Explanatory Memorandum - Guidance Note: Standards and Application Framework for the Use of Internal Capital Models (ICM) for Regulatory Capital Purposes - Revised (June 2012)

Summary

This is an explanatory memorandum accompanying the Bermuda Monetary Authority's revised Guidance Note on Standards and Application Framework for the use of Internal Capital Models (ICM) for regulatory capital purposes (June 2012 revision). It explains, in track-changes form, what has changed since the prior guidance and invites industry comment on the revised note before finalisation.

• Scope expansion: The ICM framework is expanded beyond Class 4 insurers to explicitly cover Class 3B, Class 3A and Class 3BE insurers, with the standards applied proportionately for Class 3A, and further work planned to extend to Long-Term insurers and Classes C and D.
• Risk metric for LT insurers: The Authority confirms TVaR 99% remains its preferred risk metric, adopting one year of new business plus a one-year time horizon for reserve development (rather than run-off to extinction) to better suit long-term insurers, while remaining open to VaR or other metrics if demonstrated to be equally prudent.
• Economic balance sheet: A one-year reserve development horizon implies use of an economic-type balance sheet; the Authority will later issue its own Economic Balance Sheet proposals but will also accept Solvency II or Swiss Solvency Test equivalents.
• Use Test, Statistical Test and Governance: Guidance is expanded on Economic Scenario Generators, use of expert judgment in the Statistical Test, how the ICM fits into company management (Use Test), and model governance expectations including Board approval of the ICM and handling of model changes.
• Fees: The Authority adds commentary noting it will try to control ICM approval costs, including reliance on other regulators' work and relevant external validation.
• Comment period: The Authority invites written comments on the revised guidance note, to be sent to ICM@bma.bm no later than 1 August 2012.

The underlying revised Guidance Note (attached to this memorandum) sets out the pre-application process, affirmation statements, and information request that insurers must satisfy to obtain and maintain approval to use an ICM in place of the standard Bermuda Solvency Capital Requirement (BSCR) for calculating their Enhanced Capital Requirement (ECR).

Key obligations

• Insurers wishing to use an ICM for regulatory capital (ECR) purposes must go through the Authority's pre-application process, including a self-assessment, ICM overview, model demonstration and documentation gap analysis (Attachment A).
• Insurers must submit affirmation statements confirming their ICM meets specified general standards (Use Test, Statistical Test, Calibration Test, Validation, Documentation, Model Governance, Internal Controls, Risk Categories) prior to commencement of an ICM review (Attachment B).
• Long-term insurers using Economic Scenario Generators must document how the ESG is used within the model.
• Insurers' Boards must approve the ICM for use within the business and document how model changes are governed.
• Interested parties must submit comments on the revised guidance note to ICM@bma.bm no later than 1 August 2012.

Applies to

Class 4 insurers, Class 3B insurers, Class 3A insurers, Class 3BE insurers, Long-Term (LT) insurers, reinsurers

Deadlines

• August 1st, 2012: Deadline for submitting comments on the proposals in the revised guidance note to ICM@bma.bm.