Determination of Discount Rates for Economic Balance Sheet Framework (July 2015)

Summary

This BMA guidance document sets out how discount rates are determined under the Economic Balance Sheet (EBS) framework used to value technical provisions for Bermuda's commercial insurers and insurance groups. It explains the risk-free yield curve methodology and describes two optional adjustments insurers may use: a standard illiquidity premium approach and a scenario-based approach for cash-flow matched business.

• Risk-free curve: BMA constructs and publishes quarterly risk-free discount curves for eight major currencies (USD, CAD, GBP, CHF, EUR, JPY, AUD, NZD) using swap rates adjusted for credit risk and extrapolated to an Ultimate Forward Rate of 4.2 percent at duration 60, extended to 100 years, with a Last Liquid Point of 30 years.
• Alternative curves: Insurers may use alternative risk-free curves (e.g. Solvency II approved curves) only with the Authority's prior approval.
• Standard approach: Insurers may add a liquidity premium adjustment to the risk-free curve, based on a representative corporate bond portfolio, EIOPA default and transition cost data, and a currently 35 percent uncertainty margin, to reduce artificial balance sheet volatility.
• Scenario based approach: Long-term commercial insurers with bespoke, cash-flow matched business may instead use a scenario-based approach applying eight prescribed interest rate stress scenarios to a base scenario, with the reserve set equal to the highest resulting asset requirement across scenarios.
• Actuarial documentation: Reinvestment assumptions used in the scenario-based approach must be considered as part of the Approved Actuary Opinion and disclosed in an accompanying Actuarial Memorandum.
• Eligibility limits: The scenario-based method is unavailable for blocks of business below a certain level of asset-liability matching, and where results diverge from the base scenario by more than 10 percent the Authority may require the standard approach instead.

The document is directive guidance from the BMA rather than a standalone rule, elaborating on the EBS Valuation Principles referenced in Schedule XIV of the Prudential Standards Rules (Form 1EBS and Form 4EBS).

Key obligations

• Commercial insurers and insurance groups must obtain the Authority's prior approval before using alternative risk-free discount curves (e.g. Solvency II curves) instead of BMA-supplied curves.
• Where the scenario-based approach is used, reinvestment assumptions must be considered as part of the Approved Actuary Opinion and disclosed in an accompanying Actuarial Memorandum.
• Insurers whose blocks of business fall below a certain level of asset-liability matching must adopt the standard approach instead of the scenario-based approach.
• Where the scenario-based result diverges from the base scenario by more than 10 percent, the insurer may be required by the Authority to adopt the standard approach following further discussion.

Applies to

Class 3A insurers, Class 3B insurers, Class 4 insurers, Class C insurers, Class D insurers, Class E insurers, insurance groups