Bermuda – finding the right balance of regulation

Read our article in the Cayman Financial Review Magazine, eversion 

Like other financial centres Bermuda has been impacted by the financial crisis and international economic uncertainty.

While the industry is attempting to regain the level of pre-crisis transactional activity, the Bermuda Monetary Authority has to find the right balance of regulation to allow business to thrive while maintaining international credibility and staying at the cutting edge in growth markets such as insurance linked securities.   

Compared with the Cayman Islands, Bermuda has a distinctly different insurance market. Bermuda not only has a large captive segment – it is in fact the number one location worldwide in terms of the number of registered captive insurers – it also has a big commercial reinsurance sector, which covers a broad spectrum of risks but is predominantly a property catastrophe market.

“Captives have always been the bread and butter of Bermuda’s insurance industry, but the commercial reinsurance sector in Bermuda is the third largest reinsurance market in the world after New York and London,” says Chris Garrod, a director with Conyers, Dill and Pearman in Bermuda.

Ratings agency AM Best noted in a report on the global reinsurance market in August 2012 that 15 of the world’s top 50 reinsurers are based in Bermuda. The report ‘Reinsurers show resilience under weight of catastrophes, economic woes’ analysed the gross premiums written by reinsurers last year and ranked them by the location of their holding companies. PartnerRe and Everest Re are the largest Bermudan insurers with $4.6 billion and $4.28 billion respectively in gross premiums written. Other large reinsurers, such as Ace, XL, Flagstone Re and Allied World Insurance, have substantial operations in Bermuda but are headquartered elsewhere.


In contrast to Cayman, which maintains a wait and see approach with regard to the adoption of Solvency II, the European regulatory regime for insurers, the Bermuda Monetary Authority opted for Solvency II equivalency. Solvency II aims to establish capital reserve requirements for European insurers that are proportionate to the risk they underwrite. The rules which are expected to come into force in 2014 have raised concern that they may lead to higher capital requirements for many insurers.

However, given the exposure of the commercial reinsurance sector to European business, it was the right decision for Bermuda, says Garrod. For instance, about 40 per cent of the European property catastrophe reinsurance market is covered by Bermuda-based reinsurers.

Garrod notes that it was not a decision made in isolation, but largely driven by the organisations representing the commercial reinsurance sector in Bermuda. “One of the great things the Bermuda Monetary Authority does is closely consult with private industry. Ever since the insurance sector started to evolve in the 1970s, it developed out of a public private initiative and there has always been this cooperation between what used to be the government and now the BMA and the private sector,” he says.

The BMA took the industry feedback on Solvency II on board to eventually draft legislation.

Captives and Solvency II

The Bermuda Management Association, which represents the captive industry, also offered its opinion in terms of how captives would be impacted by these changes. Some critics have argued that Solvency II could make Bermuda less attractive as a captive domicile, if captives were treated like regular insurance companies.

In a preliminary assessment in October 2011, the European Insurance and Occupational Pensions Authority (EIOPA) said Bermuda’s regulatory regime for large insurers mostly complied with Solvency II. In talks with EIOPA, the BMA has made a case for a less stringent treatment of captives than the one proposed for commercial reinsurers that are covering third party risks.
Shelby Weldon, the director of insurance, licensing and authorisation for the Bermuda Monetary Authority, said at the Bermuda captive conference in June:

“We are of the opinion that the regulatory regime for captives would already meet the high levels of requirements for Solvency II on a proportional basis. There would be no significant changes for how we treat captives.”

“When there is finally Solvency II equivalence, the expectation is that the captive industry will not be impacted,” agrees Garrod. “The only slight impact right now in terms of captives is that one of the pillars of Solvency II encompasses corporate governance and risk management functions; so we introduced a code of conduct which came into effect last summer and that applies to all insurance companies.”

The BMA implemented this, like so many of the Solvency II measures, on a proportional basis, which means a pure captive is not required to put in place the same risk management and corporate governance practices as a commercial reinsurance company, which had to do more work.

“That was a slight hump we had to get over,” Garrod says.

There are, however, a number of long-term insurance companies with enhanced capital and reporting requirements that are currently in the process of negotiating with the BMA to agree to modifications. Garrod says the BMA is more business practical now than it used to be and is very receptive to handling requests made by Bermuda insurers.

“They are a risk-based regulator; they will assess the company to see whether an exception could be made to the rule.”

In a few cases long-term insurers have moved out of Bermuda, but “we have not seen lots”, he says. “So there have been a couple of casualties, but we have also had a few captives come into Bermuda as well from different jurisdictions for different reasons.”

Overall the feeling in the insurance industry of Bermuda is that Solvency II will offer real benefits by enhancing Bermuda’s credibility and trust internationally.

Growth area ILS

Cheryl Packwood, CEO of Business Bermuda says despite the global financial crisis and economic uncertainty, Bermuda has a deep infrastructure and insurance expertise, including auditors and attorneys.

“We feel that we are in a leadership position in financial services, especially in regards to insurance and reinsurance”. More recently Bermuda has grown the insurance linked securities business tremendously, she says.

ILS, a sector in which the capital markets and reinsurance are converging, has become one of the growth sectors, as institutional investors, including large pension funds, are considering alternative opportunities to generate higher returns in volatile markets. Insurance linked securities are regarded as attractive because they are uncorrelated to typical market risks.

Bermuda has become a leading ILS jurisdiction over the past two-and-a-half years, having listed more than $4.25 billion of this type of securities on the Bermuda Stock Exchange.
The growth of this sector is expected to accelerate according to a research paper co-authored by PwC in Bermuda. The white paper ‘Unlocking the potential of ILS’ notes that after 20 years the $15 trillion ILS market represents 14 per cent of the global catastrophe reinsurance capacity and a far more substantial percentage of property catastrophe reinsurers.

