Bermuda is proving a convergence centre for alternative risk financing solutions.
All too often, in recognised leading jurisdictions financial entrepreneurs find themselves bogged down in a mire of red tape and bureaucracy, or are stalled by multiple commissioners and regulators. As a result, many forward-looking risk managers and business innovators will seek a jurisdiction where their entrepreneurial talents and pioneering investment acumen can flourish.
To this end, Bermuda boasts highly sophisticated insurance, e-commerce and hedge fund communities that are all substantively on the ground. These communities are internationally validated (OECD, HMG/KPMG, FATF, et al) with effective systems of regulation.
The strength of these claims is borne out by some statistics:
Bermuda began its risk transfer life as a niche captive market. Over the years, the island's reputation as the insurance laboratory to the world has bred an entrepreneurial spirit and aptitude to tackle risks in creative and pioneering ways. This spirit and approach has seen the development of specialty insurance markets including:
Traditionally (and to a certain extent dictated by regulation), insurance and reinsurance companies have invested the majority of their assets in ‘safe' fixed income investments. According to Robert J. Cooney, CEO of Max Re, “A traditional insurance company probably has a balance sheet that has 90% high grade bonds, maybe 8% equity, and maybe 2% in miscellaneous classes, such as real estate or maybe alternate asset classes.”
For businesses writing low volatility, long payout pattern business (such as life and annuity business), the opportunity arises to invest in alternative investment strategies and receive higher returns. From a US tax perspective, legitimate active offshore insurance companies can benefit from tax deferral on investment income until disposal. In addition, the income of the investment portfolio accrues offshore in a tax neutral jurisdiction like Bermuda and thus on a compound basis. If these companies choose to list on an exchange (such as the Bermuda Stock Exchange), the possibility arises for investors to be holding an investment that is accruing, income tax-free, and possibly get a multiple on that investment if it trades.
Several companies have started to use Bermuda to develop financially innovative structures or products. The Imagine Group provides an example of the convergence of reinsurance and capital markets as a next-generation finite risk reinsurance enterprise, which seeks to be the leading provider of structured insurance and reinsurance capital to the global insurance marketplace. Its products are individually customised, capital-intensive contracts typically written over a multi-year period to provide more predictable revenue and claims payment streams. These contracts may cover multiple lines of business in the life and annuity and property and casualty areas.
Co-CEO Thomas Gleeson commented: “Imagine is in part an organic Bermudian enterprise. It represents a new capital market-focused reinsurance algorithm designed to alter traditional thinking about organisation process, design and the nature of risk and return. Imagine Reinsurance is a tangible demonstration of what our commercial environment and individual determination can create.”
Another recent addition to the Bermudian stable is Max Re, which partnered with Moore Capital and is blending elements of reinsurance risk transfer with hedge fund strategies. Max Re was incorporated and licensed in Bermuda, carrying on both general and long-term reinsurance business.
In particular, it was set up to write long-term mature life business (low volatility, long payout), and some property and casualty business with a capped (finite) limit.
Mr Cooney commented, “Currently 40% of Max Re's investible assets go into alternative strategies managed by Moore Capital in a wide variety of strategies and have quarterly liquidity, including long/short equity funds, macro-hedge fund products and leveraged fixed income products. The expectation is that, over time, returns can be significantly higher than a traditional portfolio principally comprised of 6% or 7% coupon bonds.”
Because reinsurance contracts typically need to be collateralised with letters of credit, 60% of Max Re's assets remain in fixed income. This asset split between traditional and alternative investments is not limited by legal prerequisites; it results from the practical needs of the insurer looking to manage risk and cash flow.
Another significant example of the convergence of hedge fund asset management and insurance is the use of an insurance guarantee instead of a bank guarantee to return to investors the principle invested in a hedge fund at a specified date. A guaranteed hedge fund or hedge fund of funds has proved particularly useful where the investment strategy is alternate asset classes.
The insurance community in Bermuda, notably the Zurich Group and XL Capital, has created products to look at treating the volatility of a hedge fund manager's performance (including multi-manager funds) as an insurable risk, which does not require setting aside collateral against that risk. In other words, such a fund could invest most of its capital in its alternative strategy on day one and confer on investors the benefit of their principle guaranteed by an ‘AA' rated insurer.
Traditionally, a guaranteed fund has used a guarantee collateralised by a bank taking up to 60% of the funds assets and using these funds to purchase a zero coupon bond, which will return the relevant principle on maturity. However, this traditional type of structure means that the fund loses the ability to trade at the outset a significant amount of its assets in its alternative portfolio.
According to Sharon Beesley, executive director of Bermuda-based ISIS Ltd, the firm that helped raise the $509m in funding to seed Max Re, “There are several reasons why these structures are becoming more popular and one of them is the fact that you are able to offer both premium and the returns generated from (hedge) funds.” ISIS's role with Max Re was largely that of a fundraiser, but ISIS can also help create the product structure.
From its Bermuda base, Stockton Re offers a wide variety of risk transfer coverages married with a proprietary investment strategy, including a blend of fixed income, equity and derivative positions.
The combination of a Bermuda domicile, private ownership, proven asset strategy and demonstrated willingness to evaluate both risk and return over the long term has allowed Stockton Re to develop its business in the creative deployment of capital. Unique in the reinsurance market, Stockton Re supports its underwriting with a diversified active investment strategy intended to generate attractive long-term rates of return while containing downside volatility within acceptable parameters.
