Bermuda has strengthened its position as a world force in the re/insurance sector.

A year ago, Bermuda was marketing itself as the `convergence island'. The facilities on the island meant that the separate disciplines of asset management, reinsurance and technology were beginning to come together, offering a new environment for managing and transferring risk, at least according to the marketing brochures being issued by organisations such as the Bermuda International Business Association. Indeed, those claims appeared to be backed up by the new breed of reinsurer springing up on the island, businesses such as Max Re which blended traditional reinsurance with innovative investment strategies.

A year later, and it can be argued that the 2001 tag line still holds true, but for different reasons. Instead of convergence of business disciplines, Bermuda has proved itself the leading jurisdiction for the convergence of investment capital into more traditional reinsurance entities. And recent events have proved the magnetism of the island for what has effectively become the redomiciliation of reinsurance operations within the major re/insurers. The announcement by St Paul Re that all its US business will now go through yet another new Bermudian reinsurer, Platinum, highlights the capital exit from some players in traditional markets in the US and Europe, and the flight towards Bermuda.

With the amount of new investment hitting Bermuda in the last seven months now creeping towards the $20bn mark, there has understandably been concern voiced by some industry commentators that too much capital has rushed in, in the wake of September 11, without the counterbalance of capital lost through withdrawals or drains on reserves. Few on Bermuda - particularly among the new start-ups - subscribe to that view, instead pointing out that yet again, just as with the liability crisis of the mid 1980s and the property catastrophe crisis post-Hurricane Andrew ten years ago, Bermuda has provided a solution to a void created by the withdrawal of the long-established markets.

How true that is remains unclear. First quarter results recently issued by some of the new writers seem to point to less business being put through their books than was anticipated at start-up, and word on the street in Europe and the US suggests there have been substantial write-downs in the business bound by the new Bermudians over the renewals season. Nevertheless, Arch's announcement that in the first 21/2 months of this year it entered into around 800 reinsurance transactions on Bermuda and in its US operations would appear to counter the detractors.

The rumours circulating the markets do not appear to have dismayed the new writers. Indeed, some of them have used the opportunities offered by setting up on the `convergence island' to focus on the core reinsurance skill of underwriting.

"Everybody here is employed in the wealth creation side of the business," said John Charman, CEO of Axis, about the people employed in his organisation. "We have outsourced all the back office functions and that is a feature all the way through the business." Set up in the final quarter of 2001, Axis transacts all its business through a website it created itself, which "provides a modern platform to have a lean and mean staff income ratio," he explained. "We want to spend 99% of our time on wealth creation... and grow quite rapidly with absolute control." Six months after setting up in Bermuda, operations were established in Dublin and London, and Axis bought Royal & SunAlliance Personal Lines and Connecticut Specialty Reinsurance to establish a US presence, but the focus on technology remains strong across the expanding group.

IT collaboration
Along with Axis, Bermudian cat property powerhouse Renaissance Re and Zurich Financial Services have been working with technology company QuoVadis to start introducing digital signatures to bind risks electronically. Stephen Davidson of QuoVadis, based in Bermuda and backed by Centre, explained that the technology company has also been working with other sectors of the Bermuda business community and the island's government to refine the digital certificate offering and the binding legislation surrounding it. QuoVadis recently became the first authorised certification provider on Bermuda, and under the certification service provider standard now operating on the island, if a document is digitally signed using QuoVadis, the signature is automatically binding under Bermudian law. The implications in time and costs are pretty huge; as much as anything else, the wider-scale adoption of digital signatures would significantly reduce the plane-loads of paper coming into Bermuda every week, a current reflection of the truly international flavour of the Bermudian reinsurers' business. Although some reinsurance markets have been noted by their backwards approach towards technology, Mr Davidson argued this is not true of Bermuda. "The market is accepting of technology, for convenience, for efficiency or for risk reduction," he said. "There has got to be an argument for it. The overriding argument is whether these methods are accepted by their counterparties, such as New York or London."

In fact, London technology providers have turned their faces towards the incubator island, looking at it as a great potential market. Back in February, ROOM - a UK-based technology company - joined forced with Hamilton-based Independent Consulting Solutions to offer its ROOM Analytics and Exact products to Bermuda-based organisations. ROOM has been strong in the London market over the past decade or so, and its westward gaze may partly be a reflection of the increasing number of London-based re/insurers setting up on Bermuda. Lloyd's agency GoshawK has set up GoshawK Re, while Catlin, backed by Westgen, now has a presence. Others are known to be actively looking at Bermuda as either a location for an underwriting operation or as a source of capital. With the last few years of Lloyd's history being marked by the Bermuda re/insurance market's move into One Lime Street, this is an interesting development in the other direction.

