Exploiting the winds of change

15-11-2016

Exploiting the winds of change

Brad Kading, ABIR president

Despite the many challenges facing the reinsurance industry, Bermuda is well positioned to maintain and build on its role as the global risk transfer hub of choice, Brad Kading, president of the ABIR, tells Bermuda:Re+ILS.

The benefits offered by Bermuda mean it is increasingly becoming a true global hub with capital from all over the world invested in its companies. But while embracing the current upward curve of the domicile, it must not rest on its laurels, keeping pace with change and managing the challenges it faces.

That is the view of Brad Kading, president of the Association of Bermuda Insurers and Reinsurers (ABIR), who says that a combination of its regulatory structure, commercial infrastructure, talent, tax agreements and compliance with international standards has made it an extremely attractive place to do business.

On top of all these things, Solvency II equivalence now gives it an extra edge and appeal to international companies seeking security and high standards, and also ease of access to many markets including the European Union.

“People used to see Bermuda as a market for North America but if you look at where the investment has come from in recent years it is all over the world,” Kading says. “Australian, Dutch, Italian, Japanese, Chinese, Swiss and German companies all have investments here. The capital pool is now very diverse and that is part of Bermuda’s success.”


Keeping abreast of change

The pressures on the domicile are constant, however. Kading warns that Bermuda must always keep pace with tax compliance and changes to global standards, and changes to its own government can pose a risk. There are also elements of political risk that are outside its control, he adds.

“Political risk comes in the form of local government in changes to various policies including tax or work visas, etc, but also it exists in ways that are outside Bermuda’s control. There is always a possibility that other countries can change policies in ways that can have a direct impact on Bermuda.”

This is mitigated to some extent by Bermuda’s long standing commitment to Solvency II equivalence as well as issues such as the OECD’s international tax standards. But he stresses that certain things are outside Bermuda’s control.

“The US is probably entering its fifth year of debate around tax reform. With a presidential election in 2016, perhaps we will see a shift in policy at some point and that could affect Bermuda. A lot of these issues are local risk factors outside our control and the threat will never really go away. It is like the fairground game Whack a Mole—as soon as you think one issue has disappeared another emerges,” Kading says.

“WE ARE ALREADY SEEING SOME COMPANIES ADDING THE UNDERWRITING SUBSTANCE NECESSARY TO WRITE BUSINESS THROUGH THEIR BERMUDA SUBSIDIARIES TO GAIN THE BENEFI T OF EQUIVALENCE.”

That said, some problems can also become opportunities for Bermuda. The recent Panama Papers scandal, which revealed the extent of the use of shell companies in many offshore domiciles, has probably helped Bermuda in the long term. Bermuda was not mentioned in the papers, which inadvertently illustrated that big differences exist between offshore domiciles in terms of their quality and transparency.

“Those papers identified the top locations for shell companies and Bermuda was not on that list,” Kading says. “Bermuda has never been used in that way because of the transparency we have. We have collected and maintained records of beneficial ownership for more than 70 years—to put that into context, many US states don’t do that.

“We are also at the cutting edge of anti-money laundering initiatives. So in many ways an incident like that helps us. Companies will be far more cautious about using certain domiciles going forward and we should benefit from that.”

Even more momentum could be created in Bermuda’s favour by the base erosion and profit shifting (BEPS) Action Plan by the OECD, which at a very basic level is designed to ensure that companies have substance and meaningful activities where they pay their taxes.

“There will be tests emerging in the coming years around what economic substance looks like. For Bermuda, however, the economic substance is pretty clear. It is not the case in some other jurisdictions and that should benefit us.”


Well positioned

Turning his attention to Solvency II equivalence specifically, Kading believes the benefit to Bermuda could be more tangible in the short term than many expect. Many companies based in other jurisdictions including the US are only now coming to terms with the consequences of what Solvency II will mean.

He says that when the regulators of many European countries changed their own regimes to give Solvency II precedent, they also—sometimes inadvertently—made things much harder for reinsurers based in non-Solvency II-compliant countries to do business there. Some companies may have thought that posting collateral may be necessary whereas, in fact, they may find it difficult to do business there at all.

Germany, Poland and the Netherlands are just three countries where this applies. In Poland, the Polish cedant can’t do reinsurance with a non-EU or a non-equivalent reinsurer. In Germany, much the same rule applies although there is a narrow exemption tied to not using a German broker. In the Netherlands, the non-EU reinsurer has to file its financial statements on a Dutch accounting basis in order to qualify to write reinsurance.

The UK Prudential Regulation Authority has raised questions about group supervision for non-EU groups and has used regulatory leverage to gain branch or subsidiary formation.

“Some of the challenges may only become clear as the renewals season goes into full swing. But the situation could benefit Bermuda, as a natural way around the problem will be to use an entity that is based in a Solvency II-equivalent jurisdiction—such as Bermuda,” says Kading.

“Solvency II equivalence is a badge of credibility and helps with our wider reputation as a robust prudential supervisor. But it will also have some very practical implications,” he says. “There are now some clear impediments for reinsurers wishing to do business in some European countries, which could become a big problem. Collateral may not be a solution but using a Bermuda-based entity could be.”

