The benefits of Bermuda’s regulatory framework

In the October issue of Bermuda:Re+ILS, this panel of experts examined the size of and opportunities around the life reinsurance sector on Bermuda. Its growth has been steady and characterised by a diverse range of business models that have emerged in the sector.

Gokul Sudarsana from Deloitte interviews Sylvia Oliveira (Wilton Re), Scott Selkirk (Somerset Re) and Manfred Maske (Monument Re) about the nature of this regulatory landscape and assess how this applies to life reinsurance. To read the panel’s thoughts on the growth and opportunities in the sector, see the October issue of this publication.

Gokul Sudarsana: One common misconception about Bermuda reinsurance is that it is primarily motivated by tax efficiency although, as you have described, there are a multitude of other reasons. But the question remains, how does your company think about tax?

Scott Selkirk: It’s important to recognise that any reinsurance premium ceded from a US company to a company in a jurisdiction that does not have a tax treaty with the US, or has a limited tax treaty like Bermuda’s, is subject to US Federal Excise Tax (FET) which is currently 1 percent for reinsurance premiums. On an inforce transaction, where the reserve transfer is considered the reinsurance premium, that can be a substantial amount. So, to make a ceding company neutral from their perspective, a reinsurer in these jurisdictions would often offer a ceding commission to offset that tax expense.

Somerset Re is structured somewhat differently. We are domiciled in Bermuda and regulated by the Bermuda Monetary Authority (BMA), but we have been granted tax residency in Ireland, so we pay Irish corporate income tax. This affords us the protections of the US-Ireland tax treaty, which includes an exemption from FET.

We feel that this provides our transactions with a little more tax efficiency and also provides our business more stability, in the sense that if the US were to increase excise tax we would not be affected.

Manfred Maske: I will comment more from an EU-based perspective. The EU tries to harmonise its approach across a number of areas, but does not do that with respect to taxation, so you get a range of treatments. As a reinsurer or acquirer, there are implications for us to think about.

As a reinsurer, some territories levy something similar to the FET called an insurance premium tax—Spain would be one example, but the UK does not. As an acquirer, some territories levy withholding taxes on the payment of dividends from that country to Bermuda (eg, Belgium), while other countries do not (eg, the UK).

So, for us, it is quite an important feature of how we do business in terms of selecting and working with a domicile, and structuring the reinsurance or acquisition arrangement. Taxation does have a very important bearing on how we conduct ourselves in the pricing of a transaction.

Sylvia Oliveira: To reiterate Scott’s comments, FET can be expensive for different structures. Some companies in Bermuda elect to be US taxpayers. These companies have elected to become US taxpayers under the US Internal Revenue Code section 953(d). The fact that there are several of these companies in Bermuda gives further evidence that tax is not the only reason for companies to be in Bermuda. Certainly, it’s a factor for certain transactions, but not the only factor.

The current US Tax Reform could change the picture for Bermuda reinsurers. The proposed tax reduction would decrease Bermuda’s tax advantage, which could impact the sector’s ability to attract new deals to the Island. Bermuda reinsurers that transact with US affiliates could also be negatively impacted.

Bermuda’s solvency framework

Sudarsana: Bermuda has put a lot of effort over the last decade to achieve and maintain Solvency II equivalence. It is one of only two jurisdictions worldwide, along with Switzerland, to have this distinction.

Bermuda is also one of seven National Association of Insurance Commissioners (NAIC) qualified jurisdictions. These two attributes have differentiated Bermuda among other international jurisdictions. Prior to these initiatives, Bermuda had a relatively limited solvency framework so these developments have set Bermuda apart and reaffirmed its position as a robust and reputable insurance market.

What does Solvency II equivalence and NAIC qualified jurisdiction status mean for your business and for your clients?

Maske: Solvency II equivalence is a key factor, and also the fact that Bermuda is a NAIC qualified jurisdiction is very helpful when we are talking to cedants and explaining about the Bermuda regime. Both certainly have a very direct benefit when speaking about the robustness and credibility of the regime.

