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THE WORLD’S RISK CAPITAL Bermuda provides a strong regulatory environment that allows for innovation By Michael J. Moody, MBA, ARM
What do you call a 22-square-mile piece of volcanic rock located in the Atlantic Ocean? Most people call it Bermuda, and with increased frequency it is also being referred to as “The World’s Risk Capital.” That is quite a title for such a small place. And some people are wondering if this title is warranted now that Bermuda has been receiving so much negative publicity of late. But the tiny country that is still an English possession is no stranger to controversy. From the start, it has had its critics. Bermuda has played a major role in the advancement of alternative risk financing, especially captives, for the past 40 years. Initial concern was voiced regarding the ongoing viability of these unique funding vehicles. Many critics felt that captives would simply run themselves into the ground and ultimately be bad investments for their owners. Despite these dire warnings, captives have become a mainstay in many state-of-the-art risk management programs. And Bermuda has played a critical role in their development. Much of the success of the Bermuda insurance market can be traced to its approach to regulatory control, which, according to the Bermuda Monetary Authority (BMA), is facilitating the continued development of a viable, healthy, competitive and innovative insurance industry. “Bermuda has been concerned with providing an environment in which quality business could grow and develop,” says Cheryl-Ann Lister, chairman of the BMA. “This has involved a mix of high entry standards, coupled with ongoing regulation that is appropriate to the nature of the business and the particular risks within it, and applied effectively. The development of the market that we have seen over the past decades is firm evidence that Bermuda has managed to strike the right balance. In fact, we have continually enhanced and updated Bermuda’s overall regulatory framework in line with global standards and market developments over the past 50 years.” Stages of development The advancement of Bermuda as a world-class insurance center has actually mirrored a number of insurance crises that were primarily focused on the North American insurance market. “Over the last three decades the Bermuda market has actually responded positively to a series of events which challenged the international insurance arena,” explains Lister. “Examples include the early problems in the Lloyd’s market, the shrinkage in capacity after Hurricane Andrew and, more recently, the 9/11 terrorist attacks in the U.S.” Bermuda’s responses to these crises have always been timely, accommodating and innovative. In actuality, they can be viewed as four separate phases. Bermuda’s initial involvement in the alternative risk arena began in the mid-1960s when a gentleman by the name of Fred Reiss introduced the world to the “captive concept.” The concept provided corporations with a new method of funding their own risks and allowed them to develop innovative approaches for their corporate risk management programs. Reiss, who is credited with coining the word “captive” in this context, started a captive management company in Bermuda in 1962. Bermuda soon saw the value of the new funding approach and developed a regulatory infrastructure made up of several ad hoc committees that ultimately advanced the core of the island’s insurance regulations: The Insurance Act of 1978. This act, and subsequent amendments to it, has served as the basis of Bermuda’s unique approach to regulatory oversight, and as a model that other domiciles frequently use in drafting their own regulations. The second phase in Bermuda’s evolution came as a result of the hard liability insurance market in North America in the mid-1980s. While Bermuda witnessed significant captive growth, it was the development of several large reinsurance companies that distinguished Bermuda during this period. Theretofore, regulators were primarily concerned with issues that surrounded single parent captives with minimal solvency concerns. In the mid-1980s two giant reinsurers, ACE Limited and XL Capital Limited, were launched, and regulators moved quickly to establish proper safeguards for the policyholders of the two companies. Today these two titans of the insurance world provide many different lines of coverage for businesses that operate in every corner of the globe. Property insurance market problems that arose as a result of Hurricane Andrew ushered in the third phase of the Bermuda insurance market development. The immediate impact of the hurricane was to leave the North American property insurance market with devastating financial results in 1992, which led directly to a capacity crunch that is still being felt in some quarters. Once again Bermuda responded by providing fertile ground for development, and no less than eight new specialty catastrophic property carriers were formed. Rating agencies suggest that no less than $4 billion in new capacity was brought into the insurance market by these companies. These companies also proved their worth in the hurricane-packed 2004 season, providing additional capacity during this difficult time. The