By Charles E. Boyle

From Novelty to Necessity: Bermuda’s Insurance Market 2008

Bermuda’s insurance industry has grown steadily since it began 50 years ago. It is now a mature market, and, in certain sectors – natural catastrophes, crop insurance and medical malpractice – it provides vital coverage that would otherwise be unavailable or prohibitively expensive.

Despite their now global presence, Bermuda’s insurers and reinsurers occupy a relatively modest place. “They’re not giants,” said Bradley Kading, president and executive director of the Association of Bermuda Insurers and Reinsurers (ABIR). He pointed out that only one company, ACE Limited, is listed by A.M. Best as being in the top 30 insurers by capitalization, at number 28. “Bermuda is very much a specialty market,” Kading continued. “It’s probably about as big as it can be right now.” The ABIR represents 23 of Bermuda’s insurers and reinsurers, primarily the major companies.

Bigger isn’t necessarily better, however, as Bermuda’s insurers have proven over time. They’ve honored their commitments to pay claims, even when they’ve been enormous. Any doubts about their financial stability should have vanished after the 2004-05 hurricane season. According to the Insurance Services Office (ISO) insured losses from the 2005 hurricanes were $47.2 billion, which broke the previous record of $22.9 billion set in 2004. A Swiss Re sigma report on 2005’s catastrophes estimated that Katrina alone cost the insurance industry $45 billion, followed by Rita and Wilma at $10 billion each and Dennis at $1 billion.

According to the ABIR, Bermuda’s “reinsurers will pay nearly 30 percent of the insured losses from Katrina, Wilma and Rita,” around $19.5 billion. The ABIR said, “Bermuda’s reinsurers will pay $22 billion to rebuild the U.S. Gulf and Florida coasts from the horrific hurricane seasons of 2004 and 2005.”

While these epic disasters cost the Bermuda insurers a lot of money, they also confirmed the essential role Bermuda now plays in covering such risks. It’s no coincidence that fresh capital flowed into the Island and new companies were formed after the hurricanes. This has been the historical pattern over the last 25 years, and it looks set to continue.

A recent study, “The Bermuda Insurance Market, An Economic Analysis,” by J. David Cummins of the Wharton School, University of Pennsylvania and The Fox School, Temple University, examines the post 2005 situation in depth. “Bermuda continues to play an important role [in the global insurance market],” said Cummins in a telephone interview, “and it’s poised to continue to do so.”

Although capital continues to be readily available, other considerations have to be addressed as well. To begin with, the Island is a finite space; it is limited in the number of people it can accommodate. But rules need to be followed.

The Bermuda Monetary Authority’s (BMA), Supervisor of Insurance has overseen its insurers since 2002. The BMA recently embarked on an overhaul and enlargement of its regulatory system – “to bring it into line with risk-based requirements such as Solvency II,” said Kading. There’s also competition. Bermuda no longer has a monopoly on captives (which were first introduced there), but it still gets its share. Finally, some U.S. insurers, the “Berkley Coalition,” are once again complaining of unfair tax practices. The Island’s industry leaders have vigorously responded to the complaints, as they have done in the past.

Capital Creates a Global Insurance Hub

In 1947 C.V Starr “chose Bermuda as the headquarters for his American International Company,” Cummins notes. The Island’s insurance industry has continued to develop ever since. It is now by far Bermuda’s largest industry. According to the ABIR Bermuda’s insurers “write 18 percent of the aggregate global reinsurance premium; provide 25 percent of the capacity for Lloyd’s, 40 percent of the U.S. property catastrophe reinsurance and 57 percent of the crop insurance.” All of which takes capital.

Bermuda has yet to be severely impacted by the subprime credit crisis and stock market declines. In April 2008 the BMA reported: “The Bermuda insurance market continues to maintain strong performance, against a backdrop of a soft global market. Latest available figures show that Bermuda’s insurers had aggregate total assets of $440.4 billion, which represents a 33 percent increase over the $329.9 billion achieved the previous year. The market also continued to enjoy strong results in terms of gross premiums written, which amounted to a total of $115.8 billion for the year, surpassing the $100.7 billion written the prior year.”

