Rory Gorman looks at recent developments in Bermuda's captive sector
It was Fred Reiss, a fire protection engineer working for a US insurance company, who in the late 1950s saw the opportunity for US corporations to set up insurance companies that would only insure the risks of their parent entities. He coined the phrase 'captive insurance' to describe these new insurers, but quickly found that the US itself was not the best place to establish a captive insurance company due to the onerous levels of regulation that were applied. In the early 1960s, he identified Bermuda as the best place to establish his business. In 1962, with the enthusiastic assistance of leading local lawyers, bankers and politicians, he set up the first captive management company in Bermuda.
The captive concept quickly proved very popular with US corporations, and by the early 1970s, several hundred had been established in Bermuda.
The major US brokerage houses had decided to extend the services they offered to their clients by setting up management companies. In the meantime, the large international audit firms had established presences on the island in order to service the increasing local needs of their large clients.
The government of Bermuda was careful not to impede the growth of this new business with cumbersome regulatory processes. It formed the Insurance Advisory Committee to help it in its deliberations, and in 1978, passed the landmark Insurance Act to provide clear legislative underpinning to the industry.
Initially, Bermuda captives enjoyed very favourable tax treatment from the US Internal Revenue Service (IRS), but that privileged position was severely eroded by the Tax Reform Act of 1986. Some measure of tax efficacy was retained through landmark tax cases such as the Humana decision, which defined the circumstances in which captive insurance could be treated as real insurance.
Bermuda's success as an offshore jurisdiction for captives was noticed internationally. Many sought to emulate it with widely varying degrees of success. In the US, the states of Vermont and Colorado were early adopters of captive-specific legislation, as were other offshore US-centric locations such as the Bahamas and the Cayman Islands, and Guernsey in Europe. One legend has it that a certain jurisdiction, anxious to jump-start its foray into the captive world, copied Bermuda's Insurance Act - even down to the typos.
Bermuda has continued to grow as a captive domicile. It is estimated that there are 1,250 captives registered in the domicile in 2004. Based on the statistics published by the Bermuda Monetary Authority (BMA) for 2002, captives are probably writing about $20bn in net premium on a capital and surplus base of $30bn. These are impressive numbers. However, Bermuda nowadays has many competitors snapping at its heels; 27 US states have enacted some form of captive legislation. Vermont has become a strong captive domicile, but even it has to take account of the growth of captive numbers in Hawaii, South Carolina, New York and Washington, DC. Outside the US, Cayman has carved out a strong presence in medical malpractice captives, while Dublin, Guernsey and Luxembourg are just some of the local options available to European risk managers seeking a base for their captives.
While Bermuda's captive industry is still many times the size of any of its rivals, it has to fight ever harder to sustain that advantage.
One solid advantage that Bermuda possesses is that it is not just a captive domicile. It is also home to major insurance and reinsurance markets like ACE, XL, Axis, Endurance and RenaissanceRe. There is a strong symbiotic relationship between these entities and the captive industry.
At the simplest level, it is highly convenient for the risk managers of major corporations to site their captives in Bermuda. In all likelihood they are making at least annual visits during renewal season to see their underwriters, and it makes sense to tie in a captive meeting with these trips.
Review the staffing of most of the commercial carriers in Bermuda, and you will find the names of many who began their careers in some segment of the captive industry. They worked either directly in a captive management firm, or in one of the other sectors servicing captives such as the audit firms, IT consultancies or actuarial practices. What's more, some of the insurance capital deployed in Bermuda has been used to set up rent-a-captives, or to provide reinsurance capacity for captives. Negotiations are vastly simpler and quicker when the carrier is across the street from the captive manager.
In the last ten years or so, offshore domiciles have become an increasingly important slice of the financial services pie. Many supranational regulatory bodies such as the Organisation for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF), or their less well-known offspring such as the Financial Stability Forum (FSF) and Financial Action Task Force (FATF), and, more recently, the International Association of Insurance Supervisors (IAIS), have begun to pay them more and more attention.
Naturally Bermuda, as one of the largest, has been the subject of many of the formal reviews that these bodies have undertaken, and has usually emerged with flying colours. One significant change that resulted from a 'best practice' recommendation in one of these reviews was the separation of the insurance regulatory function from the government, and as a consequence it is now a division of the Bermuda Monetary Authority (BMA). The BMA has begun to play an increasingly important role in the development of global standards for insurance and reinsurance supervision through its regular attendance at, and participation in, meetings of the IAIS. Bermuda has been very concerned that regulatory practices appropriate to the supervision of large commercial insurance and reinsurance entities not be indiscriminately or unwittingly applied to the captive sector, and has worked hard to ensure that the role and much lower risk profile of captive business is understood.
Only in America
US corporations continue to be the principal market for Bermuda's captive services. In the last few years, Bermuda has been an innocent bystander in a series of unfortunate events that have resulted in frequent media and political attention in the US. Global Crossing and Tyco, both headquartered in Bermuda, ran into well-publicised difficulties. The shareholders of a handful of US corporations voted to move their headquarters offshore to Bermuda, giving rise to a media frenzy about 'unpatriotic' activities and a lot of erroneous information about Bermuda's role in these events.
Enron's collapse was facilitated in part by the use of non-US, off-balance sheet special purpose vehicles. Although they were not based in Bermuda, the fact that the word 'offshore' kept cropping up continued to fuel the rhetoric aimed at Bermuda. Most recently, John Kerry, in his quest for the Democratic Party nomination for President, has on numerous occasions vilified offshore jurisdictions in general and Bermuda in particular.
(The major role Bermuda played post-September 11 in helping stabilise the availability and cost of insurance to corporate America seems to have been generally overlooked.) It appears that this near-continuous state of siege has caused many US risk managers to be very cautious about locating their captives in Bermuda, even when there are compelling reasons to do so.
The passage of time will allow the quality of Bermuda's captive product to re-assert itself. Very recently, Bermuda government representatives met a number of influential politicians and media personnel in Washington, DC to try to quietly but forcefully counter the spate of adverse and erroneous publicity. Their efforts already appear to be paying off handsomely, with a 1,100-word pro-Bermuda article in The Wall Street Journal early in May.
Bermuda continues to broaden and deepen its captive product. The Segregated Accounts Act 2000, which amongst other things helped strengthen the appeal of the rent-a-captive concept, was several years in production. Many felt that by taking so long to craft a multifaceted but robust piece of legislation, Bermuda had - perhaps irretrievably - ceded the field to competing domiciles which had introduced similar legislation several years earlier. However, a survey in late 2003 of Bermuda's captive managers showed that clients have flocked to sign up to the new facilities engendered by the Act, putting Bermuda firmly in the number one position.
The events of September 11th have increased the scrutiny given to 'know your customer' policies and procedures, particularly in the banking sector.
Bermuda has strong anti-money laundering legislation in place, and is now looking at extending the scope of that legislation. The application of the USA PATRIOT Act has to date been focused on the US banking sector, but it has been intended to broaden that application to include other financial sectors, including insurance. Even in advance of any such proposed moves, the captive industry in Bermuda has responded by developing a set of 'best practices' against which any manager can benchmark its activities in this regard.
Bermuda, small though it may be in physical size, punches far above its weight in the vast global economy. As the hard market continues to unravel at a tremendous pace, and more competitors vie for a bigger share of the captive pie, it will be interesting to see how Bermuda fares in this sector of the global economy that it has long dominated. Few would be willing to bet against it.