Catastrophe bonds issuance, a subset of ILS, is expected to reach $6 billion in the first quarter of 2012, which would mean an increase by $2billion compared to 2011. Bermuda has a share of about 20 per cent of the global catastrophe bond market.

With the increasing demand for catastrophe bonds, special purpose insurers (SPI) have become the fastest growing type of insurance vehicle in Bermuda. Introduced in 2012 the SPI classification offers a legal and regulatory framework for collateralised reinsurance products such as cat bonds, industry loss warranties and sidecars.

“Side cars are like cat bond insurance vehicles; often they issue notes and raise capital from outside investors and then they write just one reinsurance contract with one cedant that will be around for a particular underwriting year,” Garrod explains.

In order to be less stringently regulated than other insurance entities, all SPIs have to be fully collateralised, so that every dollar of risk is covered by a dollar of capital. The BMA has to be satisfied at the outset that the participants, including the investors and the insurance entities that are being reinsured by these vehicles, are sufficiently sophisticated. In addition the SPI’s purpose has to be specific and BMA standards for transparency and disclosure must be met.

Last year BMA significantly reduced SPI fees from $11,600 to $6,000 to help improve the Island’s competitiveness in the ILS market. In 2011, 23 SPIs were set up and by the end of July this year 13 SPIs were formed out of a total of 26 insurance companies.

Over the past twelve months Bermuda was also able to attract several start-up reinsurers that were backed by US hedge funds, such as Third Point Re, SAC Re and PaCRe, which according to the AM Best report is a growing source of capital to the reinsurance market. “These investment vehicles, like generations of reinsurers before them, are looking to Bermuda as a haven to avoid paying US tax rates on their insurance-related income.”


While ILS is seen as a growth market, captives are facing competition particularly from US states like Vermont, says Garrod.

Bermuda’s and Cayman’s numbers have notched up gradually over the years, but US states are growing more quickly today. Bermuda, much like Cayman, has as many companies in liquidation, amalgamating or merging as are being formed.

With the US election on the horizon, the image problem of setting up a captive offshore has become more pronounced. “You can set up a captive a lot faster in Bermuda or Cayman than in Vermont, but some companies don’t want to be seen to be operating offshore,” says Garrod.

Instead the captive industry is setting sights increasingly on Canada. A new tax information exchange agreement with Canada, signed last year, has put Bermuda on a level playing field with jurisdictions like Barbados which traditionally had strong ties and double taxation treaties with Canada. But, like in Cayman which concluded a similar treaty last year, this has to be put in perspective.

“Our attempts to attract captive business from Canada is focused primarily on Canadian parent companies which may have a lot of non-Canadian risk, such as mining companies or oil and energy companies,” expects Garrod.

“I don’t think we will necessarily see a wave of Canadian companies move their captives from Barbados to Bermuda, unless, for instance, they have an issue with their current service providers. The decision to redomicile is usually a serious one,” Garrod says. “But for new start-ups we now have as good a chance of getting a new captive [from Canada] as Barbados.”

Tax pressure

The image issues of offshore financial centres were also raised in the report by AM Best. The rating agency put the spotlight on Bermuda-domiciled companies that in recent years have moved their headquarters to European countries which have established tax treaties with the United States.

“Taxes may be higher than in Bermuda, but they’re lower than in the United States, and less subject to change. A shift in US tax policy toward Bermuda could prompt a further exodus,” the report says.

Flagstone Re or Allied World for instance moved their corporate domiciles from Bermuda to Switzerland and Luxembourg. Yet this has not meant that operations of these insurers ceased in Bermuda.

“By redomiciling to Switzerland, instead of having a Bermuda reinsurance subsidiary, Flagstone Re ended up with a Swiss reinsurance subsidiary, which then had to obtain a permit to carry on business in Bermuda,” Garrod explains.

“They did not close their office here and they did not let people go because of that move. All they did was change their Bermuda operating name to their Swiss name.”

Back in 2008 and 2009 the risk that the US may introduce new tax legislation that would disadvantage reinsurers in Bermuda, led companies with a physical presence on Island to examine what they would need to do in order to redomicile, Garrod adds.

“They had to; it is good to know what procedures are in place and whether you could move if you had to. A lot of them have chosen not to. Again the decision to redomicile is a big one,” he says.

But even offshore reinsurers live in fear that the US government will seek to tax more of the income they earn in the United States, the world’s biggest reinsurance market, AM Best notes.

“Bermuda-based insurers and reinsurers walk a tightrope continually, to the point of taking extreme care with what types of management issues are discussed on US soil versus in Bermuda. A slip could open a company to US tax liability that the Bermuda domicile is intended to prevent.”

Aside from these tax considerations, however, Bermuda remains an attractive jurisdiction, the report says, and its location, just two hours flight from the US, makes it easier to recruit and to get underwriters to come to the Island.

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Michael Klein
Michael Klein Editor Compass Media Ltd. PO Box 1365, Grand Cayman, KY1-1108, Cayman Islands T: 345-326-1720C: 345-815-0064 E: [email protected] Michael is a financial journalist and copywriter.  In the past he has been responsible for the Risk Management and Corporate Finance sections of a British monthly Corporate Treasury publication.  He has written various financial handbooks, notably on European Banking and Cash Management and the Debt Capital Markets.   In addition he has worked as a copywriter for banks and investment funds and served as corporate communications consultant to US and European blue chip companies.   Michael holds an MA in Political Science and International Law from the University of Bonn in Germany. 

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