On a bleak Saturday morning in March 1932, Ivar Kreuger, the "Match King," shot himself through the heart. Kreuger had in his day propped up governments around the world. The stock of his company, Kreuger & Toll Inc., had been the world's most widely held, a beacon in the unnerving darkness of the Depression. Now the greatest financial criminal of the modern age, a financial Houdini to whom people everywhere had looked for inspiration, lay dead, with three suicide notes on his table.
Kreuger's "most satisfactory solution for everybody concerned," as one of those notes read, meant darker days still for the markets. He attempted to corner the world supply of matches, then an essential ingredient of life, and he had come close. Kreuger owned forests, mines and factories around the world. He had patents, processes and power. He pioneered global corporate infrastructure, among the first to use subsidiary companies to create an impenetrable web, behind which to hide his financial affairs.
Unable to meet his obligations, broken by the unlikely combination of J.P. Morgan and the Russians, Kreuger faked Italian bonds worth millions of dollars. He had purchased paper of the right quality and had a printer run off the fakes. Kreuger then signed them himself, often misspelling the name of the Italian dictator Benito Mussolini as he did so.
But events exceeded even his fabled ability to control them, and on that Saturday morning in March 1932, in his apartment in Paris, Kreuger could no longer conceal the enormity of his crimes.
It's an ill wind that blows no good. In the years that followed, Kreuger's aberrant behavior would be pivotal in the development of an economic phenomenon every bit as important as that of Silicon Valley decades later: Bermuda's insurance industry.
A GRADUAL REALIZATION
Bermuda in Kreuger's day was little more than a fishing village with a few hotels. Eight hundred miles from New York City, in those days, meant the middle of nowhere. The island had been colonized in 1609 by settlers bound for Virginia, whose vessel foundered on Bermuda's reefs. The little island was (and is) a British colony, a corner of the world painted pink.
In 1936, four years after Kreuger's death, that little corner gave birth to the modern offshore company, though it was not the first. Similar vehicles had been formed in Jersey in the Channel Islands in the late 1920s, at around the time that Liechtenstein sanctioned individual trusts that bore similarities to the modern "exempted" international company.
A Bermuda lawyer, Reginald Conyers, and an attorney, Henry (later Sir Jack) Tucker, formulated a way around Bermudian protectionist legislation to enable the American Noble family, makers of Lifesavers candy, to shelter their non-U.S. earnings from Uncle Sam.
The first exempt company was called Elbon, the family's name spelled backward. Today, Bermuda is home to 16,000 such companies. Around the world more than a million other offshore companies and trusts harbor, by some accounts, $12 trillion.
Elbon was a solution for a particular need. At the time, few people paid much attention, and it caused little change in the world's economic behavior. But it was the second exempted company that triggered the island's gold rush: the International Match Realisation Co., formed to collect and distribute Kreuger's far-flung assets.
Before the nascent offshore community could get started in earnest, World War II intervened. When hostilities ended, what would become a successful realization of Kreuger's assets picked up apace and set the stage for all that was to follow.
The words "corporate" and "global" seem almost interchangeable today, but after World War II, multinational companies, as they were known, were not many in number. The oil companies had global businesses, and one, Shell Oil, established the first international company office in Bermuda in October 1947.
A few weeks later, on Dec. 12, 1947, Cornelius Vander Starr followed suit. The founder of American International opened an office in a cottage just outside the city of Hamilton. When the AIG Bermuda office celebrated its 60th anniversary in December, so too did the Bermuda insurance market.
Bermuda in 1947 had a population of about 25,000. Motorized vehicles were first permitted in 1948; segregation between blacks and whites would not end for 11 years after that. A white oligarchy ran the place, merchant politicians who carved up the business between their families, in the popular view, and so earned the sobriquet "The 40 Thieves."
A handful of the world's superwealthy had their affairs managed from Bermuda: Noel Coward and Greek ship-owners were among the well-heeled clientele. The New York Times, then as now, railed against Bermuda as a tax haven, even though its impact was tiny.
A few American-owned hotels and a single professional auditor rounded out Bermuda's international business interests. Most of them were handled by David Graham, a British attorney who had replaced Reginald Conyers at the firm that bears his name, Conyers Dill & Pearman.
By the mid-1950s, American International employed almost 300 people from Bermuda, mostly on the life insurance side, a huge operation by Bermuda standards. They were joined by two other strands of the financial services industry.
In 1954, Bill Kempe, a lawyer with the island's other law firm of any substance at the time?Appleby, Spurling & Kempe--returned from a trip to London as the representative of the island's first two mutual funds. More than 2,000 investment funds are now domiciled in Bermuda, with assets in excess of $210 billion.
In 1956, the publication of a letter in The Times of London from Graham sparked a flame. Global ship-owners were wilting under heavy taxation, and Graham proposed a solution. Bermuda levied no corporate taxes, yet its vessels were on the British Registry, a respected organization that allowed crew from around the world.
Half the world's fleet was based in Bermuda within a year. It was the first evidence that financial services on a global scale could work in sleepy old Bermuda.
