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By ROGER CROMBIE, a Bermuda-based columnist for Risk & Insurance®

An assessment of how individual insurance and reinsurance companies based in Bermuda might perform in 2009 must first address a larger issue: How will Bermuda fare?

Three smaller, but still substantial, Bermuda insurance and reinsurance companies--Paris Re Holdings, Flagstone Re and Hiscox--relocated all or part of their operations from Bermuda in 2008.

An industry source told Risk & Insurance® in mid-December that four more insurance companies with employees on the ground in Bermuda were set to do the same, before long. The source says that three London companies that had intended to move to Bermuda cancelled their plans, and that two new companies slated for the island were instead starting up elsewhere.

On a single day in December, three major industrial companies headquartered on the tiny mid-Atlantic archipelago--Tyco International, Foster Wheeler and Weatherford International--announced that they, too, were seeking shareholder approval for a move to the land of watches and Alpine vistas.

And on the same day last month, the shareholders of Transocean, the world's largest offshore drilling contractor, approved a change of place of incorporation of its group holding company from the Cayman Islands to Switzerland.

Later in December, Covidien, a healthcare provider, announced that it would relocate its corporate headquarters to Dublin after 30 years in Bermuda.

Why? Because lawmakers want to make sure corporations are paying their fair share of taxes.

In the United States, the Senate Finance Committee, for example, is considering the Stop Tax Haven Abuse Act, which proposes to tax offshore companies. The IRS has vowed to chase down every possible dollar to which it may be entitled.

On the other side of the Atlantic, the British government has ordered a review of its offshore financial centers that is expected to recommend, at the very least, taxation on savings accounts. And in Bermuda, the government's corporation tax holiday, available to all international companies based on the island, will expire in 2016, with no indication that it will be extended. Companies that once had a 30-year tax holiday now have only eight guaranteed years remaining.

The question on Bermuda people's lips these days is, "When do we stop asking, 'Could something bad happen to us?' and start saying, 'Something bad is happening to us'?"

The global recession, referred to in some circles as Great Depression II, has resulted in a seemingly worldwide decision by governments to borrow and spend to stave off the worst effects of the downturn. In light of a generation bailing itself out with its children's money, the chances of a small wealthy country such as Bermuda surviving unaffected, with no one to argue its case, are as remote as its location.

Bermudians had until recently banked on the proposition that President Obama would have more urgent matters to attend to upon taking office: among them, two wars and a global financial meltdown, a crumbling infrastructure and a dysfunctional healthcare system. Obama was considered unlikely to do anything to further destabilize the financial community, such as beating on the insurance and reinsurance industry.

XL Capital CEO Michael McGavick, a man facing his own financial challenges, laid that idea to rest in late November, with words that sent a chill down Bermudian spines. The threat of U.S. tax law changes punitive to Bermuda is now "extremely real," he told a corporate audience. He cited ACE's decision to redomesticate to Switzerland earlier this year as a "warning bell."

McGavick has the credentials. He ran, albeit unsuccessfully, for a U.S. Senate seat as a Republican candidate in 2006 and served as chief of staff for U.S. Senator Slade Gordon. Paula Cox, Bermuda's finance minister, described McGavick as "key" to promoting the island's cause in Washington, when his comments resulted in a spiteful backlash among Bermudians who didn't want to hear the bad news.

McGavick, who rescued Safeco but looked likely to face even bigger challenges at XL Capital, "is not just a practitioner in the insurance field," Cox says, but "also has the wherewithal and the connections to help our efforts considerably."

Of the view widely held in Bermuda that "we've seen this (tax threat) come and go before"--various similar proposals have been floated in Congress for seven years--McGavick says, "I will tell you categorically that is wrong. The threat this time around is extremely real."

Without a united effort to address the threat over the coming year, McGavick says, "tax regimes that are punitive to Bermuda and other countries will become law."

As Risk & Insurance® revealed in April 2008, ACE began looking at its options in March 2007, one month after then-Senator Obama and others sponsored the Stop Tax Haven Abuse Act. Within 16 months, ACE had moved its domicile from Cayman and its corporate headquarters from Bermuda, both to Switzerland.

Not long afterward, Paris Re Holdings, the successor to Axa Re, which had moved to Bermuda in 2007, announced that it, too, would settle in Switzerland. Flagstone Re followed suit, moving its capital and financial management team in the same direction. In October, Hiscox shuttered the Bermuda-based specialist reinsurance and insurance team it had established earlier in 2008 and reopened for business in the United States, a move that would have been unthinkable a year earlier.