For us specifically, permanent Solvency II equivalence has a number of meanings. “Permanent” genuinely means permanent, subject to periodic reviews, so the BMA needs to maintain its equivalence. As mentioned, they have worked very hard to achieve this status so will certainly maintain it going forward.

This is a key reason for us and a number of other life reinsurers to be based in Bermuda. It’s no coincidence that Switzerland and Bermuda are the first jurisdictions to achieve equivalence—they are both recognised reinsurance hubs.

There are three specific articles granted by equivalence. One of them speaks to what I alluded to earlier: all Bermuda-based reinsurers are treated as if they are EU-based. What does that mean? In practice, this has a significant commercial benefit. It means you have market access.

We have an unfettered right to reinsure into EU markets. From a commercial position, we are not starting from where a non-EU based reinsurer would start, where they are legally obliged to offer collateral for a reinsurance transaction. It becomes a commercial discussion between a Bermuda-based reinsurer and an EU cedant.

Second, there is the standing and recognition of the BMA as the group supervisor. For us, and some other companies, we are a group of companies, and the BMA would lead the college of supervisors and be recognised as an EU-standing supervisor.

Therefore, when we are looking at particular features that do not fit within an existing framework, it is important to have access to the group supervisor for discussion and approval.

The third article recognises that the capital regime in Bermuda can be used instead of the Solvency II capital regime for a Bermudian subsidiary of an EU insurance group—the so-called “deduction and aggregation” method of consolidation of the group capital position. This is very relevant for Bermudian entities that have group parents in the EU and acts to reduce reporting requirements and workload.

Selkirk: Even though we are a US-facing reinsurer, Solvency II equivalence is a positive in that it gives ceding companies a sense of comfort that the Bermuda regulator is experienced and well-respected, and the solvency framework is credible and consistent with leading practices.

Specifically on the NAIC qualified jurisdiction, this allows a Bermuda reinsurer to become certified in the ceding company’s state of domicile, which allows for more flexibility on the amount of collateral that is required in order for the ceding company to receive reinsurance credit on the transaction.

Oliveira: The NAIC qualified jurisdiction status is also very important to us. This is just the first step in the process. To become a certified reinsurer, there is an application process for every single state that you would like to transact in, and this certification must be renewed every year.

This allows you to hold reduced collateral based on the credit rating of your company. For example, an A-rated reinsurer would hold 20 percent collateral as opposed to an uncertified reinsurer that would have to hold 100 percent.

In September 2017 the EU and the US signed a Covered Agreement which eliminates the collateral requirements on reinsurance transactions between these two jurisdictions. This is a bit different but accomplishes a similar goal, but it was negotiated at a federal level so there isn’t the annual state-by-state recertification process. We hope to see the certification process with Bermuda evolve to be more similar to this covered agreement, to level the playing field.

The regulatory picture

Sudarsana: What has happened as the new regulatory regime in Bermuda has been implemented? How has the industry participated in these discussions and collaborated with the BMA throughout 
this process?

Oliveira: When I moved to Bermuda more than 18 years ago, the regulatory capital requirement was minimal—it was $250,000. Around the mid-2000s, the property and casualty (P&C) industry decided it wanted to be equivalent to Solvency II, mainly for Lloyd’s and UK businesses. So, Bermuda initiated some changes to the capital framework.

They later realised that life insurance companies would need to be equivalent too. At the time, most of the life reinsurers were US-facing and not particularly interested in Solvency II equivalence.

We explored bifurcation (ie, to apply for equivalence only on the P&C side) but the EU said no, although the EU did allow us to break off captives, so captives in Bermuda are not deemed Solvency II-equivalent and have different capital requirements.

The life sector needed to be brought up to speed very quickly, so the BMA hired two life actuaries and engaged consulting firms. The BMA also formed a long-term working group with representatives from industry. We collaborated with the BMA on various sub-topics (longevity risk charges, asset risk charges, etc) as they worked to form a risk-based capital model for the life sector.

Around the same time, the life companies banded together to form Bermuda International Long-Term Insurers and Reinsurers (BILTIR), an association to represent our industry. BILTIR started out with five companies in 2011; we now have 43 member companies and 17 associate member companies.

