Regulatory Update October 2013

Transcription

1 Regulatory Update October 2013

2 Table of Contents Preface 1 Quarterly Synopsis 2 Market Analysis and Quarterly Statistics 4 a) Bermuda Money Supply 4 b) Domestic and Foreign 5 Currency Position c) Banking 6 d) Bermuda Stock Exchange (BSX) 8 e) Investment Funds 10 f) Company Authorisations 11 g) Insurance 12 Quarterly Review of the 13 Commercial (Re) Insurance Sector Supervisory Highlight Review of 16 Year-end 2012 Large Commercial Insurer Statutory Filings Regulatory and 19 Legislative Developments Special Feature 21 Statistical Index Bermuda Money Supply 4 BD$ Deposit and Loan Profile - 5 Combined Banks and Deposit Companies Foreign Currency Position - 5 Combined Banks and Deposit Companies Banking Sector Assets and Deposits 6 Regulatory Capital to Risk Weighted Assets 6 Combined Balance Sheet of Bermuda Banks 7 and Deposit Companies (Consolidated) Selected Stock Market Performance Indicators 8 Chart 1. Price Level, indexed (Q1 2005=100) 9 Chart 2. Annualised Return Volatility 9 Chart 3. Dividend Yield 9 (nominal and inflation-adjusted) Chart 4. Ratio Between Trading Volume 9 and Market Capitalisation Investment Fund Statistics 10 Insurance Registrations 11 Companies, Partnerships and 12 Permits Statistics - Applications Approved Table 1. Select Financial 14 Soundness Indicators (FSIs) Figure 1. Dispersion of Financial 15 and Reserve Leverage Figure 2. Claims Volume and 19 Premium Income (Q Q2 2013) Table 2. Select Financial 17 Soundness Indicators (FSIs) Figure 1. Dispersion of Financial 18 and Reserve Leverage Figure 2. Claims Volume and 18 Premium Income (FY FY 2012) Regulatory Update October 2013

3 Preface This bulletin reports on recent activities at the Bermuda Monetary Authority ( the Authority ) and recent developments affecting the financial sector, as well as the community generally. Attached to it are the regular statistical data covering Bermuda dollar money supply, Bermuda banks balance sheet analysis and other financial and company sector information, updated for the quarter ended 30th June The Regulatory Update is published in print and electronic formats. The electronic version is available on the Authority s website and can be downloaded as a PDF file. If you wish to receive an notice when the electronic version is available, you may sign-up to our e-subscriptions service by ing your request to enquiries@bma.bm. If you currently receive the print version and would like to receive the electronic version instead, please indicate this in your request. 01

4 Quarterly Synopsis The financial sector remains stable, but existing imbalances in the local economy, such as rising unemployment and growing fiscal constraints, have exacerbated vulnerabilities as the restoration of growth remains protracted. Adverse macroeconomic conditions have put a premium on the timely de-risking of bank balance sheets, which has further constrained credit supply as higher provisions reduce the earnings capacity of the sector. In contrast, Bermuda (re)insurance groups showed steady growth of premium income, which helped offset higher claims payments during the quarter. Bermuda (re)insurance groups maintained high capital buffers and improved their liquidity position. Even though a series of natural catastrophes weighed on operating profits during the quarter, the capital structure of the sector continued to be marked by low leverage (which increased during the quarter but remains less than half of that reported by international peers). As a result of steady premium growth (up by 3.1% q/q), 1 net written premiums (NWPs) increased by 3.7% q/q relative to equity; however, the sector still held on average almost twice the amount of capital for each dollar of NWPs. Profitability declined during the quarter but remained above the long-term average. Gross profits declined, with the aggregate combined ratio rising to 92.2% (up by 6.8% q/q) as underwriting performance deteriorated due to higher claims payments. Notwithstanding this, additional operating income was generated as premium growth exceeded the growth in reserves. In fact, the aggregate market-implied risk profile of Bermuda groups improved. All large commercial underwriters have managed to exceed their pre-crisis market valuation by early 2013 and their equity prices continue to trend upwards. Continued demand for alternative risk transfer and costefficient (re)insurance capacity has helped solidify Bermuda s status as the premier jurisdiction for the issuance of insurance-linked securities (ILS). Issuance activity more than doubled q/q after SPI registrations tripled relative to the same period last year. Bermuda-based Special Purpose Insurers (SPIs) underwrote $2.1 billion of various property and catastrophe risks via ILS transactions, which represented almost 63% of global issuance. Net issuance year-to-date confirms the historical experience of rising issuance volume until mid-year. During the quarter, the BSX added $3.4 billion worth of new issuances (including 4 ILS deals sponsored outside Bermuda), which increased the total number of ILS deals to a total of 28 (comprising 37 tranches) with an aggregate nominal value of approximately $6.9 billion. The overall capital position of the banking sector deteriorated marginally this quarter. The aggregate risk asset ratio (RAR) decreased to 21.4% (down from 22.8%) on a consolidated basis during the quarter, as net capital levels fell by 6.1% related to a planned equity transaction not indicative of recurring activity. However, credit risk in banks loan books has marginally increased as the decline in risk-weighted assets (down 0.3%) lagged behind the contraction of total assets (down 1.3%), with the sector placing a greater focus on investment activities. The leverage ratio (equity to total assets) declined to 9.2% (down from 11.7%), indicating higher gearing in the sector (but without an otherwise expected inflationary effect on money supply). Capitalisation was above the internationally recommended standard for capital adequacy under the Basel III regime. The greater diversification of income sources and cost savings were insufficient to enhance the earnings capacity of the sector, which remains challenged by rising levels of asset impairments. Higher fee-based and other banking income improved profitability; however, overall net income fell during the quarter due to lower interest margins, above-average provisioning and higher net charge-offs compared to the previous two quarters. Even though the deterioration of overall asset quality has further slowed compared to the previous quarter, the rise of non-performing loans (NPLs) to 11.4% of total loans suggests continued pressures on net interest income, which limited the sector s ability to build up additional capital buffers. Banks augmented existing provisions for future asset impairments by 12.4%, which outpaced the 4.6% increase of NPLs (net of provisions) attributable to continued asset quality challenges. The annualised RoE and RoA remained stable at 6.4% and 0.7%, respectively. Lending growth resumed after more than four quarters of declining credit supply but without materially altering the sector s structural funding position. New lending exceeded the amount of amortising loans, which reversed the recent retrenchment of private sector credit as a result of de-leveraging in the sector. 1 Note that the quarter-on-quarter (q/q) change compares the change in a value between the current quarter and the corresponding quarter of the previous year, e.g., Q and Q Regulatory Update October

