Bermuda has long proved a magnet for US ceded reinsurance, and according to Ronald Gift Mullins, the island's pull is growing stronger

While Bermuda's captive sector has encountered stiff competition from a number of US states, the tiny island still commands the largest share of ceded US reinsurance. And in spite of troubling US transparency laws and investigations by several government agencies, there is little doubt Bermuda will remain the country of choice for ceding US reinsurance premiums, especially as the fusing of US reinsurers continues, and few new ones are funded.

In 2003, the latest figures available, US re/insurers, according to the Reinsurance Association of America (RAA), ceded about $53.5bn in premiums to affiliated and unaffiliated alien reinsurers - companies that are domiciled outside the US. This was 15.9% above the $46.2bn reported in 2002, and more than double the $22.9bn in 1999.

If a clear distinction is made, noted the RAA, of the ultimate parent of a reinsurer, alien (or alien-owned) companies accounted for 80.4% of US premiums assumed in 2003 while US companies accounted for under 20%. In 2002, the figures were 77.1% and 22.9% respectively. About 2,350 alien reinsurance companies assumed premiums ceded from US companies.

Of premiums ceded to affiliated alien reinsurers in 2003, Bermuda ranks first with $14.2bn; second is Switzerland, $7.5bn; then Germany with $4.3bn; the UK with $1.5bn and Barbados with $1.1bn. These five countries represent more than 95% of the affiliated alien ceded premiums. The ceded premiums to Bermuda jumped close to 80% from 2002 to 2003.

Bermuda, for more than 20 years, has welcomed all kinds of insurance and reinsurance companies and is now the prime arena for formation of new insurers and reinsurers. From the early 1970s, captive reinsurers were established on the island, and the crisis in general liability in 1985 and 1986 brought forth ACE and XL. Then, following the destruction from Hurricane Andrew in 1992, seven companies were created with a total capital of $4.5bn. The 9/11 World Trade Center attack sent more than $13bn in capital to Bermuda.

Through Sarbanes-Oxley clearly

Though Bermuda now dominates reinsurance ceded by US companies, recent problematic incidents in America may have a future dampening affect. The passage of the Sarbanes-Oxley Act in 2002 requires CEOs and CFOs of all public corporations to prepare a statement to accompany the audit report to certify the "appropriateness of the financial statements and disclosures contained in the periodic report, and that those financial statements and disclosures fairly present, in all material respects, the operations and financial condition of the issuer." Violating this provision knowingly can lead to heavy fines and litigation for a company's board of directors as well as chief officers. Sarbanes-Oxley applies to offshore public companies if they are listed on a stock exchange in the US, and while private companies are not governed by the act, many are following the rules as a good governance practice.

Further, since last October when a complaint was served on Marsh & McLennan Companies for accepting contingency fees, Eliot Spitzer, attorney general for New York, and others have been investigating specific reinsurance transactions, some located offshore including Bermuda. In addition, the Department of Justice, the Securities and Exchange Commission, and the New York State Insurance Department have also been actively examining insurance and reinsurance practices, again some of them within Bermuda companies. But will these on-going investigations and examinations have an insalubrious influence on the transmission of billions of reinsurance premiums to Bermuda?

Bermuda shunned?

Dave Bradford, executive vice president, Advisen Ltd, has no doubts that Mr Spitzer is going to turn up the heat on US companies with offshore subsidiaries, where the offshore company's financials are - or should be - consolidated with the US parent, "but I'm not sure what he is empowered to do about offshore companies operating in the US through licensed US subsidiaries. Of course, he may pressure the New York insurance regulators to tighten up on offshore companies writing in New York, but I don't know if even the New York regulators want to start that battle."

Mr Bradford does think fewer US companies are likely to establish - or at least heavily utilise - offshore subsidiaries in the current environment, "but it still appears to make sense for Bermuda companies to establish US subsidiaries."

There is no empirical data that suggest there will be a slow down in sending reinsurance premiums to Bermuda said W Scott Williamson, assistant vice president, RAA. In fact, all data point to a lot of growth in that market. "Bermuda is the largest country currently assuming US business," he said, "and that volume has been growing from 1996 when the RAA first began publishing reports on alien reinsurers."

Mr Williamson believes that some reinsurers and insurers in Bermuda will participate in Sarbanes-Oxley to the extent they are listed on American exchanges. He said, "Some offshore reinsurers may not be subject to Sarbanes-Oxley, but they would be required to post collateral if they are not licensed/authorised in the US and subject to state insurance regulation."

Sarbanes-Oxley has an impact "but is not a deterrent to setting up companies in Bermuda or ceding reinsurance," said Damien Magarelli, director, Standard & Poor's. He sees companies moving to and staying in Bermuda because of its flexibility, speed in approvals for changes in contracts and no taxes. "All in all Bermuda entices," he said, "with a very favourable environment for the establishing and operating of reinsurance and insurance companies."

However, the fact that they are offshore, Mr Magarelli observed, does not mean they are untouchable by the investigations being conducted by the New York attorney general and the SEC, as can be seen by the subpoenas issued to several companies in Bermuda. "But because of these legal actions I am not seeing any company moving out of Bermuda for the US or another country," he said. "Bermuda is the centre of excellence for catastrophe underwriting expertise. The act of setting up an offshore company doesn't signal something unusual or questionable is going on. It doesn't raise red flags for analysts."

