David Lines, Jr outlines Bermuda's regulatory environment.
The recent influx of capital into Bermuda's insurance market, which stood at over $15bn (from new and existing companies) at the time of writing, has made this tiny island powerhouse the envy of the reinsurance world.
The new capital flowing into Bermuda is largely a result of Bermuda's remarkable success over the last 50 years. The island's reputation in the world of reinsurance and insurance has been steadily growing and Bermuda is now widely recognised as one of the world's great financial marketplaces.
More than that, Bermuda has always been able to respond swiftly and efficiently to shortfalls in the industry; witness the formation of giants ACE, XL and Centre Re in the mid-to-late 1980s, and the new `cat companies' that set up in Bermuda in the aftermath of Hurricane Andrew. In each case, a lack of capacity created an investor-friendly hard market.
This time, some of the newly incorporated firms include:
Many have commented that a `sheep' mentality dominated the decision of which jurisdiction these companies would set up in. While that, in some small part, may be true, it does not sufficiently answer the question why Bermuda has been able to maintain, enhance and expand upon its tremendous record of success in the insurance and reinsurance industry.
It has always been an axiom of business that success breeds success; the paradigm in Bermuda has been shown to work and to be well tested. In this sense, the new companies incorporating in Bermuda are not taking any material risk in setting up their operations. Indeed, the paradigm has been clearly set and many of these companies are simply following a well-trodden and explored path of success.
Over the years, Bermuda has developed into a competitive marketplace for a range of insurance, reinsurance, legal, tax, accounting and brokerage services with substantive physical operations. The newly incorporated companies come to the island with clean balance sheets and (with few exceptions) will all have fully operational offices in the market. As one would expect from a functional market, the underwriters, actuaries and executives will be largely based in Bermuda and write their business out of Bermuda.
Those traits have served Bermuda well, as recent figures indicate.
Statistics show the Bermuda insurance market continues to develop as one of the world's most important providers of insurance capacity and expertise. In 2000, Bermuda insurers recorded total assets of $146bn with capital and surplus rising to over $59.2bn. Overall gross premiums written grew to just over $38.1bn and net premiums were over $32bn.
One of the hallmarks of the Bermuda insurance industry is its continued growth within the confines of strict adherence to sound underwriting principles. This commitment to underwriting restraint and security is strongly reflected in an industry-wide premium to capital and surplus ratio of 0.54 to 1.
While Bermuda continues to be a leader in captive insurance, it has been the sustained growth in the non-captive sectors that may have the greatest significance for the future of the evolving Bermuda insurance market.
Bermuda's class 3 insurers, which includes reinsurers writing third party business, insurers writing direct policies with third party individuals, captives deriving more than 20% of net income from unrelated risks and finite reinsurers, experienced very strong growth in capital and surplus, finishing 2000 with over $27bn. The rising importance of this class was further evidenced in the year 2000 incorporation figures in which class 3 formations accounted for the biggest single category of new companies, representing 38% of all 2000 insurance formations.
However, these successes have been crafted on solid foundations. These foundations include insurance regulation, regulatory flexibility, outstanding reputation, the legal system and market acceptability.
The regulation of the Bermuda insurance industry may be characterised as being a system of shared regulation. As such, the regulators work closely with insurance industry professionals, principally under the aegis of a system of committees, with a view to maintaining standards, addressing common issues and problems, reacting to changing market conditions and otherwise promoting Bermuda. Importantly, all applications to incorporate an insurance company in Bermuda must first seek the approval of the Insurance Admissions Committee, the members of which are drawn largely from the market.
Indeed, at the behest of the industry, Bermuda substantially amended the Insurance Act 1978 and related regulations to increase its regulation of those companies which write substantial third party (unrelated) business. The amendments also identified the unique nature of excess liability and property catastrophe companies and their needs for special regulatory requirements.
As a result, Bermuda operates under a multi-licence system, and the Insurance Act provides for four classes of general business insurance licence. On application to incorporate, the Supervisor of Insurance, will assign an applicant to a class depending on the criterion set out in the Insurance Act and depending on the relationship between the company, its shareholders and policyholders, and the type and scope of the business it will underwrite.The four classes are:
Class 1: pure captives or companies, which write coverage for a group of affiliates.