5 Negative real interest rates and a wide deposit base (primarily due to the international business sector) have helped mitigate additional de-leveraging pressures. The overall loan-to-deposit ratio remained flat at 43.4%, indicating a stable funding structure; however, higher BD$ lending (up 1.0%) was not matched by a commensurate increase of BD$ customer deposits (down 5.7%), which increased the dependence of BD$ lending on foreign currency-denominated deposits. In spite of higher leverage in the banking sector, money supply contracted as a result of the declining BD$ deposit base; the external debt balance deteriorated after having improved over three consecutive quarters. A shift towards foreign currency-denominated deposits and subdued lending growth forestalled inflationary pressures associated with higher leverage of the sector s aggregate balance sheet. The net foreign currency position declined to a $399 million deficit. The sector s net foreign currency liabilities increased by 2.6% (or $433 million) while net foreign currency assets decreased by 1.6% (or $272 million) due to lower foreign currency-denominated investments (down 4.1%) during the quarter. 03

6 Market Analysis and Quarterly Statistics a) BERMUDA MONEY SUPPLY Money supply declined during the quarter, reverting to its historical trend of gradual contraction. A shift toward foreign currency deposits and muted lending growth has prevented inflationary pressures from higher leverage of the sector s aggregate balance sheet. The contraction of money supply was driven mostly by a decline of 5.4% (or $196 million) in deposit liabilities while the stock of base money (i.e. notes and coins in circulation) and cash on hand at banks remained stable. Most of the reduction in deposits was due to lower savings balances, which declined by 10.6% (or $175 million), reversing almost 83% of the gains experienced in the previous quarter. When compared to a year earlier, domestic money supply was down 1.4% (or $50 million). Bermuda Money Supply (BD$ millions) 2013-Q Q Q Q Q Q1 Notes & Coins in Circulation* Deposit Liabilities 3,386 3,582 3,351 3,398 3,437 3,480 Total 3,509 3,704 3,480 3,513 3,558 3,599 Less: Cash at Banks and Deposit Companies BD$ Money Supply 3,470 3,666 3,434 3,479 3,520 3,562 % Change on Previous Period -5.35% 6.76% -1.28% -1.16% -1.19% -1.10% % Change Year-on-Year -1.41% 2.92% -4.65% -5.04% -5.42% -4.10% Totals may not add due to rounding. * This table includes the supply of Bermuda dollars only. United States currency is also in circulation in Bermuda but the amount has not been quantified. Regulatory Update October

7 B) Domestic and Foreign Currency Position BD$ Deposit and Loan Profile Combined Banks and Deposit Companies (Unconsolidated) (BD$ millions) 2013-Q Q Q Q Q Q1 Deposit Liabilities 3,386 3,582 3,351 3,398 3,437 3,480 Less: Loans, Advances and Mortgages (4,897) (4,804) (4,855) (4,885) (5,332) (5,306) Surplus/(deficit) Deposits (1,511) (1,222) (1,504) (1,488) (1,895) (1,826) Percentage of Deposit Liabilities Loaned 144.6% 134.1% 144.9% 143.8% 155.1% 152.5% Totals may not add due to rounding. During the quarter the funding profile in local currency deteriorated. The loan-to-deposit ratio increased from 134.1% to 144.6% as higher BD$ credit balances were not matched by a commensurate growth in local currency deposits. In fact, the deposit base contracted by 5.5% (or $196 million) during the quarter and remained 1.5% (or $51 million) below levels from a year earlier (on an unconsolidated basis). Deposit levels have remained stable compared to last year while lending declined by 8.2% (or $435 million) as a result of de-leveraging efforts of the sector. Foreign Currency Position - Combined Banks and Deposit Companies (Consolidated) (BD$ millions) 2013-Q Q Q4 012-Q Q Q1 Total Foreign Currency Assets 17,818 18,111 18,759 18,147 17,770 18,852 Less: Other Assets Less: Foreign Currency Loans to Residents Net Foreign Currency Assets 16,872 17,144 17,744 17,071 16,602 17,808 Foreign Currency Liabilities 17,079 16,621 17,434 16,902 16,990 17,970 Add: BD$ Deposits of Non-Residents Net Foreign Currency Liabilities 17,271 16,838 17,612 17,086 17,186 18,194 Net Foreign Currency Position (399) (15) (584) (386) Totals may not add due to rounding. After having improved over three consecutive quarters, the sector s net foreign currency position deteriorated. The sector s net foreign currency liabilities increased by 2.6% (or $433 million) while net foreign currency assets decreased by 1.6% (or $272 million) during the quarter. These divergent developments were driven by declining foreign currency-denominated investments (down 4.1%) and an influx of U.S. dollar-denominated deposit liabilities, namely in the form of both savings and demand type deposits. Both foreign currency-denominated assets and liabilities were ahead of levels recorded a year earlier by 0.3% and 0.5%, respectively. 05