Although the headline news over the past few months has been the investment into the new and existing re/insurers in Bermuda, other changes are happening in the industry. On the regulatory front, the beginning of October witnessed the launch of the Office of the Supervisor of Insurance, brought in to take over the bulk of insurance regulation from the Minister of Finance. On January 1, regulatory responsibility moved from the Ministry of Finance to the Bermuda Monetary Authority, though still under the eye of Jeremy Cox. Despite these changes, primarily brought in to appease some of the bodies looking an unfair practices in offshore locations, most practitioners on the island seem sure that it will make little practical different to day-to-day regulation in Bermuda. There are still, however, regulatory changes afoot further on this year, in particular the implementation of on-site inspections of Class 3, Class 4 and long-term insurers, on a so-called `risk focus basis'.

Salient change
Another key change in regulation this year is the extension of the Segregated Accounts Companies Act to include non-insurance companies. The original legislation, which came into force on 1 November 2001, opened up the opportunities for setting up cell captives. Before that point, each proposed cell captive required separate private legislation to establish. Captive managers on the island have reported an active interest in both cell operations and an increasing growth in both use and numbers of more conventional captive structures following the hardening of the reinsurance market, in part to manage the higher deductibles currently prevalent.

In the past, there has been a noticeable dislocation between the captive and reinsurance businesses on Bermuda, but the two disciplines now seem to be converging. This was displayed earlier this year by the launch of HSBC Insurance Solutions, which brings together the broking and captive management operations on HSBC on the island, along with facilities to access capital markets transactions. At the launch of HSBC Insurance Solutions, managing director Roy Fellowes commented, "this will enable HSBC Insurance Brokers to access the important Bermuda underwriting market on behalf of international clients and to play a leading role in the management of captives on the island."

At the World Insurance Forum, held on Bermuda in February, Clark Hontz of Max Re said the company was seeing an increasing number of opportunities to structure products from behind a captive, particularly for those with US parents. Although the initial purpose of a captive should be the efficient management of insurable risks, captives and the structured products behind them can act as a hedge to changing market conditions, he said.

It's not quite all plain sailing in the captive area, however. The issue of fronting operations for captives is proving a problem in some circumstances, and there is little doubt that captives are going to be forced to take higher retentions and risk. At the same time, with the uncertainty in the reinsurance market, captive managers were warned to keep their authorised list of reinsurers up to date, to ensure security for their captive clients.

Tax remains a thorny issue, particularly with current initiatives in the US against `unpatriotic' organisations moving headquarters offshore to reduce their tax bills. In the post-Enron environment, the Bermudian captive management community is increasingly aware of the potential difficulties of the situation. Speaking at the conference, Rohm and Haas director Henry Good commented, "Truthfully, [captives] are giving us tax benefits, though they shouldn't be formed for tax benefits." In fact, according to Bermuda-based law firm Conyers Dill & Pearman, more than 60% of the US-owned captives on the island elect to pay US tax, to some extent countering the accusation of Bermuda being a tax haven.

It's been a fast and furious year for the Bermuda re/insurance community, one that is probably a major turning point in the island's status as a leading marketplace. And the signs are that the rate of change is not abating.

MRM in troubled times
For Bermuda-based insurer Mutual Risk Management (MRM), 2002 is shaping up to be a year it would rather forget. The company and its US subsidiaries have been put through the wringer; delisting from the New York Stock Exchange, surveillance by the Bermuda Monetary Authority, senior level losses and two group companies put into rehabilitation are a few of its woes in the first few months of this year.

In February, AM Best downgraded Legion Insurance Group to B with a negative outlook, from A-. The downgrade followed an MRM announcement earlier in the month that Legion had increased its fourth-quarter 2001 reserve charge to $61.5m from $45m pre-tax and $30m after tax. MRM also established a $63m valuation reserve to offset its deferred tax asset. Towards the end of spring, Standard & Poor's dealt a further blow by lowering MRM's counterparty credit rating to CC, reflecting "the highly vulnerable status of existing obligations to non-payment".

The year kicked off badly in January, the company had posted a fourth-quarter net loss of $99.7m, an increase of $62m compared to a net loss of $37.7m in the same reporting period a year earlier. The net loss for the full 2001 year was $86.2m compared to a net loss of $5.6m in 2000.

Less than a month later, MRM announced the sale of its fund administration business, Hemisphere Management, to the BISYS Group Inc for an estimated $130m. But the sale, which saw MRM realise gains of $100m after tax earmarked for debt repayments to banks and debenture holders, failed to ease the financial plight of its US subsidiaries. By the end of March MRM had placed two of the three - Legion Insurance and Villanova Insurance - into voluntary rehabilitation in response to an order issued by the Commonwealth Court of Pennsylvania.