Capital formation has tended to come in spurts, usually after a major catastrophe. It began with ACE and XL in the 1980s in response to the U.S. commercial liability crisis. Another fast growth period occurred in 1992, following Hurricane Andrew. Renaissance Re, Partner Re and a number of other companies that have since been absorbed, were formed in 1993.

After the Sept. 11 attacks a veritable flood of new capital and new companies landed in Bermuda. A few examples: AXIS Specialty – set up by MMC’s Trident II fund with $1 billion in capital; Allied World launched by Goldman Sachs, AIG and Chubb, capital $1.5 billion; Endurance sponsored by Aon and Zurich with $1.2 billion in capital.

A similar capital inflow followed the 2004-05 hurricane seasons when, among others, Ariel Re, Harbor Point Re, and Validus Re were established. Post-Katrina also saw the introduction and rapid growth of “sidecars,” which Cummins describes as “limited term investment vehicles designed to reinsure specific sponsoring reinsurers.”

Cummins explained: “Bermuda reinsurers have developed a risk appetite for the ‘large loss tail’ of the catastrophic loss distribution, with the result that Bermuda firms sustained substantial losses from the 2004-2005 hurricane seasons. Thus, Bermuda firms play a critical role in financing losses from U.S. catastrophes, as well as providing coverage for many other types of events worldwide.”

Cummins also noted that Bermuda expanded to provide “reinsurance coverage for the other major jurisdictions worldwide and also provides a domiciliary jurisdiction for firms from Continental Europe, the U.K., Asia, South America, and Africa.” He describes Bermuda’s progress as evolving from “primarily a domiciliary jurisdiction for captives (pre-1980s), to a reinsurance market primarily for liability insurance and property catastrophe reinsurance (1980s and early 1990s), to a world leader in taking on all types of insurable risks (mid-1990s to the present day).”

In this electronic age the world’s capital providers – investment banks, private equity funds, hedge funds, investment partnerships and insurance companies – can place their capital anywhere in the world. Bermuda remains their first choice for insurance ventures because it offers a number of advantages.

A Business-Friendly Regulatory System

Bermuda’s regulatory system is probably its single greatest asset in attracting and keeping capital and companies. The majority of the companies mentioned were all established within months – not years – of the disasters that precipitated them. Bermuda is one of the few places in the world where that’s possible. That is not to say, “anything goes.” The Island’s integrity, and its continued prosperity, depends on efficient, but not unduly onerous, regulatory principles.

There are four classes of insurance companies in Bermuda. Class 3 is the largest, as it includes large captives and special purpose vehicles. Class 4 companies include the major insurers and reinsurers domiciled there.

Cummins notes that Bermuda’s regulators have been “given generally favorable reviews by international organizations such as the International Monetary Fund (IMF) (2005) and KPMG (2000). The BMA periodically issues ‘Guidance Notes’ on various insurance regulatory issues and is taking steps to fully comply with the Insurance Core Principles adopted by the International Association of Insurance Supervisors (IAIS) in 2003.” He describes the overall purpose of Bermuda’s regulations as “designed to facilitate the creation of companies and products while ensuring that companies operate responsibly within specified margins of solvency.”

To ensure that the Island’s regulations keep pace with regulatory changes in other jurisdictions, the BMA plans to increase its staff by up to 50 percent. It’s intent on “making Bermuda more like the rest of the world,” said Cummins, and “that’s a favorable development, as they prefer to keep up with global [regulatory] standards.” Uppermost for regulators are the European Union’s risk-based Solvency II insurance industry regulations, which are due to come into force in 2012.

Achieving mutual recognition by adopting the same standards would be a boon for Bermuda’s insurers, and is strongly supported by the Island’s larger companies. Cummins said: “The ease of incorporation in Bermuda is a principal factor explaining Bermuda’s attractiveness as a regulatory jurisdiction and also helps to explain why there have been virtually no new reinsurers incorporated in the U.S. during the past 20 years.”

