Basking in the Sun Once More
Bermuda is one of the world’s biggest and most successful offshore reinsurance markets, largely as a result of its tax advantages, strong regulatory system and its proximity to the U.S. and Europe.
But in recent years, many of the island’s reinsurers redomiciled to Europe, amid concerns over Bermuda’s international reputation, regulatory uncertainty and political instability.
The outflux started in 2010, when Flagstone Re redomiciled to Luxembourg and Allied World moved its holding company to Switzerland. The latest, Canopius, followed suit at the end of last year.
Companies are now returning to the island, though, after the announcement in March that the European Union granted it Solvency II equivalence.
Bermuda, along with Switzerland, is the only country that garnered Solvency II equivalence and was designated a “qualified jurisdiction” by the National Association of Insurance Commissioners (NAIC), allowing free cross-border trade with the U.S.
Further evidence of the island’s resurgence is borne out by the fact that 64 new reinsurance companies incorporated in Bermuda last year, according to the Bermuda Monetary Authority (BMA).
Meanwhile, seven of the island’s biggest reinsurers merged or were acquired over the last four years, with more deals expected, according to the Association of Bermuda Insurers and Reinsurers (ABIR).
Bermuda is also firmly established as one of the leading offshore domiciles for captive insurance, as well as an alternative capital market.
“Bermuda was always a leading reinsurance domicile,” said Brad Kading, president and executive director of ABIR. “These two bilateral agreements [Solvency II and NAIC qualified jurisdiction status] further cemented its position as a reputable domicile for reinsurance.”
Movers and Shakers
XL Catlin’s proposed move from Ireland back to Bermuda made the biggest headlines this year and will be accomplished in the third quarter, subject to shareholder approval. Bermuda was a stronghold for both companies before their merger. XL moved its main operations there 30 years ago, and Catlin incorporated its holding company in Bermuda in 1999.
XL Catlin’s CEO Mike McGavick said the fit with Bermuda is a natural one, given that a significant part of the company’s business and its largest operating subsidiary are already there. He cited Solvency II equivalence as the main reason behind the move, adding that it would benefit clients, partners and shareholders alike.
“These two bilateral agreements [Solvency II and NAIC qualified jurisdiction status] further cemented its position as a reputable domicile for reinsurance.” — Brad Kading, president and executive director, Association of Bermuda Insurers and Reinsurers
“With the recent determination of full Solvency II equivalence in Bermuda, it has been concluded that the BMA is best situated to serve as XL’s group-wide supervisor and to approve XL’s internal capital model,” McGavick said.
Qatar Re also announced at the end of last year that it would relocate its main operations from Dubai to Bermuda after its merger with parent Qatar Insurance Co.’s Bermuda-domiciled reinsurer Antares Reinsurance.
CEO Gunther Saacke cited Bermuda’s “decades of proven reliability” and said that the move would enable the company to consolidate its capital and move closer to its brokers and clients in the U.S.
Ross Webber, CEO of the Bermuda Business Development Agency (BDA), said the decision by all of these companies to redomicile to Bermuda sent a “very positive message.”
“No doubt Solvency II equivalence played a big part in all this, but Bermuda’s improving economic outlook and growth in business confidence is also a factor,” he said.
“Our company register is growing across all sectors at present, while consolidation only strengthened the physical presence of companies such as XL Catlin here on the island.
“As a result of all this, we are already seeing companies looking to set up new operations, to merge or to expand their operations here in Bermuda.”
Webber said that the main reason behind companies leaving Bermuda in the first place was a move from U.S. and European regulators to bring companies back onshore.
Being offshore “was perceived as somehow being unpatriotic and somewhere you shouldn’t be,” he said.
“Some left simply because the CEO and leadership wanted to physically move themselves back onshore, along with the corporate structure that goes along with it.”
David Brown, a retired insurance industry veteran and former CEO of Flagstone Re, which redomiciled from Bermuda six years ago, said there was no single trigger for the exodus.