David Kalainoff, executive vice president, Max Re, Bermuda, said, "I don't know that anyone wants to move back to the states. Rather, they can set up a subsidiary in the states, which is as good as being there." He noted that most if not all reinsurance and insurance companies in Bermuda ascribe to Sarbanes-Oxley.

Alluring Bermuda

Following the trend of the past 25 years, Bermuda has been the favoured location for establishing new highly capitalised re/insurance companies. In 2004, two new professional reinsurers were funded: Channel Re, a financial guarantee reinsurer, and Wilton Re, a life reinsurer. Ownership of Channel Re with $350m capital is divided between RenRe, Koch Financial, Partner Re and MBIA. Wilton Re was established in Bermuda with $600m in capital contributed by MMC Capital's Trident III Fund and private equity firms Vestar Capital Partners and Friedman Fleischer & Lowe. CIG Re Ltd was formed in September 2004 with capital of $450m provided solely by Citadel Investment Group LLC, a Chicago-based hedge fund manager.

At year-end 2003, there were 410 professional insurers and reinsurers in Bermuda. Of these 410, 232 beneficial owners were in North America, mainly the US, and 72 were in Bermuda. Total capital and surplus of these re/insurers was $65.2bn; North American-owned companies' surplus totalled $30.8bn, compared with Bermuda-based companies' $26.8bn.

In the US, within the past 20 years, withdrawals and increasingly mergers has reduced the number of "professional reinsurers" (as opposed to reinsurance departments) to just 35 in 2004. The number of professional reinsurers reporting to the RAA in 1989 was 74; in 1982 the number was 129.

With regard to surplus, US reinsurers reported $62.1bn in 2003, according to the RAA, and includes all US reinsurers regardless of ultimate parent domicile. The figure doesn't include all the foreign affiliates of US companies. Of the $62.1bn, $17.2bn was reported by US subsidiaries whose ultimate parent domicile is outside of the US. The remaining $44.9bn reflects the surplus of the US-owned reinsurers. Remarkably, the policyholders surplus of National Indemnity and General Re, both part of Berkshire-Hathaway, is close to $28.4bn, representing more than 60% of the total surplus of US-domiciled reinsurers.

Since 1984, the US reinsurance business has never produced an underwriting profit for any year, though it came close in 1997 with a loss of only $637m. It has since 1986 (except for 2001 due to 9/11 when it had a net loss of nearly $3bn) produced a net profit, though that figure sometimes varied as much as $4bn from one year to the next.

Within the past 15 years, there have been a number of affiliates of Bermuda and European reinsurers formed in the US, but except for the creation of Risk Capital Holdings Inc in 1995, there has been no new US-domiciled reinsurance company formed for decades. Risk Capital after undergoing a name change to Arch Capital Group Ltd, sailed off to Bermuda in November 2002, though it maintains a number of US affiliates.

Unfriendly US

Increasingly, US insurance companies have declined to set up a reinsurance department or subsidiary in the US. In the 1980s and 1990s, US insurers often allocated a certain amount of their surplus to get into a line of reinsurance. This new entry enabled it to write reinsurance business in areas where it was not writing primary risks geographically in America, step into new markets or write international risks.

Today, most of the reinsurance affiliates and departments of primary insurers have been merged with US and foreign professional insurers, sold or put into run-off. Most experts agree the reason for the declining US professional reinsurance industry is the US income tax rate and the tightening grip of regulation of reinsurance. "Clearly it is Bermudas' tax advantage," said S&P's Mr Magarelli. In the US, the income tax rate for corporations is 35%, though few reinsurers, using credits and losses, pay at that rate. But in Bermuda, there are no income taxes, no taxes at all; none.

Mr Magarelli sees a continuing strong interest in Bermuda for establishing new companies. At present, there has not been a great rush to set up additional reinsurers, because usually the greatest increase comes following a catastrophe, either natural or man-made, but no single multi-billion dollar catastrophe has occurred recently. "Besides there is more than enough capital now in the market," he said. "Before investors would want to fund an additional reinsurer or insurer, the investors would have to be convinced they could make a profit, perhaps by filling a specific niche that lacks competition presently."

Brokers curbed

The on-going investigations of brokers and re/insurers may curtail a historical source of capital for setting up re/insurers in Bermuda. The big brokers - Marsh, Aon and Benfield - have long been involved in creating new re/insurance companies, including captives, in Bermuda. Willis has decided not to invest in companies in which it places business. It views assigning certain markets with specific reinsurers a potential conflict of interest.

At the beginning of December 2004, Aon completed the sale of almost all of its 19.4% stake in Endurance, for which it received $321m. Other brokers may follow suit. Marsh & McLennan Companies could see its profits further reduced if required to forfeit its investments in re/insurers. MMC Capital had previously participated in providing the capital for at least 10 re/insurance companies.

Preventing brokers from being involved in the formation of re/insurers or requiring them to dispose of their present investments, could reassure reinsurance buyers of a more straightforward placement of their coverage. On the other hand, when next the market suffers from a multi-billion disaster, the capability to generate new capital may be severely limited with the expulsion of brokers' money.

Whatever the outcome of these governmental inquiries and lawsuits concerning the integrity and solvency of Bermuda's re/insurer industry, the island has existed as a rock in the thrashing Atlantic for a very long time. Rest assured it will survive this latest puny assault.

Ronald Gift Mullins is an insurance journalist based in New York City.