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1. Introduction and overview
On 4 July 2024, the Bermuda Monetary Authority (BMA) issued its Guidance Note: General Business Insurers with Segregated Accounts and Separate Accounts (GN) for consultation.
The GN seeks
- to provide clarity to ensure that stakeholders have a sound understanding of the regulatory regime for Segregated Account and Separate Account companies in Bermuda
- to outline the BMA’s expectations of companies that use Segregated Accounts and Separate Accounts (also referred to in the GN generically as “cells”) to conduct regulated insurance business
- to ensure the manner in which insurance business is conducted through cells is in a way that gives policyholders an appropriate level of policyholder protection that is consistent with the policyholders of insurers that are not conducting insurance business in cells
- to enable greater consistency in reporting, licensing, authorisations and prudential supervision, as well as providing the BMA with a more comprehensive view of insurance in cells in Bermuda.
Although we understand that the GN has been gestating for some years, it seems more than a coincidence that its issuance follows a recent high-profile incident regarding the use of collateral in general business conducted through cells. The GN’s emphasis on governance and audit responsibility in verifying the existence of collateral is notable. The GN also clarifies the relevance of the role of the Principal Representative and approved auditor to matters concerning the existence and impairment of collateral and of the loss reserve specialist in connection with cellular business.
2. Scope of application
The GN applies to insurers who maintain cells for conducting general business whether they are Limited Purpose Insurers or Commercial Insurers. It does not apply to Incorporated Segregated Accounts Companies, which are covered by a separate guidance note.
3. Broad statements of policy
The GN begins with some broad statements of policy.
- The manner in which business is conducted through cells should ensure that the policyholders have an appropriate level of policyholder protection that is consistent with policyholder of insurers that are not conducting insurance in cells.
- Insurers should ensure there are clear contractual arrangements established to govern the operations of each cell, such as a (re)insurance contract, arrangement for collateral or funding agreements/documentation (including arrangements related to further capital contributions, ie, top-ups).
- The GN is not exhaustive. It is intended to set out information regarding the BMA’s regulatory and supervisory approach and expectations, but it is the responsibility of the insurer’s Board and management to ensure ongoing compliance.
- The GN explicitly does not prevail over the Special Purpose Insurer Guidance Note issued by the BMA on 1 July 2020.
4. Effective date; transitional provisions
The GN will become effective on 1 January 2025 and apply to financial years commencing on or after that date. The BMA anticipates that the transition process may be complex and will entertain applications of a transitional nature in the first year following implementation. It also anticipates further consultation before the requirements are operationalized.
5. Ownership and governance of segregated accounts
In what is essentially a reminder, the GN confirms the board of directors’ responsibility for ensuring that cell business is conducted with “integrity, due care and appropriate professional skills” and as regards the management teams’ compliance processes for assessing and documenting the fitness and proprietary of members, controllers, officers, insurance manager and any outsourced service providers.
Boards of directors should ensure that robust processes are in place for KYC materials to be obtained, that due diligence is performed for all cell participations, sponsors and capital/collateral providers and that there is ongoing monitoring.
6. Licensing
Applications must be comprehensive and include all relevant documentation related to the insurance business including draft or executed insurance contracts, collateral agreements, account owner agreements. The nature of the relationship between account owners, policyholders and the insurer, the flow of capital, the nature of funding (including contingent capital if applicable), arrangements for topping up capital, arrangements for ensuring the capital for each cell is segregated from assets of the other cells and the general account and the inclusion in the contracts of limited recourse language.
General guidance is given on acceptable collateral for different licence classes
- For class 1, 2 and 3 insurers, capital or collateral that is capable of absorbing and paying losses as and when they become due.
- a class 3A, 3B or 4 insurer licence is the default registration for an insurer that proposes to use cells and intends to write unrelated business (that is, roughly, business other than risks of its shareholder(s) or their affiliates).
The BMA may consider approving a company that conducts business through cells as a class 3, CI, SPI or IIGB insurer if the business will be fully collateralised[1]. In this case, the insurer’s board of directors is responsible for ensuring that controls are in place that ensure the limit of the exposure in cells is at all times backed by collateral capable of absorbing 100% of the exposure written in the cells.
Where an insurer only intends to conduct insurance using cells, the BMA will include a condition on the insurer’s Certificate of Registration that requires prior written approval if any insurance is to be conducted through the general account of the insurer.
At the registration stage, it will also be necessary to substantiate the existence of the capital funding the exposure in the cells.
Insurers with cell structures should ensure that they organize their governance framework and composition of their board of directors in a manner that mitigates reliance on, or conflicts of interests with, the account owner or participant.
