Emergence and role of Bermuda’s insurance industry

Bermuda is an unlikely place to be a major insurance hub.

More than 600 miles from the USA, comprising of 24 square miles of limestone rock, wholly dependent on rainfall for its water, a population of only 65,000, and with no natural resources other than a benign climate and natural beauty, it has to import everything from energy to electrical kettles.

It has no opera house, no concert hall, no central bank, no national airline and no university.

A visit to Bermuda would reveal that the natives are wealthier than their counterparts in United Kingdom or United States. Per capita income in 2012 was $84,381, down somewhat from the $89,613 of 2010 but still significantly higher than the U.S. or U.K.

Whilst not a land of milk and honey, Bermuda is a land of economic success, even taking into account the horrendous financial problems of the past six years.

Its affluence is attributable in large part to the creation of the offshore insurance industry. The question is – why Bermuda?

Until the 1970s, the cost of insurance was only a modest expense of doing business. Fire, loss, and accidents were the main risks covered. This relatively simple arrangement changed when the concept of liability was radically altered by the United States courts.

Asbestos companies were penalized for failing to advise workers of potential cancer risks from breathing in asbestos dust, and cigarette manufacturers for failing to warn smokers that cancer might arise from smoking their product; even McDonalds was penalized when a customer scalded herself from hot coffee. The large and capricious awards and the penalties levied led to a significant increase in the number of lawsuits brought against manufacturers, many of which were frivolous, and inspired by tort lawyers paid on a contingency basis.

The strict accountability rules led to many companies going out of business entirely: Cessna discontinued the production of light aircraft, and resource companies like Manville (that foolishly tried to cover up asbestosis problems) were forced into liquidation.

At the same time, there was a growing awareness of the importance of the environment and many companies were sued for environmental damage, directors and officers of large companies were taken to court accused of negligence, and actions for medical malpractice soared. The business of insurance was changing dramatically, and during the mid- and late 1980s, there was a growing sense of crisis in the insurance industry.

For example, there were a number of natural and man-made disasters, such as the terrorist bombing of a Pan American World Airways flight; the Exxon Valdez oil spill in Alaska; Hurricane Hugo in the Caribbean; Hurricane Andrew in Florida; and the San Francisco earthquake.
As a result of these occurrences, major property losses were paid. The financial impact was such that several insurance companies either withdrew from the business, or went into receivership, or reduced coverage to the market.

In short, by the mid-1980s, what was once a cozy, predictable, almost pedestrian industry, with a history of 200 years of stability, was in deep trouble in both the U.S. and U.K. The entire industry had become fat and contented selling their life, health, property, and liability policies, with little thought about how the industry was changing, but the industry could not insure its own financial health. It had become too comfortable and complacent.

In London, a major part of an industry that had depended on trust, confidence, and reputation had attracted too many sharks and crooks, who covered the spectrum from being negligent to being fraudulent. The mirror image of the crooks were the naive names (or investors) suckered in by the cachet of being a part of Lloyds of London, and unaware of what unlimited liability meant in practice – it meant they could lose everything they owned. In 1871, there were 675 names; by 1990, there were more than 31,000, all eager to make a quick buck but most of whom lacked the skill or sophistication to know what was going on. Unlimited liability was an obligation they did not understand, and one which they should have never assumed. There was also, at one stage, a real risk that Lloyds would be unable to pay some of its claims – a situation which had never occurred before in its 200 year history. Losses at Lloyds were horrendous and some names committed suicide.

Bermuda had been involved in the insurance industry for many years before the 1980s, and was acknowledged as the birthplace of the captive insurance concept. This concept was commercially developed (although not originated) by a cantankerous American, Fred Reiss, who established Bermuda’s first captive management company, International Risk Management, in 1962. Here was a classic case of creative destruction. Innovation is always the work of individuals who tend to be obnoxious, impatient, egotistical, and perhaps irrational in the context of large organizations. Innovation is usually a revolt against business convention and arises when a smart individual faces an old problem and refuses to deal with it the conventional way. That was Fred.

American International (AIG) had established an insurance presence in Bermuda in 1947 after its international activities in China were nationalized by the Communists. Dr. David Saul, a former premier and finance minister stated, “When you reflect back on the beginning of this industry, you would have to give as much credit as possible to the American International Group. Led by the legendary Ernie Stempel, there is no question about it. AIG sowed the seeds of interest in insurance and the wider fields of reinsurance and probably were the first to use the word actuary in Bermuda.”

In addition, major corporations like Shell and Esso had established captive insurance operations in the early 1950s. However, captive insurance was still a relatively small business activity until the convulsions in international insurance occurred in the 1980s. Today there are almost 900 captive insurance companies domiciled in Bermuda.