The capital model, the Bermuda Solvency Capital Requirement (BSCR), is a factor model similar to Risk-Based Capital requirements (US statutory) or Best’s Capital Adequacy Ratio (AM Best). This is different from Solvency II, where a shock-based method is applied more often, but the EU concluded in its preliminary assessment that the capital model was largely equivalent to Solvency II. However, the EU noted that Bermuda did not have an Economic Balance Sheet (EBS), which is one of the main principles of Solvency II.

The BMA and industry had hoped to rely on the US Generally Accepted Accounting Principles (GAAP)/International Financial Reporting Standards (IFRS) convergence to produce an EBS acceptable to the EU, but this did not occur. The BMA needed to establish its own EBS. Again, the BMA worked with BILTIR and outside consulting experts to formulate an EBS.

The discounting of the liabilities was a significant hurdle—one that held up Solvency II for several years. Solvency II settled on a ‘matching adjustment’ approach, but this was not a good fit for the Bermuda sector. The BMA established an alternative approach using interest rate shock scenarios, and the EU concluded that this approach was largely equivalent to Solvency II.

A couple of smaller but critical issues came into play at the end of the assessment period. The first was the ‘home office’ requirements. The EU expressed concern about ‘nameplate’ or ‘PO box’ companies in Bermuda and wanted all decision-making to physically occur in Bermuda. The home office requirements were quickly established.

The second was public disclosure. The EU wanted full public disclosure of company financials and the Financial Condition Report (FCR in Bermuda; SFCR in Solvency II). Under this last legislative change, all audited annual financials must be posted on the BMA website, and all companies must post an FCR annually to their websites. In the end, Solvency II equivalence was achieved and this was a big win for Bermuda.

Maske: I will touch on a few of the differences, but the common themes remain. If you recall at the beginning of Solvency II, the thinking was that regulators and governments wanted a risk-based regime that reflected market conditions on both side of the balance sheet as well as greater public disclosure.

They felt that the various types of reporting we have seen in the EU had failed to provide the information that would enable regulators and investors to take action earlier when needed. Those principles still prevail, as Sylvia described, in the Bermuda version of the economic balance sheet: it is risk-based (albeit factor-based but reflective of the risks); it is marked-to-market in that the value of assets and liabilities reflect current market conditions; and public disclosure is made through the FCR.

The difference is that the BMA tried to take a pragmatic approach to implement this, recognising that the full burden of Solvency II for Bermuda companies is onerous. If you have had the pleasure of seeing the reporting requirements and documentation coming out of a full Solvency II exercise, you will know it is a very big piece of work.

The pragmatic approach taken by the BMA was very helpful. The level of disclosure was required to fulfil the EU’s requirements but it is still lighter, and I think it is more sensible and more accessible in Bermuda.

The BMA has achieved the goals it put forth, but sensibly and supportively of Solvency II equivalence going forward.

Selkirk: The BMA has been very clear to the industry that it is committed to maintaining a solvency framework that is consistent with international leading practices and in line with Solvency II. As a result, there are already changes being outlined to be enacted in 2019.

Once they were announced, the industry, through BILTIR, initiated dialogue straight away with the BMA to agree on appropriate timelines for the phase-in of these changes.

Further changes in the accounting frameworks will also affect Bermuda statutory filings, through the refinements in US GAAP and IFRS.

Finally, to the extent that any international standards come out of the International Association of Insurance Supervisors (IAIS), the BMA will evaluate these closely, and will interact frequently with the IAIS and look to be consistent with their standards. BILTIR and the industry will continue to dialogue with the BMA and work together with it on any other proposed changes going forward.

Future changes

Sudarsana: What topics are being discussed in Solvency II that could influence how the Bermuda framework could evolve?

Maske: Solvency II has gone through a very substantial period of implementation so no-one really has a strong appetite to make any major changes. However, there are definitely hot spots being discussed that would have a bearing on Bermuda because we want to maintain equivalence.

It is important to be consistent with, albeit not identical to, any changes made to Solvency II when reviewing how to translate those to the Bermuda environment.