8 C) Banking Total assets declined for the second consecutive quarter as rising deposits increased the sector s aggregate leverage. While lending growth resumed during the quarter, investments declined by a greater margin, which resulted in a reduction of total assets by 1.3% (or $306 million). Conversely, the consolidated deposit base widened by 1.8% (or $364 million). While the quarterly change was largely the result of higher demand deposits, the year-on-year increase of 0.4% (or $82 million) was due to the combined effect of declines in both savings and demand deposits. Banking Sector Assets and Deposits 2013-Q Q Q Q Q Q1 Total Assets ($ millions) 23,189 23,495 24,156 23,588 23,662 24,695 Quarterly Change (%) -1.3% -2.7% 2.4% -0.3% -4.2% 1.6% Total Deposits ($ millions) 20,256 19,892 20,491 19,966 20,174 21,114 Quarterly Change (%) 1.8% -2.9% 2.6% -1.0% -4.5% 3.6% Regulatory Capital to Risk Weighted Assets The capitalisation of the sector deteriorated during the quarter in spite of marginal de-risking. Net capital within the sector declined significantly on account of scaled back investments in subsidiaries. However, the risk profile of banks improved marginally during the quarter as risk-weighted assets declined by 0.3%. During the same time period, net capital levels decreased by 6.1%, which reduced the aggregate risk asset ratio (RAR) to 21.4% (from 22.8% during the previous quarter). The table below shows the movement of both capital ratios over the last five quarters Q Q Q Q Q2 21.4% 19.4% 22.8% 24.5% 21.7% 23.3% 22.2% 23.9% 22.1% 23.8% RAR Period Period Tier I RAR RAR Change 19.4% Q Q2 21.4% -1.4% 22.8% Q Q1 24.5% 1.1% 21.7% Q Q4 23.3% -0.5% 22.2% Q Q3 23.9% 0.1% 22.1% Q Q2 23.8% 0.3% 0% 5% 10% 15% 20% 25% 30% RAR Tier 1 RAR Regulatory Update October

9 Combined Balance Sheet Of Bermuda Banks And Deposit Companies (Consolidated) (BD$ millions) 2013-Q Q Q4 Total BD$ Other Total BD$ Other Total BD$ Other Assets Cash Deposits 5, ,518 5, ,532 6, ,327 Investments 7, ,938 8, ,275 8, ,965 Loans & Advances 8,784 4,723 4,061 8,631 4,676 3,955 8,833 4,725 4,108 Premises & Equipment Other Assets Total Assets 23,189 5,371 17,818 23,495 5,385 18,111 24,156 5,397 18,759 Liabilities Demand Deposits 9, ,673 8, ,088 9, ,812 Savings 5,351 1,474 3,877 5,340 1,650 3,690 5,189 1,438 3,751 Time Deposits 5,389 1,005 4,384 5,593 1,004 4,589 5,650 1,018 4,632 Sub Total - Deposits 20,256 3,323 16,933 19,892 3,525 16,368 20,491 3,296 17,195 Other Liabilities Sub Total - Liabilities 20,854 3,776 17,079 20,483 3,862 16,621 21,141 3,707 17,434 Equity & Subordinated Debt 2,335 1, ,012 2, ,015 1,901 1,115 Total Liabilities and Capital 23,189 5,667 17,522 23,495 6,277 17,218 24,156 5,608 18,548 (BD$ millions) 2012-Q Q Q1 Total BD$ Other Total BD$ Other Total BD$ Other Assets Cash Deposits 5, ,245 4, ,844 5, ,921 Investments 8, ,546 8, ,293 8, ,394 Loans & Advances 8,727 4,757 3,970 9,384 5,193 4,191 9,354 5,161 4,194 Premises & Equipment Other Assets Total Assets 23,588 5,441 18,147 23,662 5,892 17,770 24,695 5,843 18,852 Liabilities Demand Deposits 8, ,119 8, ,180 8, ,896 Savings 5,072 1,437 3,635 5,099 1,476 3,623 6,090 1,471 4,619 Time Deposits 5,932 1,063 4,869 6,089 1,092 4,997 6,515 1,333 5,182 Sub Total - Deposits 19,966 3,343 16,624 20,174 3,374 16,800 21,114 3,417 17,697 Other Liabilities Sub Total - Liabilities 20,525 3,623 16,902 20,648 3,658 16,990 21,691 3,721 17,970 Equity & Subordinated Debt 3,063 1,936 1,128 3,014 1,929 1,085 3,004 1,927 1,077 Total Liabilities and Capital 23,588 5,559 18,029 23,662 5,587 18,075 24,695 5,649 19,046 Premises and Equipment and Other Assets have been restated to reclassify equipment and other fixed assets that were previously recorded under Other Assets. 07

