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​SUSEP submitted for public consultation a Resolution draft that creates a local reinsurer whose exclusive purpose is to accept risks in reinsurance and retrocession and issue securities backed by these same risks

On July 10, 2020, Brazilian Private Insurance Authority (SUSEP) submitted a Resolution draft for public consultation which allows the issuance, by certain regulated entities, of securities linked to (re)insurance risks, namely, the Insurance-Linked Securities (ILS).
 
The draft, if approved, will break new ground and bring innovation to the Brazilian (re)insurance market. Fund-raising via ILS will be a new option for the financing and transfer of insurance and reinsurance risks by regulated entities. ILS already attracts billions in the international market and such innovation will allow that a portion of such investments flows to Brazil. At the same time, ILS will allow that risks are absorbed by the insurance market and transferred to capital markets at a lower cost, as it will not require the corresponding regulatory capital, which could result in lower costs for insureds.
 
It is possible to present suggestions to the Resolution draft by August 11, 2020.
The Terms of the Resolution Draft
 
ILS are financial instruments, whose performance is based on specific insurance or actuarial risks, such as those related to (i) natural catastrophes (cat bonds), (ii) mortality, or (iii) disability, among others, as set forth in each instrument.

The draft will create a specific risk-carrying vehicle in the form of a local reinsurer named “exclusive purpose reinsurer” or simply “RPE”, which will accept risks through reinsurance or retrocession funded through the issuance of debt instruments linked to such same risks, the ILS. This will enable an important financial leverage if one considers that a local reinsurer needs a base capital of BRL 60 million, while the RPE would only need BRL 100,000.00. 
According to SUSEP’s proposal, in line with what happens in other jurisdictions, the RPE will raise third-parties’ funds to the amount necessary to fully cover the maximum loss of risks ceded in reinsurance or retrocession. On the other hand, the reinsurance/retrocession agreements must be absolutely clear in the sense that any reinsurance recovery shall be capped by the (i) the maximum possible loss and (ii) the RPE’s reserves, whichever is lower.
 
This ring-fenced structure assures that the bond will be fully collateralized. In this sense, as an example, possible extracontractual obligations of ceding companies or obligation in excess of policy limits will always be capped to the above-mentioned amounts.
 
Risks will only be transferred to the RPE after funds are raised and paid so that, at all times, the risks will be fully funded.
 
Such funds will remain invested in fixed-income securities throughout the term of the ILS and will only be used to pay for the ceded risks or to fulfill the obligations arising from the bonds. If at the maturity date of ILS, the loss ratio is smaller than expected, the investor shall receive back the original investments plus the agreed return.
 
The draft also provides that the debt instrument shall clearly state that (i) no payment will be made to the creditors in case the RPE’s reverses are lower than the maximum possible loss arising from the reinsurance or retrocession contract, (ii) the creditors will have no right over the assets of the ceding companies, (iii) the creditors will not be able to file for bankruptcy or liquidation of the RPE and (iv) the rights of the creditors will always be subordinated with regard to the contractual obligations arising from the risks ceded to the RPE.
 
ILS will have a maximum term of 3 years and the RPE will only be allowed to issue new bonds upon the expiration of all obligations arising from the previous one. Its remuneration will be linked to the ROI (Return on Investment) of the RPE’s reserves.
 
Each cession of risk to the RPE (and subsequent debt issuance) shall be previously approved by SUSEP. Moreover, in order to reinforce security and transparency, the RPE can only accept cessions related to insurance risks that are duly registered by the ceding company in the recently regulated Operations Registration System (Sistema de Registro de Operações). Depending on how the fund-raising will be made, ILS will be subject to the rules and examination of other authorities, in particular the Brazilian Securities and Exchange Commission (CVM).
 
In SUSEP’s opinion, ILS should be offered to highly qualified and experienced investors in view of the specific nature of the investment and the potential loss of the investments.
The RPE requirements
 
The creation and functioning of the RPE will depend on previous authorization by SUSEP, which will have priority over the licensing of other regulated entities.
 
The base capital of the RPE shall be of BRL 100,000.00 and its adjusted net worth shall be at least equal to the minimum required capital (CMR), which, in its turn, is the higher between the base capital and the risk capital.
 
The RPE needs to put in place governance, control, and risk management structures proportional to its exposure and compatible with the nature, scale, and complexity of its operations, including a Risk Management Policy, which shall be approved by its Executive Committee and, when existing, its Board of Directors.
 
The restrictions generally applicable to other regulated entities will also apply to the RPEs, provided, however, that the RPE (i) will be authorized to operate with derivatives in order to fully hedge for possible foreign currency exposures as long as there is a counterparty guarantee, (ii) will be able to act as a co-obligor under the ILS and (iii) will not be authorized to issue ILS to “affiliated companies”, as defined in the draft.
 
SUSEP’s decision to regulate ILS may be the first step towards other alternative risk transfer mechanisms, including financial reinsurance, reinsurance sidecars, captive reinsurers, risk retention groups or self-insured retentions, as well as new ways of funding (re)insurance activities, such as other forms of subordinated debts.
 
For qualified and experienced investors, considering the current low-interest rates scenario, ILS could be an attractive alternative, besides allowing the entrance of new players in the (re)insurance market.
 
By regulating the issuance of ILS by local players, SUSEP will allow the Brazilian market to benefit from this cutting-edge risk transfer and financing tool offered by the most modern international (re)insurance markets.
 
Mattos Filho team is available to provide any further clarification on the Resolution draft. In any event, we will follow this subject closely and inform you of any development.   

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