“I think that people were almost hedging their bets — not knowing if Bermuda was going to get Solvency II equivalence — by moving to jurisdictions in the EU that were considered more likely to succeed,” he said.
“Another factor at the time was the political risk associated with an unsustainable public debt growth, as well as a negative political climate against international business and expat employees generally.”
But he added that since the government started to tackle the debt problem and make the island more welcoming to international business, companies now are taking another look at the island.
Solvency II Equivalence
Gaining Solvency II equivalence means that Bermuda is now better positioned to meet the regulatory standards being redrawn by the International Association of Insurance Supervisors, said Kading, as well as to provide more capacity for markets like Asia and Oceania.
Being offshore “was perceived as somehow being unpatriotic and somewhere you shouldn’t be,” — Ross Webber, CEO, Bermuda Business Development Agency
“All this means is that the Bermuda Monetary Authority is now recognized as a global group supervisor for targeted insurance groups and reinsurance can be conducted on a cross-border basis without market barriers,” he said.
“For Bermuda insurers, this means an efficient rather than redundant layer of group supervision and for reinsurers, it means cross-border trade without individual jurisdictional restrictions.”
Susan Molineux, senior financial analyst at A.M. Best, who was based on the island for more than a decade, said that achieving Solvency II equivalence was a “big win” for Bermuda.
“Bermuda expended a lot of effort to really explain to Europe what they do and how they do it, and it paid off in the long run,” she said.
Despite the positives, Bermuda still has a way to go to convince everyone that it is on the rise.
Saddled with a $2 billion debt after seven years of deep recession, the government is under pressure to rein in costs and to find new revenue sources, mainly through tax collection.
A.M. Best said last year that it maintained a negative outlook for the island’s reinsurance industry. In response to this, the BDA is setting up industry focus groups. It is promoting Bermuda as a domicile in conjunction with ABIR members to attract new business from emerging markets such as Latin America and China.
After years of departures and uncertainty, Bermuda is seemingly restoring its position as a leading reinsurance market. &
Brokers: A Buyer’s Market for Captives
Today’s market offers captive insurance companies a particularly advantageous time to upgrade their investment portfolios. However, they must be willing to give up unrewarding practices in favor of more ambitious opportunities.
“Simply put, it’s a buyer’s market,” said Boston-based Josh Stirling, managing director and senior vice president, U.S. insurance, Sanford C. Bernstein & Co. “If you’re a captive owner, it’s probably a good time to buy more reinsurance or buy down your deductible or self-insured retention.”
In this environment, Stirling said, captive buyers are seeing more competition from reinsurers and primary companies that want to help them manage their risks, offering them favorable coverage at lower prices.
“With pressure from carriers and reinsurers to compete for business, this provides captive buyers and their brokers substantial leverage to negotiate for better value with their risk-taking partners,” Stirling said.
“If you’re a captive owner, it’s probably a good time to buy more reinsurance or buy down your deductible or self-insured retention.” — Josh Stirling, managing director and senior vice president, U.S. insurance, Sanford C. Bernstein & Co.
“This will lead to more opportunities for brokers to create value by partnering with carriers and reinsurers to design new coverages to better protect captives,” he said.
Added Gary Greene, Franklin, Tenn.-based Raymond James & Associates senior vice president-investments and managing director: “Captives of all sizes need to have an asset strategy, and ‘parking’ cash in the bank is not an asset strategy.
“Captive owners tend to hyper-focus on their liabilities and miss the opportunities with their assets. In doing so, they run the risk that their assets are misaligned and may increase overall risk.”
Greene noted that, overall, he believed prospects for captive growth remain favorable.
But given that interest rates have remained subdued since 2008, many captives have experienced an interest income shortfall from their actuarial forecast, Greene said.
“As these shortfalls have persisted,” Greene said, “captives found themselves recognizing the importance of developing an appropriate asset investment strategy that complements their liabilities.”
Captive owners generally remain cautious about accepting investment risk, yet they find the option of sitting in cash unpalatable, Greene said.
“So we see captives moving cash away from bank accounts and into low-to-moderate-risk investments,” he said. “Things like government and corporate bonds, with some captives venturing into diversified equities portfolios.”