The insurer’s board of directors are responsible for ensuring that effective contracts are in place such that, at no time, an insurer that uses cells and is registered as a license classes 1, 2, 3, CI or IIGB has an insurance exposure in a cell that is not fully backed by contributed capital or collateral or forms of contingent capital or collateral that can be immediately made available in the event it is required.
7. Reporting for cells
It is essential that each cell’s information is included in the statutory financial statements to help ensure that the insurer fulfils the requirement of section 15(3) of the Insurance Act 1978 (Act)(namely, that statutory financial statements are effective as a warning of possible financial operational difficulties) and facilitates regulatory oversight. The BMA has previously introduced a schedule of Segregated Accounts and Separate Accounts which will form part of the statutory filings.
The BMA’s expectation is that the schedule of Segregated Accounts and Separate Accounts is an integral part of the insurers’ statutory financial statements. The template contains the minimum cell information that insurers should provide in the statutory financial statements. It should be added to as necessary to fulfil the requirements of section 15(3).
8. Clarification regarding role of approved auditor regarding cell business and in verifying existence of collateral
The role of the approved auditor in auditing the insurer’s statutory financial statements now explicitly extends to the schedule of Segregated Accounts and Separate Accounts. What is important to note is that the GN also states that the approved auditor should audit the information for the cells (subject to the materiality threshold) and perform sufficient audit procedures to confirm the existence and valuation of all the assets and liabilities in the cells, including the instruments that are presented as the collateral that backs the insurance exposures in the cells. This confirms the relevance of the approved auditor in the verification of the existence of collateral.
Additionally, the BMA expects that, in considering whether any fact or matter is likely to be of material significance for the discharge of the BMA’s functions and is, thus, notifiable under section 16A of the Act, the approved auditor will consider matters at both the general account and cell levels.
9. Balance sheet accounting; assessment of applications
“Balance sheet accounting” is a modified accounting presentation whereby the assets related to the cells are reported on the statutory balance sheet as a single line item on line 13 and the liabilities and capital related to the cells are reported on the statutory balance sheet as a single line item under line 36.[2] The results of operations of the segregated accounts (statutory income statement) are not included as the general account of the insurer does not have an interest in the net income, asset or liabilities of the segregated accounts. The modification requires approval under Section 56 of the Act (in relation to Limited Purpose insurers) or Section 6C of the Act (in relation to Commercial Insurers). A key consideration in assessment of applications is whether the general account is exposed to the risks in the cells and whether insurance exposure in the cells is fully provided for by the account owners/participants. The BMA’s appetite for approval of balance sheet accounting is described as “low” although applications will (continue to) be assessed on a case by case basis, including grandfathering certain existing approvals.
10. Declaration of compliance
The declaration of compliance filed by an insurer pursuant to Section 15A of the Act applies, in the case of an insurer carrying on business through segregated accounts, to insurance both in the general account and in each cell.
11. Loss reserve specialist (LRS) opinion - adequacy of cell reserves; procedure for exemptions
An opinion of an Approved LRS is a statutory requirement of a general insurer’s statutory financial return (as required by Section 18 of the Act) and comprises an opinion on the insurer’s loss and loss expense provisions.
The BMA has historically approved exemptions from the requirement for some insurers with cells, traditionally where the cells are fully collateralised to policy limits or where no insurance has been written or no exposure exists in the general account.
As well as the amount reported on line 17 of the statutory balance sheet (loss and loss expense provisions) and line 19 of Form 1EBS (technical provisions), the LRS is required to opine on and the amount reported in the Schedule of Segregated Accounts – cell by cell disclosure on an unconsolidated basis. This ensures the LRS opines on the adequacy of all reserves.
The BMA’s appetite for approving waivers of opinions is described as low, however applications will be considered on a case by case basis (eg where a cell does not retain any exposure and the exposure is ceded to an insurance carrier rated A- or better by AM best or similar rating agency). In this case, the BMA may require evidence of an actuarial review of the gross reserves as well as details of the insurance program and the capital used to fund the exposures in the event that the reinsurer does not perform.
12. Restrictions to return of capital under Section 31C of the Act
Section 31C of the Act restricts the reduction of a an insurer’s capital and surplus to 15% of the insurer’s total statutory capital as set out in its previous year’s statutory financial statements.
The GN helpfully confirms that the BMA may pre-approve capital distribution applications by insurers conducting general business through cells where:
- The capital distribution is in relation to a cell or cells.
