Clarity Provided For Bermuda’s Segregated Account General Business Insurers – Reinsurance

The Bermuda Monetary Authority (the
“Authority“) has issued a guidance note
effective January 1, 2025, the aim of which is to ensure
stakeholders have a clear understanding of the regulatory regime
for segregated accounts and separate account companies in
Bermuda.

The guidance note outlines the Authority’s expectations for
companies carrying on general business insurance both in the
limited purpose and commercial insurance classes that use
segregated accounts under the Segregated Accounts Companies Act
2000 (“SAC Act“) or separate accounts
pursuant to a private act of the legislature (hereinafter a
“Segregated Account“) to conduct
regulated insurance business with an aim of ensuring policyholders
have an appropriate level of protection that is consistent with
policyholders of insurers that do not conduct insurance business
using a Segregated Account structure.

The guidance note does not apply to incorporated segregated
accounts companies or incorporated segregated accounts insurers
which are subject of a guidance note previously issued in December
2020. Further, the guidance note is subordinate to the guidance
note for special purpose insurers that was issued by the Authority
on July 1, 2020, which provides specific guidance on the structure,
reporting and operation of special purpose insurers.

The Authority has adopted a risk-based, regulatory framework and
a proportional approach given the risk profile and licence class of
an insurer. While the Authority aims to provide clarity in its
approach, it should be noted that the guidance note is not
exhaustive. A duty remains with the board of directors (the
“Directors“) and management team of an
insurer to ensure its ongoing compliance with the legislation and
regulations and that any conditions of a company’s licence are
met.

Ownership and governance of accounts

An insurer conducting insurance business using Segregated
Accounts¹ must ensure that its Directors understand
their responsibility to ensure that business, including business in
each Segregated Account, is effectively directed and operated by
the insurer’s management team, insurance manager or any
outsourced service providers and further, that all insurance
business is conducted with integrity, due care and appropriate
professional skills.

The Directors must ensure that management team has compliance
processes in place that are suitable for assessing and documenting
fitness and proprietary propriety of its members, controllers,
officers, and the insurance manager and any other outsourced
service providers. Further, the Directors are responsible for
providing appropriate oversight of the insurer’s governance and
management framework, risk management and internal controls
framework, including any activities and functions that are
delegated or outsourced.

The Directors should show that there are robust proceedings and
processes in place for suitable know-your-client information to be
collected and retained, and that due diligence is performed on all
persons participating in a Segregated Account as well as all
persons providing capital or collateral. These processes must be
subject to risk-based, ongoing monitoring. In the same vein, the
Directors are required to ensure that there are processes and
controls in place to facilitate compliance with Bermuda’s
anti-money laundering and anti-terrorist financing laws.

Licensing

Segregated Accounts companies that carry on insurance business
must apply to be registered under the Insurance Act 1981 (the
“Insurance Act“). The insurance
licensing application must be comprehensive and should include all
relevant documents related to the insurance business that will be
conducted in the Segregated Accounts including draft or executed
copies of any insurance contracts, collateral agreements, copies of
agreements with account owners and the like. The application must
also set out in detail the nature of the relationship between the
account owner, policyholders and the company, the way capital will
flow, the nature of funding that is available to the company, any
arrangements that exist for topping up capital, and any
arrangements that exist to ensure that the capital of each
Segregated Account is segregated from the assets of the other
Segregated Accounts and the general account. There must be included
within the contracts language that deals with limited recourse
between the Segregated Accounts (see below) and states that
recovery in relation to liabilities of each Segregated Account is
limited to the assets of a particular Segregated Account.

The guidance notes also provide certain criteria that will apply
depending on the class of licence within which the general business
insurer falls. For example, if the company intends to write
insurance that would ordinarily meet the criteria to be registered
as a class 1, 2 or 3 insurer as defined by the Insurance Act, the
applicant will generally be registered as a limited purpose
insurer. In the case of unrelated insurance business (as again as
defined by the Insurance Act), the applicant would generally be
registered as a commercial insurance class 3A, 3B or 4 insurer, and
in this instance will be assessed at both the insurer and
Segregated Account levels.