10 D) Bermuda Stock Exchange (BSX) The total market capitalisation of the BSX as of 30th June 2013 (excluding funds) stood at $431.8 billion, down by more than $13.5 billion from $445.3 billion in Q This decrease was primarily due to changes in the trading values of several large, international companies. Total trading volume in Q2 was 5,112,791 shares (up from 1,989,344 shares in the previous quarter) with a corresponding total market value of $13.3 million (up from $6.9 million in Q1-2013). The valuation of domestic firms constituted less than 0.4 % of the total market, with capitalisation amounting to $1.6 billion, down by $40 million from $1.6 billion during the previous quarter. The BSX accounted for almost 40% of the global market capitalisation of ILS at the end of Q The total market value of ILS world-wide stood at $18.3 billion. During the quarter, the BSX added $3.4 billion worth of new issuances, which increased the total number of ILS deals to a total of 28 (comprising 37 tranches) with an aggregate nominal value of approximately $6.9 billion. Less than 9% of the ILS market capitalisation of the BSX (or $560 million) was attributable to four ILS deals (six tranches) by SPIs domiciled outside Bermuda. Selected Stock Market Performance Indicators * In percent unless indicated otherwise 2013-Q Q Q Q Q Q1 Price Return 1/ BSX BSX - Insurance DJII Return Volatility Annualised Standard Deviation 2/ BSX BSX - Insurance DJII Normalised Squared Returns (in standard deviations) 3/ BSX BSX - Insurance DJII Trading Volume/Market Capitalisation 4/ BSX DJII Real Dividend Yield 5/ BSX DJII Sources: Bloomberg, BSX and BMA staff calculations. * The figures for the BSX and the BSX - Insurance cover the domestic listings only. 1/ Quarterly average of month-on-month change of last prices. 2/ Quarterly average of annualised standard deviation of month-on-month change of last prices. 3/ Quarterly average of the six-month moving average of squared month-on-month changes of last prices, normalised over a rolling window of four years (16 quarters); a positive (negative) value indicates above (below) average performance conditional on market volatility. 4/ Cumulative quarterly trading volume relative to the average market capitalisation during the same time period. 5/ Quarterly average of month-on-month dividend yield adjusted for headline inflation in Bermuda and the United States, respectively. Regulatory Update October

11 The overall performance of the BSX remained stable over the quarter at low levels of market liquidity. On page 8 the table provides a summary of selected indicators of stock market performance over the last six quarters (Q to Q2-2013) comparing the recent development of the BSX to that of the Dow Jones Industrial Average (DJIA) as the global equity market benchmark (which proxies the dominant impact of U.S. capital market performance on Bermuda s international business sector). Over the last quarter, the BSX index recorded a positive return of 1.13% (down from 1.44 % in Q1-2013) amid lower annualised price volatility of 1.53% (down from 1.90% during the previous quarter) and low trading volume of 0.28% of market capitalisation. The risk-return trade-off was less favourable for the insurance sub-index (BSX-Insurance), whose total return performance during the quarter was negative (even though price levels held up). The BSX index outperformed by global standards (if compared to the DJII, which recorded a higher quarterly return of 1.42% but a significantly higher annualised return volatility of 2.21%). The following charts show the BSX quarterly closing levels (indexed to Q as base year), the annualised return volatility, and the dividend yield (in both nominal and real terms) up to Q (Charts 1-4). While capital gains have turned negative since the beginning of 2009, dividend pay-outs remain high relative to international markets. The aggregate dividend yield of stocks listed on the BSX over the last quarter stood at 2.78% after adjusting for headline inflation, which was nearly three times as high as comparable yields generated by stocks listed on the DJII (at 0.98%). At the same time, the annualised return volatility (as a measure of risk) has dropped significantly below that of the DJII as a benchmark index during the quarter (but remains above the long-term average over the last four years as indicated by the positive value of normalised squared returns). Chart 1. Price Level, indexed (Q1 2005=100) Chart 2. Annualised Return Volatility indexed (Q = 100) In percent Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q BSX (Bermuda) BSX-Insurance (Bermuda) DJII (United States) 0 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q BSX (Bermuda) BSX-Insurance (Bermuda) DJII (United States) Chart 3. Dividend Yield (nominal and inflation-adjusted) Chart 4. Ratio Between Trading Volume and Market Capitalisation In percent In percent Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q BSX (Bermuda) - nominal BSX (Bermuda) - inflation-adjusted DJII (United States) - nominal DJII (United States) - inflation-adjusted Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q DJII (United States), four-quarter moving average BSX (Bermuda), four-quarter moving average (RHS)

12 E) Investment Funds The Net Asset Value (NAV) as at the end of Q was $ billion, reflecting a decrease of 6.11% or $11.64 billion from the $ billion NAV reported at the end of Q The total number of funds decreased by five during the same period. The decrease in the total NAV is due to the wind up of one substantial fund coupled with redemptions during the period. Investment Fund Statistics* 2013-Q Q Q Q Q Q1 Mutual Funds Umbrella Funds Segregated Accounts Companies (SAC) Unit Trusts Umbrella Trusts Total Number of Funds Net Asset Value (in billions) $ $ $ $ $ $ * The funds and net asset value statistics have been restated to reflect enhancements currently being made to the Authority s NAV reporting tools and more current reporting information. Regulatory Update October

