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Regulation Focus - Changes in paradise: How new Bermudan regulation will affect Hong Kong insurers

Source: Asia Insurance Review | May 2016

For years Bermuda has been the off-shore domicile of choice for insurance companies in Hong Kong and elsewhere in Asia. A combination of low tax rates, good business support infrastructure and light-touch regulation make the island an attractive location. Mr Jonathan Zhao of EY says some of this is about to change however, and this will have major implications for many insurers. Timelines are short, and firms need to act quickly.
 
 
Over the past few years Bermuda has been working with the EU to obtain equivalence status with Solvency 2. To achieve this status, the Bermudan government and the Bermudan Monetary Authority (BMA, the regulator) changed the legislation and regulations under which insurers are governed on the island.
 
   These changes came into effect on 
1 January 2016. Insurers should expect:
• More governance requirements; 
• More oversight and engagement from the regulator; and
• Enhanced methodologies for valuation and capital requirements, which will be new for insurers not currently running Economic Capital or Market consistent models.
 
   Previously Hong Kong-based and other foreign insurers were given official or unofficial exemptions from the BMA’s regulation in Bermuda. That era is now over.
 
What are your options?
Insurers are faced with two choices: 
• Re-domicile to Hong Kong or elsewhere, or
• Comply with the new regulations.
 
   Either of these courses of action involves a significant programme of work, particularly for many of the medium-sized insurance companies involved. 
 
   Domicile changes must be approved by the Hong Kong regulator, which is itself about to undergo a fundamental change with the formation of the Independent Insurance Authority (IIA). Approval depends (amongst other things) on the opinion of an independent actuary.
 
   Besides the regulatory process, the project would also involve:
• Corporate activity (setting up new companies/vehicles);
• Legal advice; and
• Tax issues.
 
   Based on prior experience, we estimate that it could take between nine and 18 months to complete the transfer.
 
   The move to modernise Hong Kong’s prudential regime through Hong Kong RBC means that this option would only be a temporary solution. Modern valuation and risk management requirements are coming, no matter where you are domiciled.
 
   The alternative is to comply. 
 
What are the key changes?
At the most fundamental level, the key change is that the BMA will no longer turn a “blind eye” to foreign insurers domiciled on the island. All insurers will need to comply with the new regime or face regulatory sanction.
 
   Following the three pillar-structure of Solvency 2, highlights of the specific changes are:
• Quantitative capital requirements 
Insurers will need to calculate risk-based capital requirements by applying stresses to an Economic Balance Sheet (EBS) model. The EBS will be valued using market consistent techniques, similar to Solvency 2 in principle, but different in some details.
 
• Governance requirements
Insurers domiciled in Bermuda will now need to demonstrate to the BMA that they are “managed and directed” from the island. There are a number of criteria which determine whether or not an insurer satisfies this criterion, including where board meetings are held, where significant decisions are taken, and whether directors or senior officers live in Bermuda.
 
• Disclosure requirements
Insurers will need to publicly file GAAP accounts, and will need to file statutory accounts with the BMA privately. The format of the filing will be substantially different from the current form and will need to be signed off by the Appointed Actuary.
 
What are the timelines?
The new legislation came into effect on 1 January 2016. This means that insurers must comply with the governance standards immediately, although we understand that the BMA is taking a pragmatic attitude.
 
   The quantitative and disclosure requirements are being tested through a “dry run” in 2016, with a deadline of end April. The BMA is allowing companies some leeway in this deadline, on a case-by-case basis. Companies which cannot do the calculations currently must submit a gap analysis by mid-year, with full live submission happening from April 2017 onward (based on the year-end 2016 position).
 
   Figure 1 below summarises the timeline.
 
Figure 1
 
What should you do now?
As a first step, we recommend getting in touch with the BMA to clarify your situation and secure an extension of the dry-run and gap analysis deadlines.
 
   Next, you should decide whether to stay in Bermuda or re-domicile elsewhere.
 
   Whichever choice of action you take, the next step is to quickly plan out requirements and engage advisers. If you intend to stay on the island, you will need a gap analysis of your current processes and capabilities against the new requirements. Even those insurers who currently use Economic Capital (EC) type models will need to add workstreams to their current reporting cycles and assess the information needed in the new filings. Others will need to fundamentally change their actuarial systems.
 
   We urge insurers affected to move quickly: timelines are short, and the amount of work is significant.
 
Mr Jonathan Zhao is Managing Partner, Asia Pacific Insurance Leader at EY.
 
EY experience
 
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