By ROGER CROMBIE, a Bermuda-based columnist for Risk & Insurance®
A curious role reversal has taken place in Bermuda. A jurisdiction that once sold its key business advantage as its "fair but firm"--read: less stringent--level of regulation has now adopted standards that meet or exceed international standards, across the board. The International Monetary Fund said as much in a penetrating review last fall. In the process, Bermuda's competitive edge has switched from less regulation to more.
The regulated are as pleased as the regulators. The new, tougher approach of the Bermuda Monetary Authority, the island's sole regulator, won 75 percent approval from those it oversees in a survey published in December.
This surprising state of affairs has occurred because the BMA and its charges understand that no other route was possible in an industry increasingly interested in the integrity of its regulation. The proof was in how little trouble, comparatively, the insurance industry finds itself in, now that so many other sectors of the financial services industry are proving to have been underregulated, with all the consequences that entails.
The BMA has made the move toward principles- and risk-based regulation, an acknowledgement that the activities of, say, a single-parent captive insurance company with $500,000 of capital, and a global reinsurer with a $10 billion portfolio, should be subject to a supervisory regime that accepts the enormous differences between the two, rather than merely focusing on the fact that both are insurance entities.
That change has been accompanied by growth in the BMA's remit. For decades, Bermuda companies had practised a high degree of self-regulation, backed up by an informal "know your customer" process. Bermuda and its markets were small enough in the early days of the provision of financial services that the island's professionals were able to turn away business that seemed likely to fail to meet the need to protect Bermuda's reputation, widely appreciated to be its chief asset in the markets from which it draws its business.
But in the regulation of financial behavior, the day of informality, however efficient, is over. Plus, Bermuda has always faced a unique challenge, in being lumped in with other offshore jurisdictions.
As Cheryl Lister, the former chief executive officer of the BMA, put it: "When a company in, say, London, has a problem, it's seen as a company problem. When a company in Bermuda has a problem, it's seen as a Bermuda problem."
Lister instituted great change during her tenure at the BMA. She negotiated the authority's independence from the finance ministry, and laid the groundwork for much of what her successor, Matthew Elderfield, now 18 months in office, has been able to achieve.
Elderfield's background is as international as those of the companies he now supervises. Born in Leeds, in northern Britain, he grew up in New York. He attended the Georgetown University School of Foreign Service in Washington, D.C., and earned his master's in international relations at Cambridge University. Bermuda's position, halfway between the United States and the United Kingdom was, therefore, a perfect fit for a man with a transatlantic background.
Elderfield is frank as to why the BMA, with a staff of 140 people, has reinvented itself. "Our old regime--not the one before me, but the one before a few years ago--wasn't going to cut the mustard in terms of new international standards," he admits.
International insurance regulation is moving to the concept of mutual recognition, as the U.S. National Association of Insurance Commissioners' latest proposals on point of entry regulation acknowledges. "It's a process whereby jurisdictions size each other up and ask: 'Are their rules equivalent to mine?'," Elderfield explains. "And if they are, it's OK for their companies to come do business in my jurisdiction, and vice versa."
Mutual recognition is important for a number of reasons, he adds. "First of all, it allows market access. Secondly, having mutual recognition means you can avoid duplicative capital calculations. If you have mutual recognition, the Europeans will say: 'BMA rules are good enough; you've calculated to a BMA standard.'
"Thirdly," he continues, "you can have optimal group structures. Particularly under Solvency II, there's the prospect of organizing the group in such a way that you can keep your surplus capital in one location, rather than having it split up. And fourthly, and more generally, it cements the reputation of Bermuda, to have an official recognition, if you like, that our rules of good standing are endorsed by the Europeans or the Americans."
The system of classes for Bermuda companies was established more than a decade ago. It has stood the test of time, except for Class 3, which was a very heterogeneous group, containing a mixture of captives, noncaptives and some large commercial companies.
"We knew that to get ready for mutual recognition, we really needed to separate the apples from the oranges in the Class 3 category--the commercial companies and the captives," Elderfield says. "And our firm policy, and I'd like to emphasize this, is that we have largely left the captive regime alone, but for the commercial companies, we are saying: 'You now have to go on this journey with us to higher standards, because if you don't then the Island as a whole will suffer, because mutual recognition won't be forthcoming.' "
Captives remain in Class 3. The smaller commercial Class 3 companies are now found in Class 3A and the largest commercial companies that are analogous to the Class 4s, now form Class 3B.
A new category has been added, called Special Purpose Insurer. "We felt that was an important innovation, in addition to all this march to equivalence," Elderfield says. "It's to make sure that our regime is still able to facilitate competition and innovation. A lot of the structures that have been formed recently have been special purpose vehicles, such as sidecars and the like. If we have another KRW year (a year like 2005, when Hurricanes Katrina, Rita and Wilma caused enormous insured losses), would we see start-up businesses or sidecars and SPVs? We felt we should have a specific category to facilitate that, and to recognize that so long as the risk is fully collateralized and the structure is suitable there's no need to have a large fixed amount of regulatory capital because the risk is completely covered."
Elderfield is at pains to point out that equivalence doesn't mean carbon copies. "What we're not doing is simply Xeroxing the rules from other regulators," he says. "There is a digestion and analysis and consideration period in seeing how can you adapt regulation to the Bermudian market. Equivalence is a broadly equivalent test, and we intend to acknowledge that exactly what works in Europe is not going to be exactly what's perfect for Bermuda, so there'll be some adaption along the way."
In short, then, Bermuda will retain its own identity as it meets the global standards it is helping to establish. Anyone familiar with the Bermudian temperament knows it could not be any other way.
March 3, 2009
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