With the arrival of the regulators in Hamilton, Mairi Mallon considers the potential fallout from the finite investigation for Bermuda

The men in black suits stepped off the planes from New York into the bright sunshine of Bermuda, walked past the local businessmen wearing brightly-coloured Bermuda shorts and slipped into the pastel-shaded offices of Hamilton almost unnoticed. But the tension which their arrival created was almost palpable.

"It was like being invaded by very, very serious auditors," said one executive whose offices were put under the microscope. "The teams have been down here and coming in and inspecting e-mails and files - that is part of the due diligence. They were all business. You knew not to fool with them."

Meet the Spitzer team. Since the announcement at the beginning of the year that New York Attorney General Eliot Spitzer was broadening his investigation to include "the sale and purchase of finite insurance products", Bermuda has found itself caught in the beam of the regulatory spotlight. And while Spitzer himself has not yet been sighted on the island, his teams have been making low-profile swoops on offices across the capital Hamilton.

Bermuda is the world's third largest reinsurance market and has been hailed the insurance laboratory of the world - a place where innovative products like finite could be used and developed with pride. Many insurers have always prided themselves on providing finite insurance - but in the current climate many such providers are keeping their heads down, hoping that if they prove what good corporate governance they have and just how squeaky clean they are, the issue will go away and they will not be targeted.

The AIG affair

Bermuda has been pulled into the investigation by New York Attorney General Eliot Spitzer and the US Securities and Exchange Commission into AIG. At the heart of the matter is a finite risk contract between General Re (a unit of Berkshire Hathaway) and AIG. In 2000, Cologne Re, transferred a block of business to the Bermuda subsidiary of AIG - a massive office block with hundreds of employees and central to the AIG global operations. Cologne Re passed $500m of premiums to the Bermuda subsidiary, matched by potential losses to the same value. AIG booked the premiums as revenue and then added $500m to its reserves.

As the premium matched the potential losses, AIG faced no real risk, and so should not have treated the $500m as revenue or boosted its reserves, according to the investigators. Cologne Re then passed an additional $100m of potential losses to AIG to "suggest" that risk was transferred. General Re "paid" AIG $10m in fees for the deal, only for this sum to be routed back to General Re through an AIG-affiliated broker with a $5m fee for General Re on top.

Access to AIG's offices in Hamilton was severely restricted and heavy security put in place hours before the decision came from New York headquarters to fire its Bermuda-based legal counsel Michael Murphy for "failing to cooperate with authorities". In addition to being legal counsel, Murphy was also a close confidant of Maurice "Hank" Greenberg, former chief executive and chairman of AIG, and played key roles in other AIG subsidiaries in Bermuda. He is still said to be in Bermuda, but has gone to ground (a difficult thing to do when there are just 62,000 residents) and some expect him to emerge, phoenix-like at some later time.

AIG has sent memos to staff ordering them not to tamper with documents in Bermuda and several other AIG employees in Bermuda have resigned. In a letter to shareholders, the group said it had become aware of efforts to remove documents and information from its Bermuda building without the company's permission - but said it immediately brought these incidents to the attention of the authorities.

AIG has also admitted it had previously overstated the independence of some Bermuda-based companies with which it does business. AIG said it had "recently" found evidence it had control, although not majority ownership, of Richmond - a company also housed in AIG's tower-block headquarters, on Richmond Road.

Finite fallout

The fallout from the ongoing investigation appears to have affected a number of other companies in Bermuda. The decision by shareholders to close Inter Ocean Re came as a surprise. In April, the company said it had voluntarily entered into run-off and had ceased writing new business. No reason was given for shutting up shop and management are refusing to say any more on the issue. However the finite risk reinsurer had just had its rating downgraded by AM Best, and there was concern that there would be little demand for the company's products in the climate of fear created by the Spitzer probe.

RenaissanceRe, one of Inter Ocean's shareholders, was forced to make embarrassing restatements because of the accounting of finite reinsurance policies with the company. It had to restate earnings for 2001 right through to 2003 because it decided it had not accounted properly for transactions with Inter Ocean, according to a 10-K report filed with the Securities and Exchange Commission.

Platinum Underwriters cancelled a finite policy on its books in order to avoid "unwelcome scrutiny", which meant it did not take a $22m in quarterly earnings on a deal that "easily met and exceeded" the standards for risk transfer, it said.

Since the beginning of the year, US regulators have peppered the re/insurance with subpoenas requesting information on finite transactions. Those hit include: AIG, General Re, Platinum Underwriting Holdings Ltd, ACE Ltd, Chubb, Swiss Re, St Paul Travelers, Zurich Financial Services, Munich Re, Hannover Re and RenaissanceRe.

"There is a huge amount of work involved when you are served a subpoena," said one executive (all the executives interviewed by Global Reinsurance would only speak frankly under conditions of anonymity). "The man-power that is involved, the cost, the total number of hours spent going through e-mails, documents etc is amazing. And it is a real distraction to the day-to-day work of a company. It is ever-present in what you do."

A word repeatedly used by executives about the Spitzer/AIG investigation and its effect on the industry in Bermuda is "taint". Executives believe that while it will not kill off the prosperous offshore centre's appeal, it has had a negative impact. One said: "Do I think there is a direct threat from this attack? No. Do I think there will be some adjustments? Of course I do."

And the Bermuda Monetary Authority is already reviewing procedures and looking at how to tighten up its processes in a bid to comply with ever-changing international standards and has launched its own probe into the AIG affair.

But there have been other, less direct fallouts. Bermuda is used to having a so-called Class 4 large insurer setting up on its shores at least once a year, and the fact that there have been none since the Spitzer investigation has led some to link the two. However, the general feeling amongst the island's reinsurance community is that the issue is not this time company specific, but issue specific, with finite insurance being the target rather than any particular company.

There is, however, resentment among the executives about the probes. Publicly the companies all toe the collective party line and say they welcome the added scrutiny and the improvements it will bring in the long run. But in private they are seething about the unchecked power Spitzer has.

"Spitzer is relatively near God in deciding what is right or wrong," said one.

Another said: "Spitzer can come in and do what he likes. You have no right of appeal. You have a legitimate business, doing nothing wrong, using common industry practice, and you have to stop everything because he comes along. Woe betide the person who does not bow in the path of the Spitzer men."

The re/insurance industry's fear in Bermuda is further magnified by the large numbers of executives, actuaries and underwriters crammed together in 22-square miles of tropical paradise. They eat together, drink together and pass each other every day in the street. There is no way of avoiding conversation about Spitzer and his probe.

Bermuda's opposition leader Grant Gibbons said, "The problem with these issues is that Bermuda tends to think the world revolves around it. There are Barbadian companies, companies from Dublin, New York, and even some Panama pieces in all of this.

"It is having an effect, particularly on morale, and everyone is a bit subdued at the moment."

Survival of the transparent

Most think that Bermuda will survive, and this too will pass. One executive put it another way. "We are keeping our noses clean and looking like the good companies that we actually are. Bermuda is flexible. Bermuda is creative. It will adjust."

Dr Robert Hartwig, chief economist at the Insurance Information Institute in New York said if the insurance sector maintains a good track record of transparent dealings, full disclosure and adherence with accounting laws and guidelines, it will be fine. "The challenge for Bermuda is going to be to deflect any accusations that it is a haven for any companies looking to benefit from lax regulation and looking to be very opaque with respect to their financials," he said. "And, after some period of being fearful of it, finite reinsurance products will remain a mainstay in the reinsurance marketplace. I don't think these probes are a death sentence for finite."

- Mairi Mallon is a freelance contributor to Global Reinsurance.