Bermuda in the mid-1980s suddenly became a very attractive place in which to carry out insurance business. International company business was long established, there were no crooks, Bermuda was close to New York and London, and the island had good airline connections and communications. There was no direct taxation on profits or personal incomes (unless one had the misfortune to be a U.S. citizen), minimal regulation, a nucleus of professional services, and a high reputation for honesty and transparency.

Most important of all was the right of appeal through the English legal system to the Judicial Committee of the Privy Council. Insurance is a long-term business; claims may take years to emerge and there can arise complicated disputes about coverage which may need resolution in commercially respected courts of law. The right of appeal to England also meant that entrapment in the American legal system could be avoided.

It was, and is, politically stable and fiscally conservative and, equally important, Bermuda had a sensible and effective regulatory system in place that was self-regulated through an Insurance Advisory Council, the members of which were appointed by the minister of finance.

Enlightened regulation continues to be a key attraction to the industry. The main regulator, The Bermuda Monetary Authority (BMA), continues to work with the industry to ensure that the reputation of Bermuda is not impugned. Many industry leaders continually praise the constructive efforts of the BMA – in contrast to criticism to which regulators elsewhere are exposed. One chief executive of a major company has stated that the industry and the BMA will continue to enjoy a “healthy and robust relationship.”

John R. Cox, the first chairman of ACE (a major re-insurer), stated back in the 1980s that: “Bermuda was chosen as offshore headquarters back in 1985 for more than just economic reasons. Very simple – enlightened regulation. Everybody in the world said taxes – that we came here because there were no taxes. But taxes had no bearing on it. The reasons were regulatory.”

Whilst Cox minimizes the importance of taxation, today many foreign governments, especially in the U.S. and Europe, are blaming tax evasion for their budget deficits and it is rare to find any complimentary comments about offshore financial centers like Bermuda. Unspecified and oblique references to money-laundering, tax evasion by the wealthy, and general financial skullduggery are the norm.

In his 2008 presidential campaign, President Obama threatened to shut down tax havens and it appeared that Bermuda (and the insurance industry there) was firmly in his sights. There has been a continual drum-beat about international companies of U.S. origin failing to pay their “fair share” of U.S. taxes and this will undoubtedly continue. In addition, the OECD continues to hammer away at any country which pursues policies of minimal taxation.

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What is overlooked when Bermuda is attacked is the huge sums paid as a consequence of significant disasters as the following table indicates:

Bermuda Reinsurers’ claims paid to US disaster events 2001 to 2012 

 

    US$ billions
2001 9/11 $ 2.5
2004 Florida Hurricane Quartet $ 3.5
2005 Katrina, Rita and Wilma $ 18.0
2008 Hurricanes Ike and Gustav $ 4.0
2010 BP Deep-water Horizon $ 1.0
2011-12  US Tornadoes and Irene $ 3.0
2012 Hurricane Sandy $ 3.0

 

  • What could be considered a self-inflicted wound was the locally important issue of immigration. Insurance, and financial services in general, are highly dependent on a small cadre of well-connected professionals, many of whom do not have documented certificates that meet with bureaucratic approval.
  • From about 2000, the Department of Immigration became difficult with approving foreign work permits, and many Bermudians publicly objected to the number of foreigners. Under pressure from xenophobic voters, the Bermuda government implemented a system of term limits which allowed foreign personnel a period of only six years consent to work – unless they were designated as essential. This, as can be imagined, created many problems for international companies of providing key employees with a career path.
  • Pandering politicians and their accomplices in institutions like OECD can never understand that protectionism does not protect but destroys prosperity and jobs.

Don Kramer, one of the pioneers of the insurance industry, in a massive example of understatement declared that term limits were “flawed.” Another way of saying that prosperity is advanced by openness to immigration.

Another senior executive who is Bermudian stated, “Bermuda has to start thinking more about whether the world has changed, and whether, as an island with a shrinking population that wants to compete globally, it can do that by closing the doors to the outside, which is what the previous government effectively did.”

In December 2012, a general election ousted the former Progressive Labour Party (which favored strict immigration) and replaced it with a new governing party called the One Bermuda Alliance whose stance towards international business is distinctly more friendly.

In May 2014, the new Premier, Craig Cannonier and his attorney-general resigned amidst a scandal involving potential investors in a gambling casino.  Michael Dunkley, an experienced and popular politician, replaced Cannonier. This is clearly not an image Bermuda wishes to portray to the world, although at this stage it has not affected any long-term plans of international business. What better example can we have of the aphorism of PJ O’Rourke that “When buying and selling are controlled by legislation, the first things to be bought and sold are legislators.”

The insurance business dominates offshore international finance, although there is still a substantial presence in such things as hedge funds (who are major investors in many reinsurance companies), mutual funds, and trading. Currently, 15 of the top 40 global reinsurers are based in Bermuda and Bermuda is one of the top three largest insurance centers worldwide.

