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Summary of "ANALYSIS OF SYSTEMIC RISK IN THE BERMUDA LONG-TERM INSURANCE SECTOR"

Core Content

This report evaluates the potential for systemic risk arising from the Bermuda long-term insurance sector, particularly in the context of global trends such as increased allocation to private credit and the use of asset-intensive reinsurance (AIR). The analysis is based on three hypothetical scenarios that test the key transmission channels of systemic risk.

Main Purpose and Structure

• Purpose: To conduct a fact-based assessment of the systemic risk posed by the Bermuda long-term insurance sector in relation to global trends in the life insurance industry.
• Structure: The report begins with an executive summary, followed by an introduction, an overview of the economic and social role of (re)insurers, the market landscape, and the concept of systemic risk. It then explores the potential for systemic risk through three scenarios and concludes with recommendations for risk management and regulatory oversight.

Key Points

1. Economic and Social Role of (Re)Insurers

• Insurers provide long-term capital and contribute to financial stability and macroeconomic resilience.
• They serve individuals and institutions by offering protection and funding, particularly in retirement savings.
• Life and annuity insurance products are crucial in addressing the global retirement savings gap, estimated at $70 trillion in 2017 and expected to grow to $400 trillion by 2050.
• Bermuda is a global insurance hub, with reinsurers supporting over $1 trillion in life insurance reserves.

2. Systemic Risk and Its Transmission Channels

• Systemic risk refers to risks that can threaten the functioning of the entire financial system, not just individual institutions.
• Four main transmission channels are identified:
  • Asset liquidation: Rapid selling of assets due to financial stress.
  • Interconnectedness: Linkages between financial institutions.
  • Critical function: The essential role of certain institutions in the financial system.
  • Contagion: Loss of trust leading to panic and customer withdrawal.

3. Potential for Systemic Risk in Bermuda Long-Term Insurance Sector

Scenario 1: Credit Crisis Triggering Mass Reinsurance Recapture

• A severe credit crisis could lead to mass recapture of reinsurance assets, but this is unlikely to threaten global insurance solvency.
• Bermuda reinsurers have similar asset allocations to life insurers in other jurisdictions, particularly the U.S.
• The BSCR framework ensures that Bermuda insurers hold sufficient capital to withstand severe events.
• Structural protections in AIR contracts (e.g., collateralisation, right to recapture) reduce the risk of solvency impairment.
• Even if recapture occurs, the impact on cedents would not threaten the industry's solvency.

Scenario 2: Confidence Shock to the Bermudian Insurance Market, Triggering Mass Lapse and Fire Sale of Assets

• A confidence shock could lead to mass lapses and liquidity demands, but the impact is limited.
• Only ~30% of Bermuda insurance reserves are subject to surrender, and the rest are deferred annuities or life products with liquidity constraints.
• The BMA has shown that even in a stressed scenario, the total surrender value is less than the value of liquid assets held by reinsurers.
• The median 1 in 200 post-stress LCR is 360%, indicating strong liquidity resilience.

Scenario 3: Withdrawal of Insurer Private Credit Demand

• Insurers contribute to credit market stability through long-term funding.
• The Bermuda long-term sector represents a small share of the global credit market (<1%).
• Other investors can substitute for insurer funding, and a pullback would likely result in more attractive spreads, encouraging alternative funding sources.

Key Findings

• The Bermuda long-term insurance sector does not meaningfully contribute to global systemic risk.
• Safeguards such as regulatory frameworks, market practices, and capital requirements limit the potential for systemic risk.
• The long-term nature of insurance liabilities reduces the likelihood of rapid asset liquidation or liquidity crises.

Recommendations

• Enhanced Public Transparency: More detailed public disclosure of AIR structures, counterparties, and volumes would improve understanding of risk concentrations.
• Regulatory Oversight and Safeguards: Ongoing regulatory monitoring and stress testing are recommended over restrictions, to ensure a well-functioning reinsurance market.
• Risk-Based Monitoring: A nuanced, risk-based approach to monitoring asset and liability portfolios is critical, rather than generalised assumptions or broad regulatory interventions.
• Counterparty Risk Management: Insurers should develop robust counterparty risk frameworks, including recapture planning and stress testing.

Conclusion

The Bermuda long-term insurance sector, while significant in its role within the global insurance and financial services landscape, does not pose a material threat to the broader financial system. The report highlights the importance of maintaining a well-regulated and resilient market, with a focus on transparency, risk-based monitoring, and effective counterparty risk management.