Some of the areas being talked about in particular include the treatment of longevity risk and the risk margin associated with that, which has proved to be very onerous—there is a lot of lobbying in that regard. We expect that this would decrease but exactly when that would come through with the EU’s timeframe for changes is another matter.

Other areas being modified include the adoption of internal ratings for credit risk and their acceptability. Some of the disclosure requirements may change; this is an interesting one because some regulators are pushing for less while others are pushing for more.

It could go either way, but I think the current Bermuda requirements still fulfil the core principle of what Solvency II is trying to achieve, and I wouldn’t expect much change on that front.

The proposed changes in Bermuda that Scott alluded to are a set of changes that will come through, and I expect some smaller ones to follow.

Sudarsana: What are some of the other key topics for Bermuda?

Oliveira: Bermuda is currently being assessed against international standards for anti-money laundering (AML), and this is very important for the Island. Bermuda strives to enhance and protect its reputation as a world-class financial centre. The outcome of the assessment could have a big impact on Bermuda’s reputation, which affects all industries.

Bermuda has been focused on tax reporting as well, collaborating with the Organisation for Economic Co-operation and Development. Bermuda wants to demonstrate as much transparency as possible and has been an early adopter of country-by-country reporting and the Common Reporting Standard.

We expect the BMA will continue working with the NAIC on qualified jurisdiction status and collateral requirements. BILTIR continues to work closely with the BMA and greatly appreciates this relationship. The BMA typically pre-consults with industry on consultation papers, so BILTIR has an opportunity to understand the BMA’s thought process and is able to provide early opinions and impact assessments.

Considering Bermuda

Sudarsana: Long-term reinsurance in Bermuda is a rapidly growing market and in my role, I see a lot of companies interested in accessing the Bermuda reinsurance market, or already benefiting from transactions with their Bermuda reinsurance partners.

In what ways have you helped clients through your Bermuda platform, and what are some of the key takeaways for a potential cedant to consider?

Oliveira: Wilton Re specialises in reinsuring legacy blocks, and we have been successful in this market. These deals are transacted either through Wilton’s US affiliate and then retroceded to Bermuda or else directly to Bermuda—whichever better fits with the capital efficiencies and tax efficiencies of the particular transaction.

We are very transparent with our pricing, and with the fact that the deals are coming into Bermuda, so companies can be confident that the competitive pricing we offer is due to Bermuda’s efficiencies and not due to taking haircuts or thin capital positions.

Selkirk: I would echo that statement: there are efficiencies in Bermuda that can be passed on to the ceding company. We see a lot of interest in our reinsurance support for indexed products, and we are also focused on legacy blocks of business. For example, 
there are companies in the US with older blocks of universal life products with higher guaranteed crediting rates and, as a result, they are considering raising cost of insurance charges, with all the issues that go along with that. We may be able to assume that business through reinsurance, in a coinsurance arrangement, at the current rates.

For key takeaways for ceding companies, when you are considering a reinsurance transaction, of course in addition to price, there are few key questions you want to ask:

Maske: For us, it’s really about helping companies balance their risks and capital, and trying to provide some solutions to that. The only thing I would add is that Bermuda, as a jurisdiction, is an excellent place to be able to support that kind of strategy.

Future trends

Sudarsana: What does the future hold for long-term reinsurance in Bermuda, in terms of regulatory developments as well as responding to global trends?

Selkirk: I’ll talk about the size of the US market. First for the inforce transactions, US life insurers currently have about $1 trillion in each of life and annuities in their general account reserves. Not all of that reserve is in spread compression but the demand for this reinsurance conceivably could be more than the current capacity in the market.

Second, of course, everyone wants their new business initiatives to be more competitive and we can help companies through reinsurance make their new products—especially the interest rate-sensitive products—more competitive.

Looking at demographic trends, the products that US life insurers offer, whether it be deferred annuities, indexed annuities or even immediate annuities, can all benefit from the solutions that Bermuda reinsurers provide.

Maske: There will be short-term and long-term factors. In the short term, the key thing is the impact of regulatory change as these often provide the kinds of opportunities we’ve spoken about and that will continue for some time.