Currently, life reinsurers are becoming an increasingly important part of the Bermuda market. David Cash of Bermuda Business Development Agency states that life reinsurers are establishing themselves as a new class in Bermuda, and that long-term and life reinsurance (including annuities) represents around a third of the Bermuda markets in terms of gross written premiums and total assets, and that that amount looks set to increase even further, given the potential time bomb of retirement costs in Europe and North America.

In addition, Bermuda is at the forefront of developments and innovation in such new products as Insurance-Linked Securities (ILS) and this has been a major force in hedge fund backed insurers in the life and annuity sectors of the business to incorporate in Bermuda. There is $9.7 billion in ILS, 44 percent of the world’s total. There is no reason to believe that such innovations will fail to be successful in much the same way as Bermuda insurers were pioneers back in the 1980s.

Bermuda reinsurers are forecasting record premium growth and 53 new reinsurers were established in 2012. Business activity is brisk and the future looks bright.  

The Association of Bermuda Insurers and Reinsurers (ABIR) provides the following data in respect of the industry’s importance to Bermuda and the rest of the world. Such data is available to fiscal authorities overseas and international organizations such as OECD but is rarely quoted when offshore financial centers such as Bermuda are under attack.  

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1 The Association of Bermuda Insurers and Reinsurers (ABIR) reports: 

  • 21 Bermuda-domiciled insurers and reinsurers.
  • 97 percent of gross premium written by companies traded on the New York or London stock exchanges (86 percent of premium written by U.S. SEC registrants).
  • In 2012, wrote $66.4 billion in global gross written premium.
  • Aggregate global capital over $95 billion in 2012.
  • Employ nearly 16,000 in the U.S., nearly 1,600 in Bermuda, more than 8,600 in Europe and nearly 35,000 worldwide in 2012.

2 ABIR members and other Bermuda (re)insurers play an important role in the US economy:

  • Bermuda’s reinsurers paid nearly 30 percent of the insured losses from 2005 Hurricanes Katrina, Rita and Wilma.
  • Bermuda’s reinsurers paid $22 billion to rebuild the U.S. Gulf and Florida coasts from the horrific hurricanes seasons of 2004 and 2005.
  • Bermuda’s carriers provide more than 60 percent of the hurricane reinsurance in Florida and Texas.
  • Bermuda’s carriers provide up to one third of U.S. crop reinsurance in key states.
  • Bermuda’s carriers support 25 percent of the U.S. medical liability insurance and reinsurance market.
  • Bermuda’s reinsurers contributed $35 billion between 2001-2012 to U.S. catastrophe losses.

3 ABIR members and other Bermuda-based (re)insurers:

  • Generate income from 150 countries.
  • Write 20 percent of the broker-placed European property catastrophe reinsurance.
  • Are expected ultimately to pay 62 percent of the claims for the U.K.’s largest peacetime fire and explosion – the Buncefield oil terminal fires of 2005.
  • Provide 26 percent of the capacity for Lloyds of London.
  • Write 14 percent of aggregate global reinsurance premium.
  • Include 15 of the top 40 reinsurers in the world.
  • Supply 40 percent of the U.S. and EU broker-placed property catastrophe reinsurance market.

4 ABIR members and other Bermuda (re)insurers are large global property catastrophe (re)insurers as demonstrated by recent events. Bermuda (re)insurers covered:

  • 50 percent of the reported losses for the 2012 Costa Concordia cruise liner sinking.
  • 16 percent of the reported liabilities for United States’ 2012 Hurricane Sandy.
  • 29 percent of the reported liabilities for the international reinsured share of the 2011 Japanese earthquake.
  • 37 percent of the reported liabilities for Europe’s 2010 Windstorm Xynthia.
  • 38 percent of the reported liabilities for Chile’s 2010 earthquake.
  • 51 percent of the reported liabilities for New Zealand’s 2010 earthquake.
  • 22 percent of the theoretical $1 billion market loss for the 2009 Air France crash.

Note: the above figures were updated in October 2013 and were compiled from data provided by: A.M. Best, Standard and Poor’s, Aon Benfield, Dowling and Partners, Insurance Insider, Bermuda Monetary Authority, ABIR.

It is easy to parrot happy things about the state of the Bermuda insurance industry, when other parts of the local economy are languishing from government deficits, massive Bermuda government debts including huge unfunded liabilities for pensions and medical benefits (totaling around $5 billion), unemployment in Bermuda for the first time since the Second World War, and increasing social stress.

There is, however, little doubt that the insurance and reinsurance sector has been a savior of the Bermuda economy, a major contributor to international insurance markets, and that its prospects are bright.

It is also worth noting, that a speck of nothing in the North Atlantic with a population of a small town in U.S. or U.K., which would not even rank as a village in China or India, plays such a significant role in one of the most complex of international industries. Leave people alone, in peace and freedom, and they will achieve magnificent things.
 

 

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