Cummins points out, however, that several U.S. states, starting with Vermont, “liberalized their insurance regulations applicable to captive insurance companies. As a result, the number of captives established in the U.S. has been rising dramatically.”

Infrastructure and People

Insurance companies do not operate in a vacuum. In addition to acquiring the capital and complying with the regulations, they need the executives, managers, actuaries, underwriters and technical experts to actually operate the business. That’s no longer a problem. “Bermuda now houses significant intellectual capital in all areas required to successfully operate an insurance enterprise,” Cummins wrote. “This includes significant expertise in actuarial science, insurance brokerage, insurance underwriting, accounting and auditing, tax management, and general business management. Bermuda also has significant intellectual capital in computer modeling and analytical capabilities, which is particularly important in insurance underwriting and pricing.”

He also stressed that this infrastructure support is “located in a small concentrated area consisting of about one square mile in Bermuda’s capital, Hamilton, with everything within easy walking distance.” Similar concentrations of expertise have made New York and the City of London global financial centers. “Yes, you can do business on the Internet,” said Cummins, “but it’s an advantage to have the experts you need to talk to in one area. Look at Manhattan – eight square blocks provides access to global capital markets.”

A small island has that advantage, but there’s also a downside, as space is limited. In an interview a few years ago, Brian O’Hara, then chairman and CEO of XL, said Bermuda could never accommodate the full range of services needed to operate a truly large company, as there simply is neither the space nor the infrastructure to support them. As Kading indicated Bermuda is just about at it limits as far as people go.

The Eternal Tax Question

Bermuda levies no corporate income tax on its reinsurers and insurers. Three times in the last 10 years U.S. companies have called this a “tax loophole” that gives Bermuda-based companies a competitive advantage. The “Berkley Coalition” is the latest effort lobbying Congress to pass a bill mandating taxes on the income of U.S.-based subsidiaries of Bermuda companies that they cede to the Island.

But as Kading noted: “If you increase taxes on U.S. derived income, you’d have two alternative consequences. You would reduce capacity, and/or you would raise rates. In either case the U.S. insurance buyer [mainly business and commercial enterprises] would suffer.” If they pay more for insurance, they eventually pass on the cost increases to their customers, the U.S. consumers. For this reason most U.S. business associations have sided with Bermuda, and oppose the Berkley Coalition’s proposals.

This is really “all a protectionist battle,” Kading continued. Past efforts have concentrated on Bermuda, and the current one certainly does as well, but it goes further. The proposals would take in all “foreign” companies. If adopted they could well spark a “trade war,” as the United States would have to abrogate some provisions of long-standing tax treaties with a number of countries to do so.

“They’re also focusing on just one aspect [of insurance company income],” said Kading. “Bermuda companies operate in a number of domiciles, and their global GAAP income should be the applicable measure.”

He backed up that statement by citing recent testimony, given before the Senate Finance Committee at its request. The ABIR calculated the overall tax payments – including excise taxes, which are paid regardless of income – for 2004, 2005 and 2006 of four of Bermuda’s largest companies. Although the figures remain confidential, they showed that their average tax rate was 27 percent, not much less than the 35 percent corporate income tax levied by the U.S. “The real problem,” said Kading, “is the U.S. tax rate, but there’s been no discussion on that, as there has been in the U.K.”

He also pointed out that for all of their claims of unfair competition, very few of the Berkley coalition companies [the notable exception being Berkshire Hathaway] are interested in offering the types of coverage Bermuda does in the areas, such as Florida and the Gulf Coast, where they continue to write business.

Bermuda is now the world’s fourth largest insurance market, and despite the inevitable natural disasters, changing regulations and challenges to its tax system, it looks likely to maintain that position for some time to come.

The report, “The Bermuda Insurance Market, An Economic Analysis,” is available online at: www.bermudamarketsolutions.com.

Topics Catastrophe USA Carriers Profit Loss Legislation Hurricane Reinsurance Market