Kempe saw it first. That year, he declared, to universal derision, that Bermuda could in time become "the Switzerland of the Atlantic." How could a sleepy 21-square-mile island ever match the wealth or sophistication of Switzerland?
Enter Frederic Mylett Reiss, a former property insurance engineer from Youngstown, Ohio, who had attended college on the GI Bill. Having worked with the Ohio Inspection Bureau, he had become an insurance agent.
The steel mills that Reiss insured also owned coal mines. The coal was then turned into coke solely for their owners' use in making steel. The mines were called "captives," and that, according to Reiss' nephew, is the origin of the term "captive" in the insurance context.
In the mid-1950s, Reiss formed Steel Insurance Co. of America for its parent, which was its only insured: the first captive insurance company. Though some church groups and fraternal organizations had by then formed insurance vehicles, they were essentially risk retention groups. Reiss was after much bigger fish.
At a weekend social occasion outside London, Reiss was introduced to lawyer Kempe. Reiss was bemoaning his inability to persuade the world of the compelling argument captive insurance represented. People to whom Reiss spoke said they would be delighted to be his second Bermuda customer, provided someone else was first.
Kempe explained how locating such companies in Bermuda would add, at the very least, a deferred tax advantage in an atmosphere of sensible regulation, and promised to be back in Bermuda in two weeks. Reiss didn't wait and flew straight to Bermuda, where he was introduced to lawyer David Graham.
Late in 1962, he formed his first captive insurance company in Bermuda. In time, Graham and Kempe would be inundated with work when captives caught on and took off. as a result of Reiss's perseverance.
Reiss' business turned into the International Risk Management Group, the captive management and consulting company that he subsequently founded in Bermuda, and Bermuda became the world's risk capital.
Reiss and his lawyer, Sidney Pine, are rightly regarded as heroes of a sort in Bermuda. Pine, a New Yorker, was Reiss' attorney who worked closely with him in the development of the captive industry. Pine handled most of the negotiations with the Internal Revenue Service over the assessability of offshore captives.
The 1970s were the last golden age of Bermuda tourism. The industry, which had sustained the Island for 60 years, peaked at the end of the decade, just as the Bermuda captive industry took a wrong turn.
The larger captives faced the same problem. They had accumulated enough capital that profits could not be shipped back to the United States without incurring substantial taxation. Their chosen solution was to write third-party business.
Living in Bermuda can produce an unreal, euphoric effect that can lead to overestimating one's powers. When the Bermuda captives went to London and New York and asked for business to write, they were given the business, all right.
Bermuda became a market of last resort, little more than a joke in the insurance world. Of the business ceded to Bermuda, Middle Eastern taxi fleets are cited as the classic example. The result was serious losses and the retrenchment of the Bermuda captive market to lick its wounds.
Along with the captives, though, Bermuda boasted some more successful entities. In 1966, Guy Carpenter had formed Intercontinental Re with new capital of $23 million, the forerunner of the island's reinsurance sector.
Oil Insurance, the successful mutual that still provides a range of coverages suitable to the needs of the global energy industry, had been formed in 1970. Although it failed within a year, it was recastin 1971 to insure the assets of its energy company members. Today, it insures assets in excess of $1 trillion. AIG had headquartered its non-U.S. business in Bermuda in the late 1960s and moved into its own building, just outside Hamilton.
But as the 1980s dawned, these companies hardly constituted a market, and Bermuda had yet to shrug off the bad press its captive forays had earned. A hiatus ensued.
ACES IN THE HOLE
A severe liability crisis dogged the markets in the mid-1980s. Major corporations in the United States could barely find coverage beyond the personal lines.
On a Concorde flight from London, two senior Marsh executives wrestled with the problem. Robert Clements sketched out an idea he had been incubating to colleague Robert Newhouse Jr.
What if, Clements asked, Marsh were to form a company whose shareholders were its insureds, a captive whose owners would be the very Fortune 100 companies that were having such a hard time finding coverage at decent rates.
What if, indeed? Within a year, Marsh had incorporated Ace and Exel (now XL Capital) in the Cayman Islands, with $250 and $500 million, respectively, from almost 100 shareholders between them.
Both companies initially wrote high-level excess casualty. Both were originally managed from tiny offices in Bermuda, unnoticed. Both went on to add directors' and officers' liability coverage and then, in the space of 20 years, join the ranks of the largest global insurance companies.
Although Ace and XL thrived, neither was a headline name when Hurricane Andrew hit southern Florida on Aug. 24, 1992. Nor, outside of short pants and captive insurance, was Bermuda.
Andrew, a Category-5 storm, incurred what was then the largest insured loss in history. Globally, property-catastrophe cover, the bedrock, simply dried up.
Led by Clements and Newhouse, who formed Mid-Ocean and domiciled it in Bermuda, a group of substantial property-catastrophe companies were started in Bermuda. They brought with them $5 billion, six months' earnings for the Bermuda market today, but a dramatic investment 15 years ago when the total capital of the Bermuda market barely totaled $5 billion, before the arrival of the 1993 companies.