A company which plans to write a combination of related and
unrelated insurance business will be registered in the highest
applicable registration class.

Where an insurer only intends to conduct insurance using
Segregated Accounts, the Authority will include a condition on the
certificate of registration that requires its prior written
approval if any insurance is to be conducted through the general
account.

When the application for registration is made, the company will
also need to disclose details related to ongoing funding
arrangements related to the insurance business to be conducted
using the Segregated Accounts and will have to substantiate the
existence of the capital funding the exposure in the Segregated
Accounts. Capital and the collateral requirements will be reviewed
by the Authority as part of their review of the annual statutory
filings that are required to be made by the company.

Risk Management

In accordance with the Insurance Code of Conduct, a company with
Segregated Accounts must establish sound and effective governance
and risk management proof frameworks that are proportionate to its
risk profile.

The framework should facilitate the effective and efficient
operations of the company and address the organizational structure
of the Segregated Accounts including the delegation or outsourcing
of management and operational tasks, the segregation of duties and
any conflicts of interest that may be held by management. It should
be noted that the governance and oversight responsibilities rest
with the insurer’s Directors and may not be delegated.

Any possible conflicts of interest between or reliance on the
Directors and an account owner or participant should be mitigated
as much as possible. The Directors are responsible for ensuring
that controls are in place such that a company that uses Segregated
Accounts and is registered under classes 1, 2, 3, CI or IIGB has
insurance exposure in the Segregated Account but is not fully
backed by contributed capital or collateral that forms of
contingent capital or collateral can immediately be made available
if necessary.

Reporting requirements

Statutory financial statements must include information that is
calculated to fulfill or provide: (i) as much of an early warning
as is possible to any person examining the insurer’s statements
of any financial or operational difficulties into which the
insurer’s business has fallen or is likely to fall including
statements made by way of notice of the observance or
non-observance by an insurer of any margin of solvency and (ii) a
basis upon which the Authority or another regulatory agency may
within a reasonable period of time take action under the Insurance
Act or other legislation which will enable the Authority to
safeguard any element of the public’s interest involved in, or
affected by, the insurer’s business.

Information on each Segregated Account of a company that is
writing insurance must be included in the statutory financial
statements to help facilitate regulatory oversight. The Authority
has now introduced a schedule of segregated accounts and separate
accounts (the “Schedule“) which will
form part of the statutory filings. The contents of the Schedule
are designed to provide sufficient information in the statutory
financial statements to allow the Authority to assess the financial
and operational status of an insurer’s general account as well
as each of the Segregated Accounts.

Going forward, the completed Schedule will form an integral part
of an insurer’s statutory financial statements. It will include
the minimum information insurers should provide and any additional
information necessary to fulfill the requirements of the Insurance
Act relating to statutory financial statement disclosures.

The insurer’s approved auditor must annually audit the
company’s statutory financial statements. The audit should
include in its scope the Schedule as it now forms part of the
statutory financial statements, and the Authority will expect
auditors to perform sufficient audit procedures (within their
materiality threshold) to confirm the existence and valuation of
all assets and liabilities of a Segregated Account including any
instruments that are presented as collateral that backs the
insurance exposures in the Segregated Accounts. An auditor is
required to give notice to the Authority if it becomes aware of any
matter in relation to an insurer that is likely to be of material
significance in the discharge of the Authority’s functions
under the Insurance Act.

Balance sheet accounting

This is a modified accounting presentation in which the assets
related to one or more Segregated Accounts is reported on the
balance sheet as a single line item and the liabilities and capital
related to the Segregated Accounts are reported on the balance
sheet as a single line item. Modification in the presentation of
the statutory financial statements now requires approval under the
Insurance Act in relation to both limited purpose insurers and
commercial insurers. This will enable the Authority to consider
whether the general account is exposed to risks in the Segregated
Accounts and whether the insurance exposure in the Segregated
Accounts is fully provided for by the account owners or
participants.