Class 2: insurers owned by unrelated shareholders, which insure the risks of any of those shareholders or their affiliates.
Class 3: a catch-all class for insurers not falling into classes 1, 2 or 4.
Class 4: this class applies to large carriers writing business including property catastrophe reinsurance or excess liability business.
In each class the regulatory requirements vary. For example, compliance for a class 1 captive is not nearly as severe as for a class 4 catastrophe company; the minimum capital and surplus for a class 1 company is $120,000 whereas it is $100m for an operation falling under class 4. Further, a class 1 captive does not have to file a loss reserve specialist opinion, while a class 4 company must file one annually.
Unlike onshore jurisdictions, Bermuda's insurance laws and regulations are designed to facilitate creative structures for risk transfer, while ensuring that companies operating in Bermuda do so responsibly and maintain appropriate margins of solvency. To that end, the Insurance Act specifically enables insurers to apply to vary or set aside certain sections of the Act.
Locally referred to as a Section 56 Application, this section of the Act provides tremendous flexibility and enables applicants to seek to structure their business in a way which best suits the market rather than a set of immovable regulations. Also, there is an opportunity to obtain private legislation from the Bermuda Parliament and so create unique insurance structures.
This inherent flexibility is one reason why the vast majority of financial reinsurance companies and rent-a-captive companies are based in Bermuda. The flexibility has also enabled the creation of `transformer' companies such as Arrow Re and Lehman Re, hybrid companies that transform insurance and reinsurance risk into capital market products and vice versa.
Bermuda regulators have also kept pace with the expanding insurance industry by responding with legislation aimed at streamlining government processes and allowing for increased flexibility and ingenuity in structuring companies, services and products. The passing of the Segregated Account Companies Act 2000 (SAC) was a significant event for Bermuda insurers and reinsurers.
A segregated account company employs statutory divisions between accounts to protect the assets of one account from the liabilities of other accounts. These statutory divisions do not create separate bodies corporate, but rather achieve within a single company what would otherwise be achieved by incorporating subsidiaries or by a company creating a floating charge over certain assets in favour of its obligations.
The legislation provides for fast, effective and responsible segregation of assets, and makes Bermuda even more effective as a jurisdiction in which to structure insurance derivatives and structured reinsurance transactions.
Bermuda legislators are also mindful of Bermuda's role in the global market and have responded with measures to ensure that its favourable status as a jurisdiction for the conduct of international business remains intact. In this regard, the Proceeds of Crime Act 1997 was enacted to prevent money laundering and the National Anti-Money-Laundering Committee was created to ensure that Bermuda was in compliance with, and where possible, exceeds international anti-money-laundering requirements.
Not surprisingly, this focus on quality and reputation has been repeatedly cited as one of the principal reasons why many of the world's largest institutional players have selected Bermuda. For example, Bermuda companies are well known to, and readily accepted by, the world's major stock exchanges. Professionals can, therefore, be confident of the securities commission reviews that reflect high confidence in Bermuda. Likewise, investors have confidence in the probity of Bermuda's English common law-based system and its ability to protect their interests. This level of comfort is reflected in the recent influx of capital to Bermuda and the fact that a large number of Bermuda's companies are registered on major stock exchanges around the world.
The Government of Bermuda recently commissioned a joint study with the UK, which reported that Bermuda meets or exceeds world regulatory standards. The report suggested a number of enhancements and Bermuda has replied positively and is reviewing further improvements to keep Bermuda in the forefront as a responsible jurisdiction. Bermuda has also received the approval of the Organisation for Economic Co-operation and Development and has not been included in its list of harmful tax jurisdictions.
With a solid regulatory foundation in place, Bermuda's insurers are busy today with a myriad of activities. They include underwriting traditional casualty insurance or property catastrophe reinsurance, developing expertise and capacity in such growth areas as life reinsurance and professional insurance, and bringing innovation to the expanding risk transference marketplace through derivatives, securitisation and credit enhancement products.
By David Lines
David Lines is a partner and a member of the insurance team at Appleby Spurling & Kempe in Bermuda. He can be reached by e-mail at firstname.lastname@example.org .