This could be a problem for US reinsurers in particular, he says. Negotiations around an EU-US regulatory deal are underway but the final implementation process could take years and it looks unlikely that a solution will be in place by the January 1 renewals.

“That is the potential solution long term but the process will not be quick,” he says. “The renewals will really bring things to a head.”

In a similar way, Bermuda could also benefit from the UK’s leaving the EU. He says there is the potential that UK-based companies that already have links to Bermuda could leverage these to gain access to the single market.

“For a UK-based reinsurer with a Bermuda subsidiary, it would now be natural to trade with Europe using that subsidiary,” he says. “We are already seeing some companies adding the underwriting substance necessary to write business through their Bermuda subsidiaries to gain the benefit of equivalence.

“We don’t want Bermuda to be used in a game of regulatory arbitrage. Instead we believe that equivalence means adding more underwriting substance to the Bermuda legal entity so that more business can be written from more clients. It can expand our market footprint.”

He also notes that Bermuda will need to establish its own arrangements with the UK as quickly as possible. “We need a twin-pillar approach where a solid regulatory arrangement is established with the UK as soon as possible post-exit. The UK is the most important European market to Bermuda companies so we have to establish what Brexit looks like and protect our own interests but ensure the relationship is still in place.”


The plight of an industry

In some ways, the positivity around Bermuda’s current place in the world of risk transfer is in stark contrast with the plight facing many ABIR members. Kading says the burdens of an elongated soft market, and low interest rates putting pressure on investment returns, continue to cause problems for companies.

A mixture of reserve releases and low cat losses for many years have helped the industry in the short term but that cannot last forever, Kading says. He believes that only some large paradigm-shifting events would change the market conditions, but even those may not have an impact as they did at previous points in the industry’s history because there is so much capital markets money waiting to enter the industry should rates increase even moderately.

The solution the industry should be seeking, he believes, is growth by sourcing new business for the industry as a whole. Changes in governments’ appetite for risk has seen large government programmes start to be opened up to the private sector. In the US, the national flood programme is being opened up, as has the Florida Citizens state-backed wind coverage.

The same trend can be seen elsewhere in the world. In France, a legal ruling means that the government guarantee afforded to CCR looks likely to be terminated, potentially exposing a large portfolio of catastrophe business to the private market.

“On top of these, you have the likes of the World Bank rolling out efforts to find ways of increasing coverage in emerging markets. Also we are seeing growth for the industry in certain sectors such as trade risk, mortgage reinsurance, terrorism and cyber,” Kading says.

On cyber, however, he does have a caveat. “We are seeing tremendous growth in cyber premium but people are still experimenting. It is a market opportunity but I have a feeling the industry might also lose a lot of money before they figure it out. You need the trial and error experience to price it properly; it could be a long haul on this product.”

Long-term growth prospects can only go so far towards negating the pressures of the present. These will inevitably lead to more mergers & acquisitions (M&A), he says, although he believes that the current lull in activity on this front will likely last into 2017, as the industry prioritises the year-end renewals.

“In the last six months of the year people are more focused on meeting the numbers and getting their year-end bonuses,” he says. “There will be internal pressures forcing companies to consider M&A again but I think less will come to pass now until next year.”

He stresses that, for Bermuda, such activity is just part of the natural cycle of business. “Companies tend to incubate here and then gradually develop. Some will continue to grow and potentially acquire others while others will reach the end of a natural path. It is tough to lose companies but it is also just the pattern of business in the industry,” Kading says.

He stresses the fact that Bermuda has become the risk capital of the world in other senses, with both the booming insurance-linked securities (ILS) sector and so-called ‘total return’ reinsurers making Bermuda their home.

All the aforementioned reasons including the Island’s robust yet flexible regulatory regime have made this happen and will help ensure Bermuda remains a thriving risk transfer hub for the foreseeable future.

“This is very much part of our industry now—around two-thirds of our members have links managing some form of alternative capital. It means you get that Silicon Valley effect here, where we also become the risk hub for innovation and new products. This is a very exciting time for both Bermuda and the industry as a result.”

The benefits offered by Bermuda mean it is increasingly becoming a true global hub with capital from all over the world invested in its companies. But while embracing the current upward curve of the domicile, it must not rest on its laurels, keeping pace with change and managing the challenges it faces.

That is the view of Brad Kading, president of the Association of Bermuda Insurers and Reinsurers (ABIR), who says that a combination of its regulatory structure, commercial infrastructure, talent, tax agreements and compliance with international standards has made it an extremely attractive place to do business.

On top of all these things, Solvency II equivalence now gives it an extra edge and appeal to international companies seeking security and high standards, and also ease of access to many markets including the European Union.

“People used to see Bermuda as a market for North America but if you look at where the investment has come from in recent years it is all over the world,” Kading says. “Australian, Dutch, Italian, Japanese, Chinese, Swiss and German companies all have investments here. The capital pool is now very diverse and that is part of Bermuda’s success.”

ABIR, Bermuda, Brad Kading, Insurance, Reinsurance, Risk management, ILS, Regulation, UK, Europe, European Union, Brexit, EU referendum

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