Declarations of compliance

Insurers are required to file a declaration (the
“Declaration“) confirming compliance
with certain matters as part of its statutory financial statements.
The Declaration is required to include whether or not the insurer
has achieved certain minimum criteria applicable to it with respect
to the preceding financial year. These criteria include minimum
margins of solvency, any enhanced capital requirements, any
applicable conditions directions or restrictions that were imposed
on or approvals granted to the insurer, or any minimum liquidity
ratios for general business applicable to its financial year end.
The Declaration applies to insurance in both the general account
and each Segregated Account.

Loss reserve specialist opinion

The statutory financial return required to be filed by an
insurer under the Insurance Act must include the opinion of the
approved loss reserve specialist (LRO) regarding
the insurer’s loss and loss expense provisions. Previously, the
Authority has approved exemptions from the requirement to file an
opinion for general business for some insurers with Segregated
Accounts. These exemptions have traditionally included Segregated
Accounts that are fully collateralized to no policy limits or in
circumstances where no insurance has been written or no exposure
exists in the general account. In light order to ensure reserves
are adequate and there is adequate capital to fund exposure, the
Authority will require an opinion on the reserves in the general
account in addition to reserves reported at the Segregated Account
level.

The LRS is required to opine on the amounts reported in the
balance sheet as well as the amount reported in the Schedule which
will ensure that the LRS opines on the adequacy of all reserves.
The Authority is reconsidering the frequency with which it will
approve waivers of opinions from the LRS. Applications will be
considered on a case-by-case basis and the Authority may require
evidence or an actuarial review of the gross reserves as well as
the details of the insurance program and the capital used to fund
the exposure in the event the reinsurer does not perform in support
of the application.

Restrictions to return of capital

The Authority will consider capital distribution applications
under the Insurance Act from insurers operating Segregated
Accounts. Capital distribution applications may be pre-approved in
certain circumstances Including where the insurance contract is
fully collateralized to the policy limits and has, by mutual
consent of the insurer and reinsurer, agreed to release capital or
collateral that automatically reduces the limits under the
policy.

The Authority may provide approval for a fixed period (usually
one year) subject to a condition requiring they be provided with
details of the capital return within 30 days of completion of said
return. This will allow insurers to carry out the return of capital
or collateral in respect of Segregated Accounts specified in their
insurance agreements or contractual obligations with minimal delay
in cases where they adhere strictly to agreed upon terms.

Insurers intending to reduce the total statutory capital by more
than 15% in a financial year will be required to obtain approval
from the Authority. Should an insurer have any specific conditions
attached to their registration restricting dividends,
distributions, and/or returns of capital, they will also be
required to adhere to these specific conditions.

Collateral quality, impairment and disclosures

The Directors must 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 Segregated Accounts with reference
to contributed capital and contingent forms of capital, and in line
with any representation set out in the company’s approved
business plan, licensing conditions, and any relevant contractual
arrangements.

The guidance note lists certain arrangements which the Authority
is not expected to perceive as an acceptable means of funding
insurance exposure written in Segregated Accounts. These
include:

• insurance exposure that is collateralized using speculative and
  low quality investment instruments;




• exposure that is collateralized using receivables including
  premium receivables except any net premiums receivable from the
  cedant provided the insurance or reinsurance contract has
  appropriate contractual provisions that permit the insurer to
  offset the losses payable by them against the net premiums under
  the insurance or reinsurance contract. In such a case, net premiums
  shall be the gross premium written, less any applicable expenses
  such as brokerage or tax; and




• contractual arrangements that use the limited recourse language
  instead of actual collateral or capital.

Documentation relating to a Segregated Account is expected to
disclose details such as the types, issuers, collateral structure
and requirements, investment guidelines and expectations for credit
ratings for collateral where appropriate. The Authority expects
that the Segregated Accounts will generally carry minimal
investment and counterparty risk credit risk with respect to
collateral.

