SUSEP Public Consultation creates insurance risk securitization and new modality for reinsurers

After more than two years in debate, the Superintendence of Private Insurance (SUSEP) opened for public consultation the Public Notice No. 14/2020, presenting a draft of a new Resolution that will regulate the activities of local reinsurers that act with the exclusive purpose (called “RPE”) of accepting risks by means of reinsurance or retrocession operations, as well as their financing through the issuance of (re)insurance risks (Insurance linked securities-ILS).

With the institution of insurance linked securities (ILS), the (re)insurance market is now going hand in hand with the capital market, demonstrating the growing maturity of the sector.

These markets had already been communicating internationally since the 1990s, when the ILS were created after Hurricane Andrew in 1992, following which it was found that major events would require greater division and transfer of risk around the world, including to markets other than insurance and reinsurance.

Thus was established ILS, which are nothing more than an alternative form of insurance risk transfer, which, instead of being assigned only in the insurance-reinsurance chain, also begin to rely on the resources coming from the capital market to finance this risk assumption.

Historically, the ILS had been established to share risks of great proportions, such as those involving catastrophes, which links its origins to the so-called “cats bonds” or “catastrophe bonds”, also known as “act of god bonds”.

However, today there are also ILS in maritime, aviation and special risk insurance operations. It is important to point out that there are no restrictions for the issuing of these securities depending on the type of risk covered, since, considering that Brazil traditionally does not have catastrophic risks, the use of ILS should rather be evaluated in insurance and portfolios relevant to insurance operations in the country, such as agribusiness, energy and oil, for example.

In the proposed Regulation, the position of RPE is similar to that of FIDC or the securitization company, which issues securitization securities, for distribution in the market and whose funds raised are used to acquire credit rights (e.g. agribusiness, property assets or financial). The difference lies precisely in the fact that the RPE, when issuing its debt, obtains the respective resources to acquire not a credit right (that is, only the active position of the underlying business), but rather the risk position in relation to a certain claim stipulated in the respective backing, with the corresponding remuneration.

The ILS investor’s position, on the other hand, is not linked to the insurer’s credit or investment risk: he assumes the insurance risk effectively underwritten, which makes this type of investment attractive, especially considering those players that have a well-structured underwriting and pricing policy.

The risks to which the investor will be exposed – backing, in the language of securitization – refer to insurance portfolios, supplementary pension, supplementary health, reinsurance or retrocession, with a maximum maturity of up to 3 years and prohibition of retrocession of risks by the RPE.

It is also important to highlight that the proposed Rule opens the possibility not only for the securitization of insurance and reinsurance risks, but also for supplementary pension and health risks.

In this aspect, risks related to longevity and adjustments of biometric tables can also be subject to this new modality of securitization. And, for pension funds, ILS issuances by RPEs may enable a source of funding to supply illiquidity of assets in their investment portfolio.

According to the draft under public consultation, the assets that guarantee the RPE will be used exclusively for the coverage of risks and compliance with the obligations represented in the issued debt, i.e., its technical reserves will essentially appear as collateral of the ILS.

In addition, among the requirements of the RPE securitization instrument, we highlight: (i) prohibition of payment, by the RPE to the investors of the ILS, in the case that it results in the value of guarantor assets being inferior to the total nominal value of the maximum possible loss arising from the reinsurance or retrocession contract; and (ii) inexistence of the right of the investors of the ILS to the assets of the assignor(s) of risks to the RPE, neither to request the bankruptcy or liquidation of the RPE or to modify the conditions of risks subject to assignment to the RPE.

The draft also provides for the need for approval by the regulator of risk acceptance operations and the issuance of debt by the RPE.

For the RPE, the draft Resolution provides for the description of a minimum structure to be maintained, proportional to its exposure and compatible with the nature, scale and complexity of the operations of the RPE, such as the obligation to maintain a Risk Management Policy and the appointment of a director responsible for governance, controls and risk management. However, a positive development in the draft refers to the minimum capital for an RPE to operate which, unlike a common local reinsurer, may have as its base capital the minimum amount of BRL 100,000.00, which will be added to the risk capital to be calculated based on its business plan.

Operations with related parties are forbidden by the draft presented, and the RPE cannot also issue (re)insurance risk-related debt to related companies.

Finally, portfolio transfers may only occur between RPEs and must be submitted to SUSEP for review and approval.

Thinking of the world after the Covid-19 pandemic, in which we will witness a “hard market” for placing risks in reinsurance, the arrival of the ILS will be even more conducive to generating a very favorable business environment for these operations, attracting the interest of capital market investors who seek profitability and exposure to certain risks that the insurance or reinsurance market offers.

Interested parties have until August 11, 2020 to submit their suggestions to SUSEP .

The new Resolution will come into force on October 1, 2020.

Demarest’s Insurance and Reinsurance and Capital Markets teams are available to provide any additional clarifications that may be necessary.