fourth phase of development came as a direct result of the insurance challenges that followed the events of 9/11. Again, the world insurance market suffered significant capacity problems. In response to this need, a number of new insurers and reinsurers were quickly started in Bermuda to lessen the capacity shortages. While some of the new capital came from existing organizations, the bulk of the new money came from startup insurance entities. Some experts believe that at least half of the $27 billion in new capital that was raised after 9/11 went directly to the Bermuda marketplace. The new startups, known as the “Class of 2001,” have proved to be viable insurance companies, and several have gone on to be listed on the New York Stock Exchange. Current position By and large, the insurance/reinsurance companies that have been established in Bermuda over the years have fared quite well. In fact, they have fared much better than the stocks of insurance companies in general. A detailed analysis of the financial results of the Bermuda Insurance Index (BII) will quickly show a much better performance than the S&P Insurance Index (S&PII). There are any numbers of reasons for this phenomenon that some simply call the “Bermuda Factor.” This is a theory that companies operating in an efficient environment such as Bermuda will perform better than those based elsewhere. A five-year comparison of results clearly illustrates this point; it shows a 94.13% return for the BII contrasted with a 29.33% return for the S&PII. Many believe that Bermuda’s regulatory climate makes it an ideal incubator of new insurance approaches and a market leader in setting trends. To be certain, Bermuda has had periodic regulatory problems like any domicile that competes in this rapidly moving environment, but regulators are quick to resolve open issues. Recently Bermuda received the final report from a review conducted by the International Monetary Fund (IMF) as part of its Assessment Program. The IMF looked at a number of aspects of the Bermuda regulatory environment including banking, investments, money laundering control and, of course, insurance. While some recommendations were advanced, overall the report confirmed Bermuda’s high-quality approach as an international business leader. It went on to recognize Bermuda’s unwavering commitment to ensuring that its financial services business is subject to regulations that are fully consistent with international standards. “We were pleased to receive what was on the whole a positive assessment from the IMF and an endorsement of how we conduct our regulatory activities,” says Lister. “These kinds of jurisdictional reviews are also useful opportunities to identify any areas within our supervisory regime that might require further development, complementing our own ongoing review of the completeness and effectiveness of our regulatory approach.” The IMF report did have several recommendations, and the BMA has taken quick action to resolve all appropriate open items. BMA immediately drafted legislation—the Insurance Amendment Act 2004—for corrective action, and the Bermuda House of Assembly passed the new act in November 2004. The act was designed to tighten up regulations in the insurance sector as well as provide the BMA with more power to independently regulate the sector. A key feature of the act was the establishment of a new “whistleblower” provision, which was extended to auditors, captive managers and other service providers. “The act is part of our wider review of Bermuda’s regulatory framework for insurance, reflecting the need to ensure consistency with developments in internationally agreed standards for insurance supervision, as well as addressing some specific IMF recommendations,” says Lister. “Overall it consolidates and provides statutory backing and detailed written guidance for processes that have already been applied as best practice within the current framework.” For some reason it appears that the media cannot resist putting out numerous negative stories about Bermuda and Bermuda-based companies. This seems to be even more noticeable now that the insurance industry is in the midst of a widening probe that implicates a few Bermuda insurers/reinsurers. This is unfortunately what frequently happens to the lead dog. Others who have mounting problems themselves are all too eager to cast doubts that are unfounded. Obviously, the current investigations that are being carried out in the United States may find additional wrongdoing at any regulatory body; only time will tell. Until that time, speculation regarding any domicile is premature and in the long run hurts all participants in the alternative risk market. Bermuda has been at the forefront of providing innovative solutions for many of the insurance problems facing U.S. businesses over the past 40 years. And, as has been demonstrated many times during that period, it continues to raise the bar and improve the supervisory regimes as needed. Bermuda realizes that the international insurance marketplace is dynamic and will take whatever steps are needed to maintain its position as “The World’s Risk Capital.” And there is no reason to believe that this will change any time soon. * |
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