Other protections include certain circumstances where the
Segregated Account is writing fully collateralized insurance
business. In such an instance, the collateral must be contributed
to the Segregated Account on or before the effective date of the
insurance contract.

Evergreen and irrevocable letters of credit may be acceptable
forms of contingent capital in certain circumstances. The guidance
notes set out the criteria that need to be met.

The Directors, through their oversight of the insurer’s
management, or the insurance manager is responsible for ensuring
the validity and continued existence of the letters of credit
during the period of the insurance contracts written in Segregated
Accounts or the general account are at risk. Any letter of credit
must first be approved by the Authority before it was reported. The
insurer is also required to notify the Authority through the
principal representative if it reaches the view or becomes aware
that an impairment of the assets backing the collateral has
occurred and that the insurer is liable to top up the collateral in
accordance with each insurance contract. The principal
representative must furnish the Authority with a report in writing
outlining all the relevant particulars including how the top has
been or shall be satisfied.

Limited recourse

Insurers should ensure that there are clear contractual
arrangements to govern the operations of each Segregated
Account.

Where limited recourse provisions apply, limited recourse
provisions allow contracts to be commuted or cancelled when there
is a liability to the third party that exceeds the value of the
available assets. Where limited recourse provisions apply and
Segregated Account is insolvent, the Segregated Account may be
liquidated and closed as a measure of last resort by an independent
party to the contract. Limited recourse language may not be used to
justify that the insurance business is fully funded.

Instead, limited recourse language is a backstop where there is
a shortage of assets available to fund exposure and that that has
been written and the insurer or the cell is deemed to be no longer
operating on a going concern basis.

Further, the Authority makes it clear that including limited
recourse language in a contract is not a substitute for the need to
have clear and effective contractual language within the insurance
policy or agreement specifying the limits and the aggregate limits,
the required capital and collateral structure and operations, a
prudent treasury or investment strategy, and adequate governance,
operational and risk management controls.

Material changes in the business

The following changes are considered to be material for purposes
of determining whether the Authority needs to be notified of, and
approve, the change prior to taking effect:

• the provision of insurance for any additional risks that were
  not contemplated in the initial transaction and/or business
  plan;




• material changes to the insurance contract or any of the
  collateral or ancillary contracts to the insurance contract;




• modifications to the material disclosures included in the
  original application;




• raising additional capital from investors and/or Segregated
  Account participants not identified or contemplated in the original
  documentation provided to the Authority;




• any other changes that are pertinent to the business of the
  company where the changes would be deemed by a reasonable and
  knowledgeable person to be material; and




• any material changes as outlined in the Insurance Act.

A series of minor changes when taken as a whole may constitute a
material change that needs notification.

The approval process for any material change in an insurer that
operates Segregated Accounts will take into account the nature,
scale and complexity of those changes as determined by the
Authority to ensure the risks are effectively mitigated and the
capital is appropriate to support the ongoing operations of the
insurer. The Authority will consider whether the changes constitute
a change in the insurer’s business plan and, to the extent that
it does, may request additional information in order to assess the
impact the changes will have on the insurer and the relevant
Segregated Accounts.

Conclusion

In light of recent developments in the market, the Authority
seeks to ensure that relevant stakeholders have a sound
understanding of the regulatory regime for segregated and separate
account companies in Bermuda. The aim of the guidance note is to
provide greater consistency in reporting, licensing, authorizations
and prudential supervision and will provide the Authority with a
more comprehensive view of insurance business in Bermuda. When it
becomes effective in January 2025, the provisions of the guidance
note will apply to the financial years of a company commencing on
or after that date and there is a transition period during which
companies will be required to comply with the proposed changes and
give due consideration to any applications of a transitional nature
in the first year following implementation of the guidance
note.

Footnote

1. The guidance note appears to refer to
companies that are registered under the SAC Act only.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.