Stockton Re offers earnings and yield enhancement by employing its 30-year experience of asset management as an aspect of its finite programs, where investment income is a significant component of the transaction economics. Stockton Re places a relatively high value on float (funds held on behalf of clients), which can translate into more attractive experience account credits than are offered by internal investment managers.
A carefully monitored risk management approach and a long-term view of performance support the company's investment strategy. As such, Stockton Re is comfortable holding assets that often present difficulties to others, such as swaps, options and futures. Stockton is also willing to assume liability-driven volatility, which may manifest itself as statutory or GAAP earnings fluctuations.
Tremont International Insurance Ltd is a further example of the convergence of life insurance, annuities and hedge funds. It maximises or defers the after-tax returns to investors choosing variable life insurance or deferred variable annuities wrapped around non-US or offshore hedge funds.
Incorporated in July 1996, Tremont International is 51% owned by Bermuda-based Mutual Risk Management Ltd and Tremont Advisers Inc's Bermuda-based subsidiary, Tremont (Bermuda) Ltd. MRM is a $500m-plus market-capitalization financial services and insurance company, offering program business, corporate risk management, special brokerage and financial services, while Tremont Advisers is an investment adviser and information and research company specializing in alternative investments and advises on over $7bn in assets allocated primarily to hedge funds. Tremont Advisers owns TASS Investment Research, providers of the TASS database (a hedge fund database) and is a strategic partner and minority investor in Hedgeworld.com.
The convergence community that has evolved in Bermuda draws on a history of well-established and expert insurance, technical and financial engineers. Companies like Centre Solutions, XL Capital, Stockton and ACE are being joined by the likes of Allianz Risk Transfer, Max Re and Tremont International Insurance Ltd, organisations blending alternative investments with risk transfer.
Bermuda has been developing its international business infrastructure for many decades and is a proven jurisdiction. Always seeking the next, new ‘new' thing, Bermuda has consistently built upon its innovative building blocks, which include the pioneering legislation embedded in Bermuda's Electronic Transactions Act, 1999; the self-regulation implicit in the Standard for Electronic Transactions, 2000; and the effective regulatory regime that Bermuda is renowned for. The development of these acts and Bermuda's positioning as a centre of excellence as an e-business enablement island has attracted the likes of dotRisk, WorldInsure.com and InsurE-com Ltd.
A number of leading Bermuda insurers, along with Lloyd's, have also joined WISe, the worldwide insurance e-commerce initiative designed to provide an open, collaborative platform for international e-commerce trading. WISe is open to direct insurers, reinsurers, brokers and other insurance intermediaries and is designed to reduce processing and administrative costs.
Add to this Bermuda's time zone and geographic location at the confluence of North America, South America and Europe, and the fact that Bermuda is easily accessible from the major US cities and Europe, and the choice for international companies becomes even clearer.
The presence of consulting firms such as ISIS is another factor why those interested in creating innovative financial and insurance hybrid products are flocking to Bermuda. ISIS is a licensed insurance intermediary that also serves institutions and fund managers seeking to structure offshore fund products.
Hugely important is the resident intellectual capital. The top five accounting/consulting firms all have a significant physical Bermuda presence and all offer extensive expertise in insurance structuring. The same is true for a number of the major law firms in Bermuda, in particular Appleby Spurling & Kempe and Conyers Dill & Pearman. At a recent industry function in London, Charlie Collis, a partner at CD&P, enlightened the audience with a presentation on his practical experience with the legal mechanisms behind structuring transformer companies and special purpose vehicles (SPVs), including indemnity cat bonds and credit derivatives. Warren Cabral, a partner at AS&K, concluded the presentation with a review of the new Segregated Accounts Legislation passed in 2000, Bermuda's new public registration system for creating protected client ‘cells' in any industry quickly, inexpensively, simply and effectively. The particular insurance uses for this include, but are not limited to, rent-a-captives, life and annuity companies, transformer companies, financial guarantee companies, and securitisation and derivatives structures/SPVs.
A consequence of this wealth of intellect and service provision is that Bermuda can act as a one-stop shop offering a seamless solution for most legitimate business propositions.
Bermuda is a pristine jurisdiction with a ‘blue chip' reputation in the insurance, e-commerce and financial business worlds. This status is reinforced by the presence of the Bermuda Stock Exchange, a member of the International Federation of Stock Exchanges (FIBV) and International Organisation of Securities Commissions (IOSCO), with almost 30 years of trading under its belt. The Bermuda Monetary Authority regulates all Bermuda-based financial institutions, and the island has status as a Qualified Intermediary with the IRS. In its report on the Caribbean overseas territories and Bermuda prepared by KPMG, the British government recognised Bermuda as a jurisdiction of integrity, and the OECD, FATF and the US Treasury have all excluded Bermuda from any of their blacklists.
Importantly, the Bermuda government works in tandem with the private sector, with bodies such as the Bermuda International Business Association (BIBA) and the Insurance Advisory Committee (IAC), to ensure the business environment is conducive to conducting international business.
The facilitative partners, tax and regulatory regime, enablement services and conducive business environment all blend together to ensure that Bermuda has the capital, both financially and intellectually, to create solutions that transcend the boundaries of the insurance and financial worlds.
Good things converge in Bermuda.
1 Draft year end figures from the Registrar of companies
2 TASS+ Database
3 Figures gleaned from the Bermuda Monetary Authority's website www.bma.bm