Economic conditions fail to halt expansion of the Bermuda market
By Michael J. Moody, MBA, ARM
Insurance-related organizations worldwide have been dealing with a very challenging landscape over the past few years. Many insurers/reinsurers have suffered from the worldwide financial crisis, low investment returns and soft market pricing. Despite this, some areas have managed to continue to excel and expand their place within the overall insurance world. One such place has been Bermuda, the "World's Risk Capital."
Bermuda came to the attention of the insurance world when C.V. Starr decided to headquarter his fledgling American International Company there in 1947. About 15 years later, Bermuda began its journey as one of the premier alternative risk transfer domiciles when it licensed its first U.S. corporate-owned captive insurance company in the 1960s. Without the active support of the Bermuda market, much of the innovative single-parent captive formations of the '60s would likely not have developed.
Market disruptions in the United States over the past 40 years have served to accelerate and, in most instances, encourage additional innovation in the Bermuda market. By the early '70s, Bermuda had already become the world's largest captive domicile and had set the stage for further advancements. By the 1980s, the hardening U.S. liability market encouraged even more captive growth, as well as the formation of a number of reinsurance facilities. Beginning with the establishment of ACE and XL, non-captive insurance operations started in earnest. Subsequent hard markets in the United States have led to numerous creative approaches to risk financing.
In many respects, Bermuda has been a test lab for a number of new and exciting risk-financing approaches. Today, many of the newer types of risk-financing vehicles, known in Bermuda as "special purpose insurers" (SPI), are dominating the insurance/reinsurance industry in Bermuda. Included in the SPI class are catastrophe bonds (CAT bonds), industry loss warranties, and sidecars. According to Bermuda officials, the SPIs have become the fastest growing segment of the market. In fact, they indicate, Bermuda has already captured 20% of the global CAT bond business and, they add, demand continues to increase.
Favorable legislation that provided a structure for SPIs was passed in Bermuda in 2010. It has since been utilized by many organizations to quickly make Bermuda a world leader in this market segment. There are several reasons for Bermuda's attraction:
• Less stringently regulated since the risks are fully collateralized
• Unmatched insurance expertise, including auditors and lawyers knowledgeable in the industry
• Competitive domiciliary fees
• A sound legal and regulatory framework
Additionally, Bermuda understands that risk financing for high-risk ventures oftentimes needs a speedy resolution. Accordingly, Bermuda regulators try to make the process as smooth and quick as possible.
Important issues being addressed
One of the long-standing issues that has faced Bermuda, as well as most other insurance domiciles, is the highly anticipated European regulatory directive known as "Solvency II." In essence, while there are many aspects to Solvency II, it really comes down to enhanced capital requirements, as well as additional corporate governance requirements. The directive relates to the EU insurance industry; however, non-European domiciles can, if they choose, decide to achieve an equivalency status.
For competitive reasons, Bermuda has chosen to pursue the equivalency status. It has been working on this issue for quite some time. However, concern from some individuals remains.
This concern centers around the possibility that implementation of an equivalent set of requirements could damage the captive industry. While most industry experts agree that some of the Solvency II requirements may in the long run help establish more credibility for captives, they believe the solvency and capital requirements are unnecessary and may add an additional financial burden to the captive industry.
Bermuda has taken a more enlightened approach to this matter. It has made the case that captives should not be required to maintain the same amount of capital as commercial insurers. What Bermuda has suggested is that the equivalency requirement include a "carve-out" feature that specifically applies to captives.
While a final determination from the EU has not been arrived at yet, most feel that the "carve-out" will be an appropriate course for the EU to take. Especially helpful in this determination is the method by which Bermuda has established its classification system for insurance entities. It has always had a separate classification for captives, and Bermuda regulators believe that, since they can isolate this group easily, it should strengthen their case for the "carve-out."
This will leave only the increased governance and reporting requirements to be met by captives. And since the Bermuda Monetary Authority (BMA) has already introduced a new Code of Conduct for all insurance entities, including captives, the additional governance/reporting requirements are not believed to be onerous. Additionally, the BMA thinks that the new Code of Conduct will bring significant positive credibility to the captive industry.
One of the major advantages that Bermuda recognized early on was the need to establish tax-friendly relationships with their major customers. For example, it developed a favorable tax treatment with the United States in 1986, which, in large part, initially helped it to become the largest captive domicile. And while Bermuda has added several additional tax treaties with other countries, it has not been a major area of development until recently.
Over the past several years, Bermuda has been active in expanding favorable tax treatment via "Tax Information Exchange Agreements" (TIEA). Last year, Bermuda entered into a TIEA with Canada and it has been heralded as a game-changer. Previously, Canada's primary captive domicile of choice had been Barbados, which had its own tax treaty with Canada. However, following the new tax treaty, Bermuda believes that it is now on a level playing field with Barbados.
Additionally, Bermuda has turned its attention on Latin America. Mexico is a good case in point. Bermuda had been considered a "preferential tax regime" by Mexico. Mexico uses this terminology to denote what it considers a "tax haven," and thus levies a withholding tax at a rate of 40%. However, Bermuda entered into a TIEA with Mexico in 2011 and thus upgraded its tax status so that now only standard rates for Mexican income tax apply.
Bermuda has been quite busy with its TIEA treaties over the past few years. Currently, it has around 30 in place with countries in all geographic areas of the world and expects to have 32 in place worldwide once additional treaties are signed, according to Bermuda officials. It has been pointed out that not only will the captives benefit from the tax treaties, they should also assist Bermuda reinsurers as well. Bermuda believes that by leveling the playing field with other captive domiciles, the natural choice for a captive will be Bermuda because of its "one-stop shopping" approach that appeals to many captive owners.
Bermuda has always taken a leadership role with regard to its insurance industry practices. Its proactive position with regard to additional tax treaties and unique approach to Solvency II compliance once again illustrates the commitment to this important business sector. Many of the innovations that have become commonplace today got their start in Bermuda.
As an insurance domicile, Bermuda has distinguished itself as having a forward-thinking and practical regulatory regime. As the property and casualty insurance market is beginning to see the first signs of market hardening, Bermuda will again rise to the challenge. The world insurance community will look for further advancement coming out of Bermuda.