13 F) company authorisations Companies, Partnerships and Permits Statistics - Applications Approved 2013-Q Q Q Q Q Q1 Exempted Companies (Bermuda companies exempted from the 60% Bermudian ownership requirement) Exempted Partnerships (partnerships established in Bermuda to carry on business in or from within Bermuda) Overseas Partnerships (overseas partnerships applying for permits to carry on business in or from within Bermuda) Overseas Permit Companies (overseas companies applying for permits to carry on business in or from within Bermuda) Unit Trusts Total Applications Approved The statistics shown above reflect the number of applications that have received vetting clearance from the Bermuda Monetary Authority. These figures do not reflect the actual number of entities incorporated in Bermuda during the period. Such statistics can be obtained from the Registrar of Companies. 11

14 G) Insurance Insurance Registrations During the second quarter of 2013, 21 new insurers and two intermediaries were registered in the Bermuda market. This compares to 17 registrations and three intermediaries for the same period the previous year. Insurance Registrations (Q2 2013) Type Name Date Registrations in April 2013 Class B PMG ASSURANCE LTD. 1st April 2013 Class 2 Allied Producers Reinsurance Company, Ltd. 2nd April 2013 Class 3B RenaissanceRe Specialty U.S. Ltd. 8th April 2013 SPI Altair Re Ltd. 12th April 2013 Class C Commonwealth Annuity and Life Reinsurance 15th April 2013 Company Limited SPI Kiskadee Re Ltd. 15th April 2013 SPI Sanders Re Ltd. 22nd April 2013 Registrations in May 2013 SPI Vector Reinsurance Ltd. 3rd May 2013 SPI Sunshine Re Ltd. 7th May 2013 SPI Armor Re Ltd. 8th May 2013 SPI Phoenix Cretro Reinsurance Company Limited 9th May 2013 SPI Blizzard Re Ltd. 17th May 2013 Class 3 Demeter Re Ltd. 22nd May 2013 Manager XL Underwriting Managers Ltd. 23rd May 2013 SPI Link Specialty Re, Ltd. 23rd May 2013 Class C AmFirst Insurance Company, Ltd. 28th May 2013 Class 3A Osprey Re Ltd. 31st May 2013 Registrations in June 2013 Class 1 General Administration Partners (GAP) and 6th June 2013 Risk Management Ltd. Agent XL Underwriting Managers Ltd. 7th June 2013 SPI Queen Street VIII Re Limited 12th June 2013 SPI Tramline Re II Ltd. 12th June 2013 Class 1 Beltway 8 Insurance Ltd. 21st June 2013 SPI Kinesis Reinsurance I Limited 28th June 2013 Total Registrations Insurers: 21 Intermediaries: 2 Descriptions of the different classes of insurers can be found in the Explanatory Notes section on page 22 of this publication. Regulatory Update October

15 Quarterly Review of the Commercial (Re)Insurance Sector The following section provides the main findings from a review of quarterly public U.S. GAAP filings of insurance groups that have an entity registered in Bermuda as a Class 4 or 3B commercial (re)insurer and fall within the groupwide supervision by the BMA ( Bermuda groups ). These findings reflect general trends and developments of the sector in aggregate and do not imply changes in the supervisory assessment in relation to individual firm performance. Bermuda (re)insurance groups 2 absorbed higher losses during the second quarter without any capital implications. A series of natural catastrophes, including the floods in Central and Eastern Europe and Canada, along with windstorms and hurricanes in the United States, increased the loss ratio for many (re)insurers, which weighed on operating profits amid declining investment returns during the quarter. In fact, firms experienced a positive development of aggregate market indicators and outperformed most international peers. Even though most global (re)insurers have seen a recovery in their share prices over the last 18 months, the Bermuda market remains unique insofar as all large commercial underwriters have managed to exceed their pre-crisis market valuation by early Bermuda (re)insurance groups maintained high capital levels amid a moderate expansion of balance sheets. Total assets increased by 2.2% q/q 3 on average as capital adequacy moderately declined during the quarter. Reserve leverage and financial leverage increased by 5.2% q/q and 3.4% q/q, respectively (Table 1 and Figure 1). Net Written Premiums to Equity, commonly used as an inverse measure of solvency, increased by 3.7% q/q. Profitability declined during the quarter but remained above the long-term average. Gross profits stood at $1.0 bln (down by 24.4% q/q) as the aggregate combined ratio rose to 92.2% (up by 6.8% q/q) due to higher claims payments. Solid premium growth in excess of the increase in reserves suggests that implicit risk-taking did not change materially on average; at the same time, firms maintained a moderate dependence on investment returns, which contributed 29.1% to net income at end The increase was directly driven by the loss ratio, which indicates no significant change in operating efficiency. Return on Equity (RoE) decreased significantly due to lower net income and stood at 0.7% (down 77% q/q). The aggregate market-implied risk profile of Bermuda groups improved. The average price-to-book value was largely unchanged compared to the previous quarter as equity prices continued to trend upwards. The cost of credit protection for the largest firms tightened further along the entire term structure of both senior and subordinated credit default swaps, which were significantly lower than those of international peers. However, the positive development of the sector needs to be balanced against growing challenges from adverse economic and business conditions. In general, uncertainty about changes in U.S. interest rates creates incentives for firms to invest at shorter maturities in anticipation of higher fixed income returns (as quantitative easing is likely to come to end if the economic recovery in the United States proves sustainable in the near term). However, greater reinvestment risk exists as older fixed income securities mature and proceeds are reinvested in assets with lower yields and/or asset with shorter maturities. Looking forward, short-tailed business lines are also susceptible to asset side risks if rising interest rates result in valuation losses on existing investments. 2 The presented information is based on aggregated individual firm data. Note: Inconsistencies in the numerical summary of company performance between the two most recent (quarterly) reporting periods are due to the restatement of certain Q figures to account for the Q acquisition of a company which formed part of the Q1 sample. 3 Note that the quarter-on-quarter (q/q) change compares the change in a value between the current quarter and the corresponding quarter of the previous year, e.g., Q and Q