Tim DePriest, Glendale, Calif.-based managing director for Arthur J. Gallagher & Co., noted that a captive should have in place an appropriate level of excess insurance to protect the group should a large catastrophic loss occur, or if over the course of the year the aggregate dollar amount of losses exhausts the premium that has been collected.
“Transparency is very important in running a captive effectively,” DePriest said. “Members should be privy to the inner workings of the captive, such as service costs and the revenue that is derived by the administrator or broker, as well as regulatory requirements.
“Members are essentially ‘owners’ of the captive and therefore should understand their investment.”
DePriest also offered some advice on domiciles.
“Vermont and Bermuda in particular are attractive because of their favorable regulatory and tax environment,” he said.
“While other states in the U.S. are exploring ways to make themselves more attractive for captives, they do not see captive programs as a growth area.”
Sanford C. Bernstein’s Stirling said that one area for captives to explore in today’s market is working closely with brokers to take advantage of new sources of capital.
“For example,” Stirling said, “captives might consider going to the alternative markets and issuing a CAT bond, such as that issued by New York’s MTA after Hurricane Sandy, and captives with long-tailed reserves might look to partner with alternative managers offering reserve financings that allow the captive owner to profit from the alternative manager’s lower cost of capital.”
Stirling emphasized that, with the market in such a changing environment, it’s a very important time for someone who runs a large captive with a lot of money at risk, to optimize their product to take advantage of the low cost of capital that’s coming into the industry.
Bespoke Cyber Coverage
Raymond James’ Greene said that, “As our world expands, companies are being exposed to new kinds of risk that the commercial market doesn’t have the history to price efficiently.”
He cited cyber risk as a prime example.
“Cyber risk insurance is tremendously expensive to purchase, so very few companies, captives among them, are fully covered,” Greene said. “New technological developments are changing the way we live. Driverless cars, 3D printing, nanotechnology all promise an exciting future, but they also alter the environment for risk.
“But a captive insurance company can be a great vehicle to finance cyber risk,” Greene added. “Since the captive is a private insurance company insuring risk only for the parent company, the captive can structure a bespoke coverage that specifically fits the parent company and charge an appropriate premium based upon the company’s actual risk mitigation policies.”
“As our world expands, companies are being exposed to new kinds of risk that the commercial market doesn’t have the history to price efficiently.” — Gary Greene, senior vice president-investments and managing director, Raymond James & Associates.
Additionally, if the parent does a good job managing the risk, they can potentially see return of those premiums back to the parent, Greene said.
He also noted that there is one major hurdle on the near-term horizon that will significantly change the way many captives operate.
That hurdle, said Greene, has a date: Oct. 14, 2016.
“As we have seen, captives have a propensity to avoid investment risk by maintaining very high levels of cash-type investments,” he said. “A favorite cash alternative investment has been money market funds. Captives have long used these funds because of their perceived stability and safety.”
But on Oct. 14, new regulations will go into effect that will significantly change the way money market funds operate, and in turn how many captives handle their investments, Greene said.
“These changes include requiring money market funds’ values to float like any other mutual fund,” he said.
“Additionally, money market funds may impose redemption fees or so-called ‘liquidity gates’ that could be triggered if the liquidity levels of a specific fund fell to specified levels.
“Developing a strategy to deal with these events is going to be a challenge for many captives.” &
Helping Investment Advisers Hurdle New “Customer First” Government Regulation
This spring, the Department of Labor (DOL) rolled out a set of rule changes likely to raise issues for advisers managing their customers’ retirement investment accounts. In an already challenging compliance environment, the new regulation will push financial advisory firms to adapt their business models to adhere to a higher standard while staying profitable.
The new proposal mandates a fiduciary standard that requires advisers to place a client’s best interests before their own when recommending investments, rather than adhering to a more lenient suitability standard. In addition to increasing compliance costs, this standard also ups the liability risk for advisers.