Finally, adding insult to injury, the Bermuda government has remained steadfast in enforcing its work permit time limit restrictions, making life difficult for companies to import staff at a time when Bermuda has no unemployment. The well-intentioned "locals first" policy has been perceived to have been interpreted with almost religious zeal by immigration officials to mean "foreigners out."

For 15 years, not a single major insurance or reinsurance company startup with more than $1 billion in capital had occurred anywhere in the world but Bermuda. Now, the words "anywhere in the world but Bermuda" have taken on a different meaning.

What does this portend for the prospects of the insurance companies that still call Bermuda home?

THE FATE OF LESSER TIERS

The largest companies, as noted, are either gone or going. ACE, XL Capital and AIG each has its own impressive headquarters building in Hamilton, and each is emptying, for differing reasons. None can be rented out, a condition imposed when the buildings went up.

The second tier of Bermuda companies is coping rather better. With AIG and XL business being hawked around town, companies with $1.5 billion to $5 billion in capital have been inundated with potential business.

This group includes Allied World, Aspen, Arch Capital, AXIS, Catlin, Endurance, Everest Re, Hiscox, IPC Re, Max Capital, Montpelier Re, OIL, PartnerRe, Platinum, RenaissanceRe, Validus and White Mountains.

The "both sides now" damage to the companies' balance sheets occasioned by Hurricane Ike on the liability side and the collapse of financial institutions--and potentially the Bernard Madoff fraud?on the asset side would have turned the market without the ACE/XL/AIG issues.

Add to that the collapse of the catastrophe bond market and the sudden loss of interest by hedge fund managers in anything but survival, and the outcome has been a turn in the market. Rates that had been drifting down began drifting sideways, and in some cases up.

This middle tier of companies is also exposed to U.S. tax reform, and all but the London crowd (AXIS, Catlin and Montpelier) might face a direct hit should President Obama get the bit between his teeth. What could he do? Options include raising the Federal Excise Tax on insurance and reinsurance premiums, taxing non-U.S. domiciled companies on their worldwide income, and other moves against companies run largely by Americans, with American capital and a hefty book of American business, that are quoted on American stock exchanges.

A separate challenge faces the companies in this group: the potential failure of the "post-catastrophe refunding" business model. How easily might any of these companies raise capital after a catastrophe, in a world that has little capital to spare and has priced whatever money is available at a punishing level?

Then there are specific challenges that not all of the companies face. IPC Re remains a thoroughly efficient monoline, at a time when the ratings agencies have decided that monolines don't work. Everest Re came to Bermuda as a "corporate inversion," a group of two dozen companies that relocated to Bermuda at the start of the millennium from the United States. Tyco, Foster Wheeler and Weatherford, three members of that group, chose to beat it to Switzerland before the new president could spell out his intentions. Better safe than Bermudian, was their logic.

Many among the third tier of Bermuda companies, those with capital of $0.75 billion to $1.5 billion, face the same problems, with an added cloud over their ratings.

Indications from both the main ratings agencies are that they have considered raising the price of "the ticket to the dance," in the words of Ariel Re's Don Kramer, to $1.5 billion.

Under normal circumstances, most of these companies--including AEGIS, Ariel Re, Argo, Canopius, Flagstone, Lancashire, MS Frontier Re and Tokio Millennium Re--would gladly raise additional capital to meet the new requirement, if such capital were reasonably priced. (The last two companies on that list are subsidiaries of Japanese giants and are, therefore, not faced with quite the same set of problems.)

That the Bermuda companies already shoulder almost half the burden of American catastrophe losses won't count for much in a bankrupt world where the old rules of comity and international accommodation no longer apply. Money is a relative concept. When we all have some, we don't mind our next-door neighbor having more. When we're busted, we look askance at the guy down the street who continues to live high on the hog.

Bermuda has enjoyed more than 40 years of uninterrupted growth in its financial sector, mainly insurance and reinsurance. But right now, the island's prospects look dim. Its tourism industry faces a dearth of paying customers, which means its retail sector is on life support. Construction of new buildings in the capital, Hamilton, has ground to a halt as a glut of new office space is completed and comes onto the market. Residential construction, and rents, are falling as the expatriate workforce is forced out or leaves. Until now, the insurance sector had been the only good news.

When should Bermuda stop asking, "Could something bad happen to us?" and start saying, "Something bad is happening to us"? Right now.

January 1, 2009

Copyright 2009© LRP Publications