16 Table 1. Select Financial Soundness Indicators (FSIs) (In percent unless indicated otherwise) Change (%) Q2 Q1 Q4 Q3 Q2 FY FY QoQ YoY Capital Adequacy and Asset Quality Assets (In US$ billions) Reserves to Assets (Reserve Ratio) Reserves to Equity (Reserve Leverage) 1/ Assets to Equity (Financial Leverage) 2/ Net Written Premiums to Equity 3/ Profitability and Actuarial Issues Gross Profit (excl. capital gains) (In US$ billions) Investment Income to Net Income Combined Ratio Average Claims to Reserves 4/ Return on Equity Return on Investment Cash and AAA Assets to Claims Source: BMA staff calculations. Note: numbers may not add up due to rounding; 1/ reserve leverage is the ratio between reserves and shareholder s equity (defined as share capital plus additional paid-in capital and retained earnings); 2/ financial leverage is based on total assets divided by total common equity; 3/ the quarterly values contain the cumulative amount of NWPs over the last four quarters as numerator; 4/ three-quarter average. Regulatory Update October

17 Figure 1. Dispersion of Financial and Reserve Leverage 450 Financial Leverage (In percent) 250 Reserve Leverage (In percent) Q Q Q Q Q Q Q Q Q Q Q Q Source: BMA staff calculations. Note: Boxplots include the mean (yellow dot), the 25th and 75th percentiles (blue box, with the change of shade indicating the median), and the 10th and 90th percentiles (whiskers). Figure 2. Claims Volume and Premium Income (Q Q2 2013) Claims and Net Non-Life Written/Earned Premiums (in US$ billions) Q Q Q Q Q Q Total Non-Life Earned Premium Source: BMA staff calculations. Total Non-Life Written Premium 15 Total Non-Life Claims

18 Supervisory Highlight Review of Year-end 2012 Large Commercial Insurer Statutory Filings During last quarter, the Authority completed its review of the yearend 2012 statutory filings of large commercial (re)insurers (Classes 4 and 3B) in Bermuda. The following section provides the main findings from the supervisory review of this segment of the Bermuda insurance market. The last year was relatively benign for large commercial (re)insurers. Most firms returned to underwriting profitability as a result of declining claim volumes and a steady increase of premium income, which helped improve their overall solvency position amid continued asset growth. Along with premium softening, in light of rising excess capacity in the non-life business, the key challenge for the sector remains the uncertain interest rate environment. Currently, low rates are limiting returns on fixed income investments by (re)insurers (especially as firms shorten the maturities of investments), while future asset side risks may grow if higher interest rates in the near term cause valuations of existing investments to decline. In addition, there is growing competition from supplemental underwriting capacity provided by third party capital, which is applying further downward pressure on premiums. Bermuda (re)insurers regained their strong capital position after having absorbed significant catastrophic losses in Rising net operating income due to the combined effect of higher premium income and rapidly declining claims has supported a significant improvement of capital adequacy. The aggregate BSCR ratio stood at 254.9% (up from 227.3% at end-2011). The capital structure of the largest firms was marked by declining leverage, with the ratio of net written premiums to capital, an inverse indicator of solvency, increasingly only slightly by 1.2% y/y (Table 2). Reserves decreased in lock-step with financial leverage at more than 6% y/y (Figure 1). 4,5 Profitability improved considerably last year and affirmed the relative capital strength of the sector. Premium growth generated sufficient operating income to offset claims payments and helped maintain a moderate dependence on investment income, which contributed 29.1% to net income at end Bermuda (re)insurers were rather more reliant on sound underwriting practices, which resulted in an underwriting profit of $4.6 bln in 2012, compared to an underwriting loss of $2.5 bln the year before. The combined ratio declined by 20.8% y/y from 107.6% to 85.2% amid a significant reduction of claims relative to reserves (down 28.0% y/y). The amount of liquid assets held relative to total assets decreased by 5.9%; however, the value of cash and highly-rated assets (which are potentially available generate cash inflows without significant liquidation costs) has increased, covering roughly one and a half times the amount of incurred claims during the year. Firms reported a marked improvement of their return on investment (RoI), which increased to 4.9% (up from 3.8% in FY2011); however, firms carry significant reinvestment risk as older fixed income securities mature and proceeds have to be reinvested in assets with lower yields. The aggregate return on equity (RoE) has returned to more usual levels at 13.5%. Going forward, interest rate risk has become an important consideration for the near-term risk outlook. The prospect of an end to unconventional monetary policy in the United States increases the likelihood of abrupt changes in interest rates, which could result in a sudden reversal of the term structure (possibly combined with a rise in risk aversion). This would not only increase funding costs across the financial sector but could also depress valuations of large investment holding and raise asset risks if a rapid increase of interest rates causes a disruptive unwinding of carry trades. The cost of hedging against the compression of term spreads, which is commonly referred to as risk to carry, has already become more expensive as indicated by the recent increase of the implied volatility of the 10-year/3-month swaption for the major reserve currencies. 4 Note that the year-on-year (y/y) change compares the change in a value between the current year and the previous year, i.e., FY 2012 and FY We do not report the aggregate reserve value, but according to our calculations y/y change of total reserve value was -1%. Regulatory Update October