The long-term drivers are still going to be there, such as the demographic changes, the ageing population, the retirement funding gap, etc. That is going to be a source of business for a number of years yet.

Oliveira: With respect to regulatory trends for Bermuda, as Bermuda reinsurers participate in many global transactions, the 
BMA regularly participates in supervisory colleges, and this puts the BSCR head to head with the capital requirements in those jurisdictions.

This highlights areas where the Bermuda rules may be materially different from others. There seems to be this trend to increase capital requirements, and this is coming from everywhere: Insurance Capital Standard, US, Canada, EU.

As an industry, we have to understand how these capital requirements make sense relative to the risks we have on our books. Insurance failures are relatively rare, so do continued increases to capital requirements make sense?

From a growth perspective in Bermuda, we have had tremendous growth over the past few years due and I see it continuing for all the reasons that have been stated, for companies that are in existence already as well as for startups.

To find out more about the issues affecting the Bermuda life reinsurance marketplace, visit www.biltir.bm

Meet the experts

Gokul Sudarsana

Senior manager, Deloitte

Gokul Sudarsana is a senior manager in the Actuarial, Risk and Analytics practice at Deloitte. He has extensive actuarial and risk management expertise spanning pricing, valuation, capital modelling, and asset-liability management within the insurance, reinsurance, and banking industries.

Sudarsana leads Deloitte’s actuarial service offerings in the long-term insurance market. He helps a diverse range of Bermuda and international clients with financial and solvency reporting, accounting and actuarial transformation, pricing and structuring risk transfer solutions, actuarial due diligence, and regulatory/market analysis.

Sudarsana graduated from the University of Waterloo with a Bachelor of mathematics in actuarial science. He is a Fellow of the Society of Actuaries, a Fellow of the Canadian Institute of Actuaries, a Chartered Enterprise Risk Analyst, and a Financial Risk Manager.

Sylvia Oliveira

Chief executive officer, Wilton Re Bermuda

Sylvia Oliveira is CEO of Wilton Re Bermuda, where she works with clients to enhance their value through the reinsurance and acquisition of inforce blocks of life insurance products. She is also chief risk officer of the Wilton Re group, where she has implemented and oversees its enterprise risk management framework.

Oliveira has more than 25 years of experience in the insurance industry. As a director of Bermuda International Long Term Insurers and Reinsurers, she has worked closely with the BMA over the past six years as it has reshaped and strengthened its regulatory framework. She also a director of the Association of Bermuda International Companies.

Oliveira is a Fellow of the Society of Actuaries and a Chartered Financial Analyst. She holds Bachelor’s and Master’s degrees in mathematics, from Boston University.

Scott Selkirk

Managing director, Somerset Re

Scott Selkirk is a managing director and head of pricing for Somerset Re, where his primary responsibility is to lead the evaluation and pricing of all new reinsurance opportunities. He joined Somerset Re in October 2014, and the company was licensed by the BMA in December 2014.

Somerset Re is a class E reinsurer, the largest commercial class in Bermuda, providing customised risk management solutions to the life insurance and annuity sectors, helping clients efficiently deploy capital, improve long-term performance and fund business growth.

Selkirk has held various actuarial roles in the US, at MetLife, ING, and New York Life, mainly focused on product development. He is a Fellow of the Society of Actuaries and a member of the American Academy of Actuaries. He graduated with a Bachelor of arts degree in statistics from Boston University.

Manfred Maske

Chief executive officer, Monument Re Group

Manfred Maske is a Fellow of the Institute of Actuaries with 18 years of experience in the life industry across a number of territories. He was previously CEO and director of Legal & General Reinsurance in Bermuda and CEO and director of Legal & General Gulf in the Middle East.

He has worked previously in a range of management and 
technical roles within Legal & General in the UK, culminating 
in the role of international actuary, where he sat on the boards 
of startups and either as member or chair of the investment 
committee.

Prior to this, Maske held actuarial roles with PwC in the UK, Old Mutual and Momentum Life in South Africa. He is also on the board of directors of Monument Assurance, Monument Insurance, Laguna Life and Monument Assurance Belgium.