- The insurance contract is fully collateralised to the policy limit and has by mutual consent of the insured and reinsurer agreed (either at the inception of the contract or by mutual consent through an addendum) to release capital/collateral that automatically reduced the limit under the policy (provided that, where the policy remains in force, the policy limit is reduced by at least an equivalent amount on or before the release of the collateral to ensure the policy is fully collateralised at all times).
- Where a policy has ceased because of a commutation or cancellation and the reduced capital/collateral from that cell is released.
Acceptable applications will be pre-approved for fixed periods, normally a year, subject to a condition requiring that detail of the capital return be provided to the BMA within 30 days. This allows return of capital/collateral with minimal delay.
The GN sets out details of the supporting documents required.
It is understood that this section does not alter the general exemption applied to SPIs from compliance with the restriction on reduction of capital under Section 31C.
13. Collateral quality, impairment and disclosures
In another important clarification, the GN confirms that the board of directors of an insurer that conducts general business through cells should ensure effective oversight of the insurer’s management and operational policies, procedures and controls for the collateral and funding available based on the exposure that is assumed by the cells (referring to contributed capital and contingent forms of capital) and in line with the representations set out in the insurer’s approved business plan and licensing conditions, as well as relevant contractual arrangements.
The BMA confirms it does not perceive the following arrangements as an acceptable means of funding insurance exposure written in the cells:
- Insurance exposure that is collateralised using what could be considered speculative and low-quality investment instruments
- Exposure that is collateralised using receivables, including premium receivables, except any net premiums receivable from the cedant of the type that would be acceptable for an SPI.
- Collateral arrangements that use “limited recourse” language in place of actual collateral or capital
The cell documentation is expected to disclose details such as the types, issuers, collateral structure and requirements, investment guidelines and expectation for credit ratings for collateral where appropriate. It is the expectation of the BMA that the cells will generally carry minimal investment and counterparty credit risk with respect to collateral.
Where the cell is writing fully collateralised insurance business, the collateral must be contributed to the cell on or before the effective date of the insurance contract.
Where there are contractual top-up provisions to mitigate and manage losses incurred/loss ratios or the loss of value of assets backing the collateral require additional collateral to be contributed, the insurance contract must clearly define, using explicit language specific mechanisms and arrangements explaining how the top up provision will be executed in the event it is triggered.
Letters of Credit (LOC) are acceptable forms of collateral where they meet the requirements that the BMA already expects of LOCs used to demonstrate fully funded business in an SPI.[3]
The insurer’s board of directors, through its oversight of the insurer’s management or Insurance Manager, is responsible for ensuring the validity and continued existence of the LOCs during the period that the insurance contracts written in cells or the general account are at risk
An LOC should be first approved by the BMA before it is reported on Form 8 – Statement of Statutory Capital & Surplus of the statutory financial statements.
The GN confirms the duties of the Principal Representative as regards impairment of the assets in terms similar to those applicable in relation to SPIs.[4]
14. Limited recourse
Where limited recourse provisions apply and a cell is insolvent, the cell may be liquidated and closed as a measure of last resort by an independent party to the contract.
Reiterating an observation that has been made in other contexts, the GN confirms that limited recourse language cannot be used to justify that the insurance business is fully funded or collateralised.
The GN helpfully confirms that limited recourse in a contractual arrangement is not a substitute for the need to have, among other things: clear and effective contractual language within the insurance policy or agreement specifying the limits and aggregate limit; the required capital and collateral structure and operations; a prudent treasury investment strategy and adequate governance, operation and risk management controls.
15. Material change
The Guidance Note adopts the BMA’s understanding of and approach to material changes requiring notification or approval as that already explicitly apply in the case of SPIs.
16. Consultation feedback deadline
The BMA invites the insurance industry and other interested persons to provide commentary on the proposals set out in GN by 30 September 2024. Comments should be sent to RiskAnalytics@bma.bm with the subject heading ‘Segregated Accounts and Separate Accounts’.
[1] “Fully collateralised” means a cell financed up to the full maximum aggregate exposure of a contract by cash and cash equivalents or other assets accepted by the Authority on a case-by- case basis, held to the benefit of the insured.
[2] Where Balance Sheet Accounting has been approved for insurance business conducted in cells, the approval will include a condition requirement the LRS to also opine on the reserves included in the total reported on lines 13 and 36.
[3] See X of https://cdn.bma.bm/documents/2020-07-06-13-15-00-Guidance-Note---Special-Purpose-Insurers.pdf.
[4] See VI of https://cdn.bma.bm/documents/2020-07-06-13-15-00-Guidance-Note---Special-Purpose-Insurers.pdf.
Banking and finance
Bermuda