Brazil’s ILS rules to benefit local re/insurers, first two applications are in: Fitch

Brazil’s regulations for “Letra de Risco de Seguro”, or LRS which translates to Letter of Insurance Risk and are effectively insurance-linked securities (ILS) laws, are seen as a positive step for the local re/insurance market and already some activity is expected to be seen, according to Fitch Ratings.

Brazil has taken a different approach to bringing insurance-linked securities (ILS) to the country, compared to some other domiciles.

The country has designed its legislative and regulatory framework with domestic market activity first in mind, but the ILS structures can also be used by other sponsors or investors that want to transact in Brazil using capital markets funding as well.

Rather than trying to take a share of the global catastrophe bond and ILS market activity that already has a home, Brazil has taken the sensible approach of developing something that meets its needs, while delivering on the benefits of efficient risk transfer and capital markets funding that ILS are known for.

The regulations to support the ILS-like structure were formalised and published by the government and the awaited rules on insurance-linked securities (ILS) issuance and special purpose reinsurance vehicles, came into force from January 4th 2021.

We then explained that the Brazilian regulator’s ILS ambitions were for the right reason, as it wanted to bring capital market efficiencies to its insurance and reinsurance market.

But the legislative work to make ILS issuance possible in Brazil, both of catastrophe bonds and other securitizations of insurance risk, had to continue and the Brazilian government then published the Letra de Risco de Seguro ILS rules in its gazette, which had to go before its lawmakers for approval and later passed a key hurdle and were approved by its National Monetary Council.

Rating agency Fitch is positive on the introduction of the regulations in Brazil.

“The recent regulation of Insurance Risk Letter (Letras de Risco de Seguro – LRS) securitization vehicles may benefit Brazil’s (re)insurance market, Fitch Ratings says. These vehicles, which are similar to insurance linked-securities (ILS), could provide new access to portfolio diversification and capital management, which would be supportive of (re)insurer credit ratings,” Fitch Ratings explained.

Adding that, “If successful in attracting alternative sources of risk capital, LRS should help stabilize reinsurance costs through improved competition and mitigation of reinsurer counterparty risk.”

The sharing of risk between insurers and the special purpose reinsurance vehicle Brazil has designed for issuing ILS, the Sociedades Seguradoras de Propósito Específico (SSPE), with investors, can help to reduce re/insurers financing costs, Fitch believes.

“The approach would provide an alternative to the traditional reinsurance market, which can be more expensive or restricted at times. These instruments will allow (re)insurers to optimize capital and risk management, enhance liquidity, and mitigate risk transfer expenses, including reinsurance premiums. LRS could also be an option for investors aiming to diversify their portfolios with investments that have low correlation to traditional asset classes,” the rating agency said.

Brazil’s Securities and Exchange Commission will issue and distribute LRSs, Fitch noted, while the Private Insurance Superintendence (Susep) and the National Private Insurance Council (CNSP) will regulate the activities of SSPEs.

Encouragingly, Fitch noted that according to the regulator Susep, there are already two applications pending for the SSPE, which is a very positive signal and suggests we could see the first Brazilian ILS transaction before too much longer.

Testing the regulation is critical and we expect these will be small arrangements to get all sides comfortable and ensure service providers are familiar with the differences between transacting via a SSPE in Brazil and a special purpose reinsurer in other domiciles such as Bermuda, Cayman, Ireland, Singapore and Hong Kong.

A domestic ILS market for domestic re/insurance company risk transfer needs, but pulling in overseas institutional capital to support the arrangements would be a significant win for Brazil.

Fitch commented that, “Demand and growth for these alternative reinsurance capital markets in Brazil will depend on (re)insurers’ search for alternative capacity, further capping or increasing reinsurance rates, and potential returns for investors”