On 16 December 2020 the National Council for Private Insurance (CNSP) – the Brazilian entity in charge of policy making for the reinsurance sector – issued CNSP Resolution 396/2020. The resolution introduces into the Brazilian market special purpose local reinsurers (SPLRs) and insurance-linked securities (ILS), to be issued by SPLRs.
The resolution, which was issued after a long discussion with market players, dating from 2018, and after two sets of public consultations (Public Consultations 14/2020 and 20/2020), is another step forward by the insurance authorities, which are committed to modernising the Brazilian market, albeit under regulatory supervision.
Pursuant to the resolution, in order to be licensed to operate as an SPLR companies must meet all of the regulatory requirements imposed on local reinsurers. The local reinsurer is the highest level of three types of reinsurance licence under Brazil's tri-licence system (ie, local, admitted and occasional reinsurers). Local reinsurers must have a registered office in Brazil.
ILS aim to fund the collateralisation of reinsurance or retrocession risks accepted by SPLRs, thereby significantly expanding the market's capacity to absorb such risks. In this sense, ILS are an alternative form of risk mitigation for insurers and reinsurers. In contrast to conventional cover, they offer insurers and reinsurers a means of transferring risk to the capital markets. This development follows similar developments in the international market and ILS are now an established part of the global reinsurance market.
Pursuant to Article 2(II) of Resolution 396/2020, ILS are defined as:
a debenture, commercial note, or other debt instrument, linked to (re) insurance risks, whose characteristics are described in this Resolution, issued by a Special Purpose Local Reinsurer ('SPLR').
The nature and objective of ILS are defined in Article 3: "[t]he SPLR will obtain, through the issuance of ILS, the necessary resources as collaterals to the accepted (re)insurance risks".
Among other relevant provisions, the resolution determines that the ILS issuance document must be clear and transparent about the terms and aspects of the security instrument, including:
- the conditions of the (re)insurance cover;
- the definitions of loss;
- the value of the maximum possible loss and related expenses; and
- the maximum deadline to notify a loss, if applicable.
The resolution also defines the maximum exposure to the risk as the total nominal value of the maximum loss provided for in the reinsurance or retrocession contract, plus expenses, which the SPLR may incur as a result of a loss. In line with the efforts to open the Brazilian market to foreign capital, the resolution expressly provides that the underlying reinsurance or retrocession contract may provide for indemnities in foreign currency, provided that the exchange rate fluctuations are hedged by the SPLR.
The resolution forbids SPLRs from taking part in various operations, including:
- outwards retrocession;
- operating any derivatives other than to hedge against exchange rate fluctuations;
- investing in quotas of investment funds which have no risk assessment and measurement procedures for their investment portfolio; or
- issuing loans.
The resolution, which has been in force since 4 January 2021, is a welcome example of efforts by the Brazilian market to create an environment which fosters innovation, by seeking to expand its financial capacity and creating new mechanisms to transfer risks, ultimately bridging the gap between the capital and insurance markets.
