to read and respond to here, that the collateralised insurance and reinsurance class of Limited Purpose Insurer (LPI) is a response to the increasing sophistication and scope of the insurance-linked securities (ILS) market.
Originally, back in 2009 when the BMA first created its Special Purpose Insurer (SPI) classification and began to attract a significant share of global ILS and catastrophe bond business to the island, the majority of ILS transactions were more simple in their structure and nature, so suited to a single class of insurance vehicle.
But as the ILS market expanded to include collateralised reinsurance, which has now become the largest component of the global ILS market, the BMA has witnessed the use of its SPI structure being stretched to include transactions and use-cases that had never been envisaged when the SPI was first designed.
The BMA notes the ILS market’s steady shift to include more complex transactional structures and deals, the increasing use of leverage, as well as market’s growing desire to transact with an increasing range of cedant types, including unrated non-affiliated cedants, all of which has tested the boundaries of what the SPI can support.
The ILS market is also seeing multi-use collateralised reinsurance vehicles set up as both SPI’s and Class 3A’s, neither of which were originally designed to support the most actively used examples.
All of which led the BMA to say, “The Authority is not of the view that these new insurer activities are appropriate for the SPI or Class 3 insurer regulatory frameworks; however, a more proportionate regime than the standard commercial regimes (Classes 3A, 3B and 4) appears to be required instead.
“Accordingly, the BMA proposes to establish a new LPI fully collateralised reinsurer class (Collateralised Insurers) to reflect the characteristics of the new structures.”
So, enter the “Collateralised Insurer” class of Bermuda insurance vehicle, a vehicle designed to support collateralised reinsurance in a much more flexible and appropriately regulated manner.
The BMA’s new proposal suggests that Collateralised Insurers could transact with unrated non-affiliate cedants, where as even the unrestricted SPI is only able to transact with non-affiliated cedants rated A- or higher by AM Best or similar rating agencies.
The new Collateralised Insurers class would also be allowed to fully fund potential obligations on each contract to either hard contractual limits or a modelled limit, the BMA explains, as long as the contractual terms are clear and certain.
In addition, Collateralised Insurers could make use of a wider variety of contingent collateral sources, such as reinsurance and other financial instruments such as letters of credit (LOC’s), which would also qualify under the BMA’s definition of fully funded.
On the other hand, Collateralised Insurers would need to demonstrate “a more robust underwriting infrastructure” than is required of an SPI. This would especially be the case if entering into transactions with unrated, non-affiliate cedants, the regulator said.
Collateralised Insurers would also have to have a head office in Bermuda, to support their operations and in accordance with proportionality, the BMA said.
The newly proposed collateralised reinsurer will likely be attractive to some of the more sophisticated ILS fund managers, especially those with an ambition to underwrite a broader range of business, longer-tailed risks and more types of products.
The new collateralised reinsurance vehicle will be able to write long-tailed casualty risks, for example, as well as transact capped casualty, retroactive and legacy capped transactions, complex swaps, direct insurance and reinsurance, and also implement clawback provisions within collateral arrangements.
The latter is obviously a hot topic and this could be another reason for registering for one of these new collateralised insurer licenses, if an ILS fund or collateralised re/insurer wants to be able to offer these to its clients.
The new collateralised vehicle also needs to have some permanent regulatory capital in place, in order to support operational, market and credit risks, which is another difference to the SPI that requires none.
For the new vehicle it is proposed that it has regulatory capital at the higher of a $250K floor and a risk-based capital requirement reflecting operational risk it holds.
“The operational risk charge is proposed to be risk sensitive and based upon the quality of the Collateralised Insurer’s risk management and governance in relation to its operational risk,” the BMA explains.
Collateralised re/insurers may also have to “hold permanent capital for the market and reinsurance credit risks arising from the assets held as collateral at 99% Tail Value- at-Risk (TVaR) over a one-year time horizon.”
The fact the new vehicle will be allowed to transact with unrated cedents is potentially interesting, as it could be a vehicle that allows an ILS fund manager to transact directly with large corporate risk transfer buyers, or other entities including governments, which could remove the need for fronting partners in certain cases.
As the ILS market continues to increase in sophistication and expand its remit and scope, the flexibility within a vehicle such as the one proposed should be very useful to the more expansive of the ILS funds as they grow into new areas of insurance and risk transfer.
Meanwhile, the SPI will likely continue to be a mainstay for the market, supporting catastrophe bonds and simpler collateralised reinsurance arrangements.
While, if approved and regulated for, this new class of collateralised re/insurer will provide a good graduation opportunity as ILS managers expand the range of business they transact.
As we said, the consultation paper is available to read and respond to here. We’d advise all interested parties do so.
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