19 Table 2. Select Financial Soundness Indicators (FSIs) (In percent unless indicated otherwise) FY 2012 FY 2011 FY 2010 FY 2009 FY 2008 Change (%) YoY Capital Adequacy and Asset Quality Assets (In US$ billions) Reserves to Assets (Reserve Ratio) Capital to Technical Reserves Assets to Equity (Financial Leverage) Net Written Premiums to Capital Capital to Assets Illiquid Assets to Total Assets BSCR Solvency Ratio Receivables to GWPs & Reinsurance Recoverables Profitability and Actuarial Issues Underwriting Profit (In US$ billions) Investment Income to Net Income Combined Ratio Loss Ratio Expense Ratio Claims to Reserves Risk Retention Ratio Net Technical Reserves to Net Claims Return on Equity Return on Investment Liquidity Cash and AAA Assets to Claims Liquid Assets to Total Assets Source: BMA staff calculations. Note: numbers may not add up due to rounding; 1/ financial leverage is based on total assets divided by total common equity. 17

20 Figure 1. Dispersion of Financial and Reserve Leverage 350 Financial Leverage (In percent) 180 Reserve Leverage (In percent) FY 2008 FY 2009 FY 2010 FY 2011 FY FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 Source: BMA staff calculations. Note: Boxplots include the mean (yellow dot), the 25th and 75th percentiles (blue box, with the change of shade indicating the median), and the 10th and 90th percentiles (whiskers). Figure 2. Claims Volume and Premium Income (FY FY 2012) 35 Claims and Net Non-Life Written/Earned Premiums (in US$ billions) FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 Regulatory Update October 2013 Total Non-Life Earned Premium Source: BMA staff calculations. Total Non-Life Written Premium 18 Total Non-Life Claims

21 Regulatory and Legislative Developments INSURANCE Consultation on Economic Balance Sheet Progressing Developments in accounting standards for insurance contracts are continuing at a global level. The International Accounting Standards Board and Financial Accounting Standards Board both issued exposure drafts of their proposed accounting standards for insurance contracts at the end of Q2. The Authority is currently reviewing these documents and engaging in discussions with local accounting firms and insurers to become fully versed in the issues raised by the proposals. Based on the outcome of this review, the Authority will consider how to further develop its proposals for an Economic Balance Sheet (EBS). Any revised proposals for an EBS may then be subject to further field testing during the summer of Internal Capital Models Application Review Update The Authority has received considerable interest from Bermuda (re)insurers regarding the applications process for reviewing internal capital models. In addition, as part of its ongoing programme of regulatory enhancements, the Authority will be meeting with other regulators to identify efficiencies between our respective model approval processes during Q4 of this year. The ICM framework allows (re)insurers to use their own internal capital models, once reviewed and approved by the Authority, to determine the amount of regulatory capital that would be required for such companies. The ICM application assessment includes evaluating the adequacy of the design, statistical quality and calibration of the models submitted by (re)insurers and the governance structure, controls and documentation surrounding them. The assessment is also heavily focused on determining the extent to which the models are used effectively and fully integrated into the strategic decisions, underwriting and risk mitigation strategies of the participating firms. If you would like to learn more about the internal model approval process, or to discuss estimated costs for inclusion in 2014 budgets, please contact Chris Killourhy, Internal Models Specialist, at ckillourhy@bma.bm. Banking Bank Special Resolution Regime Bill Consultation Concluded The period for industry to submit comments on the proposed Special Resolution Regime for Bermuda s banks has concluded. The Authority is currently reviewing comments received from the market on the Special Resolution Regime Act 2013 ( the Bill ). The Bill seeks to establish a comprehensive bank insolvency framework that meets international standards and ensures that Bermuda authorities have a broader range of powers that enable swift action to protect depositors in the event of a bank facing potential failure. The legislation may also be relied upon to deal with banks that are subject to regulatory and enforcement actions by the Authority. Following the completion of its review of comments received from this most recent consultation, the Authority intends to continue discussions with stakeholders with the intent of the laying a final Bill before Parliament prior to the end of Code of Governance for Investments and Trust Sector Business Published The Authority has published the Code of Governance Policy for entities licensed under the Trust (Regulation of Trust Business) Act 2001, the Investment Business Act 2003 and the Investment Funds Act 2006 (collectively, the Policy). The Policy was issued and posted on the BMA s website following a period of market consultation during which the Authority reviewed comments received from market participants on its proposals. The Policy outlines nine principles that are designed to support prudent business conduct by reinforcing key elements of corporate governance. In line with its risk-based approach to supervision, the Authority will apply the proportionality principle when accessing compliance with the Policy, taking into account the size, complexity, structure and risk profile of an entity. International Challenges and Opportunities for the Future of the Bermuda Insurance Market Presented at Bermuda Insurance Day Summit Craig Swan, Managing Director, Supervision, addressed key issues impacting the future of Bermuda s insurance market during his keynote address at the 2013 Bermuda Insurance Day Summit held in Bermuda on 26th June. In his speech entitled The Future of the Bermuda Insurance Market, Mr. Swan provided a brief overview of the Bermuda insurance market and cited the lingering impact of the financial crisis and reinsurance capacity as current challenges facing the industry. The impact of Insurance Linked Securities on the traditional reinsurance business model was also presented as both an opportunity and challenge facing the Bermuda market going forward. 19