Pennsylvania Insurance Commissioner M Diane Koken took the decision to put the two companies into rehabilitation in a bid to protect existing policyholders and prevent any further financial deterioration. "No new policies will be bound and the companies will begin a process to non-renew their in-force policies in accordance with applicable state regulations," MRM said in a statement. Legion Insurance Group had been under the watchful eye of the Philadelphia insurance department for about two years, but it was the series of ratings downgrades and a thwarted capital raising initiative that prompted the department to take action.

The insurer said that it would continue to evaluate the "financial accounting implications" resulting from the situation and look at a number of strategic alternatives with its financial adviser, Greenhill & Co.

Between the two of them, Legion Insurance and Villanova Insurance have $1.3bn in admitted assets and conducted business in all 50 states. Legion Insurance, acquired by MRM in 1987, wrote property/casualty, various health coverages, and accident and health, while Villanova wrote large deductible workers' compensation business. The companies reportedly have about 700 policyholders across the US.

The US-based surplus lines unit Legion Indemnity, acquired in 1996, remains in business, but analysts believe that in the wake of another recent ratings downgrade that the unit will be under regulatory control before long. S&P commented that "it is highly likely that Legion Indemnity Co, Mutual Risk's triple C (currently vulnerable) rated US insurance subsidiary, which is not yet under regulatory control, will fall under regulatory control prospectively."

According to Pennsylvania Insurance Department spokeswoman Melissa Fox, the group had $494m in liquid assets at the beginning of 2002, but $317m of that is said to be tied up in reinsurance recoverables. This situation mirrors the overall group circumstance, where a proportion of the total reported $2.6bn in reinsurance recoverables appears difficult to collect, though this is not particularly surprising when organisations such as insolvent units of Reliance Group Holdings are on the list of reinsurers. For 2001, MRM reported about $27m in potential recoverables was written off its books as a direct result of the Reliance failure. Other defunct reinsurers brought the total to just over $31m, with a further $18.8m in losses occurring as a result of commutations with other reinsurers.

Unfortunately for MRM, its plight did not end with the losses, rehabilitation and downgrades. In April, MRM was delisted from the New York Stock Exchange when its share value fell below $1, and it is now trading on the Over the Counter (OTC) bulletin board. What's more, the Bermuda Monetary Authority appointed a review team to monitor MRM's business - for which it has to foot the bill - on an ongoing basis because the company is in default under the terms of its convertible exchangeable debentures and its bank credit facilities. Further adding to its woes, company president of 23 years, John Kessock, resigned. The previous month, three high-profile MRM board members from XL Capital (an MRM debenture holder and a Wachovia representative) had resigned. The XL Capital representatives were added to the board last year, following a $112.5m investment in MRM by XL Capital, First Union Capital Partners, High Ridge Capital and Century Capital Partners II. This injection of funds was part of a restructuring of the group which included splitting it into two holding companies - one for specialty insurance business and one for corporation risk management, specialty brokerage and financial services - and appointing former head of programme business at AIG, Douglas Boyce as executive vice president and chief underwriting officer of the Legion and senior vice president of MRM.

It is sometimes the case that when a business starts announcing trading problems, others come out of the woodwork. MRM is no exception. At the end of April, Franklin Logistics reportedly began legal proceedings against two of MRM's Bermuda-based subsidiaries, IPC Mutual and Mutual Indemnity. Both companies are remaining tight-lipped about the case which has been filed in the Supreme Court of Bermuda. According to local media reports, $3m in MRM assets has been frozen as a result of the litigation over transferring the plaintiff's captive programme to another manager.

Where this array of woes will lead is unsure, though a recent MRM filing holds little cheer. April's 10-K filing with the US Securities and Exchange Commission outlined a restructuring programme, upon which the future of the group hangs. Possible strategies include selling off MRM's fee-based subsidiaries, though it notes in the filing that "it is not clear at this point that the sale of these assets would yield sufficient proceeds to satisfy all of the indebtedness". If this proves the case, then the company may file for voluntary liquidation in Bermuda. Under those circumstances, shareholders - including Conseco as well last year's new investors - would come below administrative expenses, policyholder claims and general creditors when payments are made. "It is unlikely that any proceeds of the liquidation would remain after the claims of the general creditors were satisfied," noted MRM in the filing. In addition, "under the terms of our 9 3/8% debentures, we may not pay a dividend of more than $0.07 per share per quarter without the approval of the holders of a majority in principal amount of the 9 3/8% debentures. While the company remains in default of covenants in the agreements governing its 9 3/8% debentures, it may not pay dividends."

The MRM management recently has commented that the best way forward would be for the Legion to come out of rehabilitation, a state of affairs which would unlock its value for shareholders, though this increasingly seems an unlikely event. In the meantime, the effect of the Legion's failure on international markets is yet to be assessed, and the future of the group remains shaky at best.

By Clare Bates and Sarah Goddard, Global Reinsurance.

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