Clarification of Guidance Note 4 - Financial Guaranty Liabilities and Bermuda Statutory Returns (April 2008)

Summary

This is Bermuda Monetary Authority guidance clarifying how Guidance Note 4 (GN4) applies to financial guaranty business when preparing Bermuda statutory financial statements, specifically the loss and loss expense provision (line 17) and unearned premium provision (line 16). It sets out a recommended actuarial approach for measuring these liabilities in light of market conditions affecting financial guaranty insurers underwriting credit default swaps and securitized instruments.

• Scope: Applies to Class 3 and Class 4 insurers writing financial guaranty business, whose loss and loss expense provisions must be annually certified by an approved Loss Reserve Specialist (LRS) under GN4.
• Line 17 valuation: Loss and loss expense provision should reflect the present value of expected future cash flows for all financial guaranty contracts (including CDS-related contracts) attaching before the balance date, allowing for adverse scenarios, and should include case reserves, IBNR and any premium deficiency provision.
• Line 16 interaction: The portion of line 17 associated with unearned exposure should be shown net of the unearned premium provision (line 16); future installment premiums not recognised under U.S. GAAP may be included in line 16 to offset line 17 liabilities, with prudent allowance for lapse risk.
• Discounting: Nominal cash flows should be discounted using a risk-free rate (e.g. Treasury or LIBOR curves), distinct from the discounting approach under GN4 generally.
• Adverse scenario allowance: Liability determination should give reasonable allowance for potential adverse development via probabilistic methods, stress testing or stochastic modelling, and any actuarial report underlying the line 17 certification should discuss this allowance.
• Downgrade or wind-up: If an insurer is significantly downgraded or enters run-off or wind-up, additional provisions (e.g. for collateral requirements) beyond this recommended approach may be necessary.
• Capital: The BMA is considering separate capital guidelines for financial guaranty insurers; in the meantime insurers are expected to determine required capital by reference to statutory solvency standards and adverse-scenario modelling (e.g. 99% TVAR).

The note is explanatory guidance rather than a standalone rule and does not impose new filing deadlines; it interprets and supplements existing GN4 certification requirements for financial guaranty business.

Key obligations

• Class 3 and Class 4 insurers writing financial guaranty business must obtain annual certification of their loss and loss expense provision (line 17) from an approved Loss Reserve Specialist as required under GN4
• Line 17 should be determined as the present value of future cash flows for all financial guaranty contracts (including CDS-related contracts) attaching before the balance date, net of the unearned premium provision (line 16)
• Any actuarial report underlying the line 17 certification should discuss the allowance made for adverse outcomes
• Nominal cash flows used in determining line 17 should be discounted using a risk-free rate
• Insurers that are significantly downgraded or enter run-off or wind-up should consider setting aside additional provisions to cover potential collateral or other future requirements

Applies to

Class 3 insurers, Class 4 insurers, financial guaranty insurers, Loss Reserve Specialists