The Class of 1993, as these companies are now known, had a rocky start. The Northridge earthquake in California on Jan. 17, 1994, resulted in heavy claims during the companies' first year, but less expensive succeeding years saw the companies prosper. Their number was halved during Ace's and XL's 1990s acquisition sprees.
Between 1993 and 1999, Ace bought Coda, Capital Re and the global property/casualty operations of Cigna, as well as Westchester Fire Insurance Co. (which became Ace USA) and Tarquin, Ockham Worldwide and Methuen Underwriting, all Lloyd's insurers.
Of the Class of 1993, Ace bought Tempest Re and CAT Ltd. In more or less the same period, XL bought NAC Re and Winterthur International and, from the Class of 1993, Mid-Ocean Re and Global Capital Re.
The money changed Bermuda. Hamilton, the capital, now had to provide modern office space on a par with that in other major markets. A building frenzy, commercial and residential, began and has barely abated since.
In 2007, Hurricane Andrew's grandchildren have 100 stories of office space under development in Hamilton.
Disaster and difficulty, as was with the case with Andrew, have continued to precipitate much of the growth.
Perhaps it was Maurice "Hank" Greenberg who said it best back in 1997, when serving as chairman of American International Group Inc at the peak of his career: "All the companies formed in Bermuda in the last 15 years resulted from a shortage of market capacity in one class or another."
One aftermath of that hollow day on Sept. 11, 2001, was a wild dislocation in the insurance markets. The loss, ultimately $25 billion, was feared to be far greater for the first few weeks, and insurers were as stunned as everyone else.
In Europe, some major companies didn't answer the phone. In the States, the reinsurance market caught a serious cold. Lloyd's and the London market didn't need more bad news at the time.
Hence the formation in Bermuda of the Class of 2001, whose story is familiar enough. A dozen new companies raised $8.5 billion, and the existing Bermuda companies recharged their dented capital by almost as much. It was the largest deployment of capital in modern history.
The moon landing took 10 years, the Marshall Plan four. The Class of 2001 put together almost as much money as either initiative, in real terms, and took just 90 days to do so.
Political risk insurance and a range of specialties were being written in Bermuda.
The technical hallmark of the Class of 2001 was writing both insurance and reinsurance; hitherto, companies had mostly pursued one or the other.
The world was saved, but Bermuda was on fire.
New office space led to new residential space, and suddenly traffic congestion, the soaring cost of housing and a shortage of acceptable education were keenly felt. Awash in money, Bermuda's per capita income topped the world.
Insurance was not the only boom industry. Trust, that most secretive of practices, was in great demand as the wave of money made in the roaring bull market of the 1990s looked to protect itself for future generations.
Worldwide, the number of captive insurance companies passed the 3,000 mark--all hail, Fred Reiss--and Bermuda still had the lead, albeit under more pressure from such exotic locations as Vanuatu and Vermont.
The 2001 companies enjoyed two relatively low-cost years, which established their franchise and enabled them to ride out 2004 and 2005, the most expensive 24 months in history, in real or any other terms, that the 300-year-old insurance industry has experienced.
Sure enough, in the wake of hurricanes Katrina, Rita and Wilma, a Class of 2005 was formed in Bermuda. Post-Spitzer, the brokers were absent as investors, but their successors, hedge funds, took innovative slices of the property-catastrophe pie.
To ensure that another trilogy of tropical cyclones wouldn't knock the stuffing out of them, many Bermuda companies formed sidecars, a mechanism for yielding some of the sharper risk to the capital markets.
Like the Class of 2001, the 2005 companies were granted two low-cost years in which to ground themselves.
AN END AND A BEGINNING
Despite its $120 billion in capital and $400 billion of assets, Bermuda is no longer notable merely for its financial clout. A formidable insurance crowd dominates life in Hamilton, an intense marketplace that perfectly demonstrates an economic effect known as "clustering."
At 60, Bermuda rightly lays claim to being the most dynamic insurance market in the world. It has all but replaced the U.S. reinsurance market that existed 20 years ago. Few major reinsurance companies have been formed anywhere else in a generation.
A focus on quality banking (just four licensed banks), a third-generation professional cadre as good as any in the world and constantly enhanced regulatory standards, along with insurance, have made Bermuda to insurance what New York City is to fashion.
Greenberg listed the ingredients of Bermuda's success: proximity to the United States, good communications, good transportation, good people and favorable tax laws.
Threats exist, however.
Bermuda has convinced any number of jurisdictions to become potential competitors, to adopt "the Bermuda model." Fifty captive jurisdictions are in business, counting the 28 U.S. states as one. The Bermuda reinsurers have 40 percent of U.S. risk on their books, and little appetite for more.
The public-private partnership on which everything has been based is less cordial. Rising regulatory standards, welcomed by the industry, add to an extreme cost of living.
Some wonder if Bermuda is nearing the end of a 60-year cycle.
Innovation and adaptation, islanders' traits, have always marked the Bermuda market. Its finest years may yet lie ahead.
Either way, it is too soon to declare the race over.
ROGER CROMBIE is a Bermuda-based columnist for Risk & Insurance®.
January 1, 2008
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