22 Discussions on EU Group Capital Requirements in Europe Include Bermuda Insight Jeremy Cox, CEO of the Authority, provided insight on a panel discussing group capital requirements at the 6th Annual International Insurance Regulatory Issues Dialogue hosted by the Association of Bermuda Insurers and Reinsurers in Brussels on 4th June. Panellists included representatives from the market, EU regulatory authorities, and the European Parliament. Topics covered by the panellists included the challenges of implementing group capital standards under group supervisory regimes; the appropriateness of group capital standards to the insurance sector; establishing common capital standards across sectors; and delivering cost-effective capital measurements regime that results in significant policyholder benefits. Authority Contributes to Development of Global Systemically Important Insurers (G-SIIs) Policy Measures Dr. Andreas Jobst, Chief Economist, attended the inaugural meeting of the Higher Loss Absorbency Drafting Group (HLADG) in London, UK, on 23rd and 24th July The HLADG is a sub-group of the International Association of Insurance Supervisor s (IAIS) Financial Stability Committee (FSC). Its mandate is to address policy measures for Global Systemically Important Insurers (G-SIIs), specifically those focused in the area of higher loss absorbency (HLA) requirements. The HLADG meeting focused on discussing a work plan to develop straightforward, backstop capital requirements for all group activities of insurance companies. As requested by the Financial Stability Board in June 2013, the design of this basic capital standard (which is referred to as loss absorbency ) is due to be completed prior to the G20 Summit in late The IAIS intends to develop implementation details for HLA in line with its recently published policy measures for G-SIIs by year-end These measures will apply to all G-SIIs starting in Regulatory Update October

23 Special Feature Two New Classes of Investment Funds Introduced The Authority has introduced a new regime that provides for two new classes of exempted investment funds. Following consultation with market stakeholders in Bermuda and overseas, as well as the Bermuda Government, on amendments to the Investment Funds Act 2006, the Investment Funds Amendment Act 2013 (The Act) was passed by Parliament during its September 2013 sitting. The Act repeals the previous provisions on exemptions making new provisions for funds that meet certain specific criteria. Funds that were exempted under the old regime have been grandfathered under the Act and continue to be exempt under the repealed provisions. The qualifications for each relevant class of funds are as follows: Class A Exemption: a. The fund may only market to qualified investors b. The fund must have an investment manager who is regulated by the Authority or a recognised regulator, or who manages assets of $100 million or more c. The fund must appoint various service providers including a fund administrator; auditor; custodian or prime broker; and d. The fund must appoint a local representative in Bermuda being an officer, trustee or resident representative who will have access to the books. Class B Exemption: a. The fund may only market to qualified investors b. The fund must have an investment manager c. The fund must appoint various service providers including a fund administrator; auditor; custodian or Primer broker, and d. The Fund must appoint a local representative in Bermuda being an officer, trustee or resident representative who will have access to the books of the fund. Bermuda s fund industry is predominately wholesale in nature, consisting of institutional, highly sophisticated investors. As a riskbased regulator, the Authority s focus with regard to regulating this sector remains on proper disclosure and market discipline. This involves initial vetting of the fund prospectus to ensure proper disclosure to investors, as well as a rigorous review of fund owners and senior personnel for fitness and integrity. In the case of investment advisors and other service providers, the Authority seeks to be satisfied that they have the required experience and a sufficient track record to manage funds. The Authority has amended the application process for the new Class A exempted funds given their sophisticated nature, the restricted group of investors and the requirement that the investment manager be regulated by a regulator recognised by the BMA or who meets the minimum requirement of assets under management. To apply for Class A exemption a fund must notify the Authority that it meets the exemption requirements. A copy of the fund s prospectus must also be included as part of the notification. A Class A fund must also file a certification with the Authority that it continues to meet the statutory requirements for exemptions on an annual basis. Additionally, it must also submit to the Authority its audited financial statements and any material changes to its prospectus that have occurred during the previous filling period. Class B funds must also submit an application to the Authority for exemption along with a prospectus. The Authority must be satisfied that the fund meets the exemption qualifications and that the fund s service providers are fit and proper. Following review of the submission the Authority advises the funds of its decision to grant exemption, which usually is provided within 10 days of receiving the application. However, if the fund has not received an objection from the Authority within 10 days, the application will be deemed as approved. A Class B fund also must file annually a certification that it continues to meet the statutory requirements along with a copy of its audited financial statements and any changes to its prospectus. Any changes to service providers during the filing period will be reviewed by the Authority for fitness and propriety. The Authority is committed to ensuring that the jurisdiction s legislative and supervisory framework is of the highest standards that are in line with international best practices, while also fostering business development and growth. The addition of the Class A and Class B exempted funds along with other fund sector related initiatives, such as the AIFMD compliance, supports Bermuda s position as a competitive jurisdiction for the global funds sector. 21