The rule changes will also disrupt the traditional broker-dealer model by pressuring firms to do away with commissions and move instead to fee-based compensation. Fee-based models remove the incentive to recommend high-cost investments to clients when less expensive, comparable options exist.
“Broker-dealers currently follow a sales distribution model, and the concern driving this shift in compensation structure is that IRAs have been suffering because of the commission factor,” said Richard Haran, who oversees the Financial Institutions book of business for Liberty International Underwriters. “Overall, the fiduciary standard is more difficult to comply with than a suitability standard, and the fee-based model could make it harder to do so in an economical way. Broker dealers may have to change the way they do business.”
As a consequence of the new DOL regulation, the Securities and Exchange Commission (SEC) will be forced to respond with its own fiduciary standard which will tighten up their regulations to even the playing field and create consistency for customers seeking investment management.
Because the SEC relies on securities law while the DOL takes guidance from ERISA, there will undoubtedly be nuances between the two new standards, creating compliance confusion for both Registered Investment Advisors (RIAs)and broker-dealers.
To ensure they adhere to the new structure, “we could see more broker-dealers become RIAs or get dually registered, since advisers already follow a fee-based compensation model,” Haran said. “The result is that there will be likely more RIAs after the regulation passes.”
But RIAs have their own set of challenges awaiting them. The SEC announced it would beef up oversight of investment advisors with more frequent examinations, which historically were few and far between.
“Examiners will focus on individual investments deemed very risky,” said Melanie Rivera, Financial Institutions Underwriter for LIU. “They’ll also be looking more closely at cyber security, as RIAs control private customer information like Social Security numbers and account numbers.”
Demand for Cover
In the face of regulatory uncertainty and increased scrutiny from the SEC, investment managers will need to be sure they have coverage to safeguard them from any oversight or failure to comply exactly with the new standards.
In collaboration with claims experts, underwriters, legal counsel and outside brokers, Liberty International Underwriters revamped older forms for investment adviser professional liability and condensed them into a single form that addresses emerging compliance needs.
The new form for investment management solutions pulls together seven coverages:
- Investment Adviser E&O, including a cyber sub-limit
- Investment Advisers D&O
- Mutual Funds D&O and E&O
- Hedge Fund D&O and E&O
- Employment Practices Liability
- Fiduciary Liability
- Service Providers D&O
“A comprehensive solution, like the revamped form provides, will help advisers navigate the new regulatory environment,” Rivera said. “It’s a one-stop shop, allowing clients to bind coverage more efficiently and provide peace of mind.”
Ahead of the Curve
The new form demonstrates how LIU’s best-in class expertise lends itself to the collaborative and innovative approach necessary to anticipate trends and address emerging needs in the marketplace.
“Seeing the pending regulation, we worked internally to assess what the effect would be on our adviser clients, and how we could respond to make the transition as easy as possible,” Haran said. “We believe the new form will not only meet the increased demand for coverage, but actually creates a better product with the introduction of cyber sublimits, which are built into the investment adviser E&O policy.”
The combined form also considers another potential need: cost of correction coverage. Complying with a fiduciary standard could increase the need for this type of cover, which is not currently offered on a consistent basis. LIU’s form will offer cost of correction coverage on a sublimited basis by endorsement.
“We’ve tried to cross product lines and not stay siloed,” Haran said. “Our clients are facing new risks, in a new regulatory environment, and they need a tailored approach. LIU’s history of collaboration and innovation demonstrates that we can provide unique solutions to meet their needs.”
For more information about Liberty International Underwriters’ products for investment managers, visit www.LIU-USA.com.
Liberty International Underwriters is the marketing name for the broker-distributed specialty lines business operations of Liberty Mutual Insurance. Certain coverage may be provided by a surplus lines insurer. Surplus lines insurers do not generally participate in state guaranty funds and insureds are therefore not protected by such funds. This literature is a summary only and does not include all terms, conditions, or exclusions of the coverage described. Please refer to the actual policy issued for complete details of coverage and exclusions.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Liberty International Underwriters. The editorial staff of Risk & Insurance had no role in its preparation.