Bermuda rides the ‘fifth wave’ of capital
Much has been written about the latest wave of merger and acquisition (M&A) activity that is sweeping the industry. The low interest rate/low yield business environment has led some firms to re-evaluate the way they operate in an effort to obtain a satisfactory return on equity or investment.
For some the path to the Holy Grail of growth has been to gain market traction through size and access to new markets. On the back of this, we have witnessed a merger mania sweep the reinsurance sector with former sizeable standalone companies such as Catlin and XL, as well as Chubb and ACE and other smaller players, merge in search of synergies that will take them to the next level and protect their position.
In the first seven months of 2015, deals worth more than $80 billion were struck, a high not seen since 2010, when deals worth $142.6 billion were recorded for the entire year, according to accountancy firm PwC.
Bermuda has witnessed an enormous amount of M&A activity recently including the XL takeover of Catlin, Endurance buying Montpelier and the RenRe takeover of Platinum. Exor has also finally completed the $7 billion takeover of PartnerRe.
PwC says firms wanted to “sharpen efficiency” in areas including capital, underwriting and taxation, cut costs and strengthen margins.
Cutting costs usually involves shedding jobs and sometimes switching locations, and has the knock-on effect of concentrating capacity. Many deals, as well as failing to remove the overcapacity in the sector, will also lead to a likely reduction in the need for reinsurance since larger combined entities will benefit from greater diversification and capital efficiencies.
The issue will be compounded if, as expected, a combined entity uses structures similar to the recently formed ABR Re fund, a joint venture between ACE and fund manager BlackRock designed to manage ACE’s reinsurance needs.
It’s why M&A is often seen as a ‘bad thing’ by some in the industry.
"People consolidate to gain an advantage—it’s an ongoing story and it is a sign of vibrancy in the market and nothing else."
Not for Brad Kading, though. As the president and executive director of the Association of Bermuda Insurers and Reinsurers (ABIR), you could be forgiven for thinking that a contraction of membership as a result of M&A activity may give him some cause for concern. But you would be wrong. He is a man who concentrates on the bigger picture and for whom the glass is always half full.
For him, M&A is part of the natural order of things in the business world and is something to be welcomed and embraced rather than feared.
“This is the natural progression of the market. People consolidate to gain an advantage—it’s an ongoing story and it is a sign of vibrancy in the market and nothing else. Sometimes people get distracted and see M&A activity as perhaps a sign of weakness—it is exactly the opposite,” Kading says.
“New companies are being formed as the older ones are consolidating and what we are witnessing is the fifth wave of capital formation.”
He can point to the numbers of new companies establishing a presence on the Island as well as increased interest from Asia and Canada and private equity capital—not forgetting China, with Minsheng Investment Corp’s acquisition of Bermuda-based Sirius Group and Panda Re’s recent cat bond deal, which secured $50 million of protection for China Re.
Where Kading sees opportunity for truly significant growth for Bermuda is in the alternative assets marketplace—he already considers the Island to be “converged”—as firms look to diversify and seek returns.
“We don’t look at it as traditional capital versus alternative capital; we see it as capital taking on risk. It’s all about growing markets to increase the opportunity to earn a return, talking to policymakers and expanding markets and talking to clients,” he says.
Bermuda seems on to a winner here. Global broker Aon predicts this market could top $150 billion by 2018.
However, there are still some regulatory hurdles to be overcome if Bermuda is to remain a player at the big re/insurance table, not least Solvency II and the demands it places on regulated firms and jurisdictions.
Again, the mood from Kading is upbeat and why not, given that the final report from the European Insurance and Occupational Pensions Authority (EIOPA) found Bermuda to be equivalent to all Solvency II requirements.
“The European Commission (EC) has said in previous statements that it will follow the EIOPA guidance,” says Kading (who by the time of publication may have discovered whether that has indeed been the case).
He has no doubt of the validity of Bermuda’s case, believing “Bermuda is deserving of equivalence and we think that the EC will find Bermuda to be equivalent”.
He makes the point that Bermuda differs from other jurisdictions in that its regulator, the Bermuda Monetary Authority (BMA), deals only with wholesale operations and not customer-facing propositions and for that reason “it focuses only on commercial practices—that gives it a tremendous advantage and it’s a reason why the BMA can move faster”.
The EC will use the EIOPA report to make a final decision on Bermuda’s equivalence later this year. Presently, Switzerland is the only non-EU country currently granted full equivalence under Solvency II.
“What Bermuda has and Switzerland hasn’t is a hub dedicated to innovation. Bermuda’s traditional role as an incubator is still strong and it is a place where people come to experiment with products,” Kading comments.
The US provides the battleground for another regulatory skirmish, this time involving hedge funds acting as reinsurance companies.
The ABIR put in a detailed response to US Treasury’s/Inland Revenue Service’s (IRS) proposed Exemption from Passive Income from Certain Foreign Insurance Companies (PFIC) which seeks to impose minimum standards for insurers in an effort to distinguish between firms that carry out genuine underwriting and those seeking profits from investment returns made on those insurance premiums in a tax-efficient way.
There are fears that, if the rules were adopted in their original form, many firms operating on Bermuda would fall foul of the proposed new rules.
ABIR was hopeful that its views on such contentious issues such as calculating what constituted a reinsurer on grounds of headcount and amounts held in reserve would be taken on board, and if not repealed, would be watered down to such a degree that it would have no adverse effect on its members.
The waters were further muddied when US presidential hopeful Donald Trump waded into the debate.
Usually the scourge of business red tape and regulation, Trump shocked associates and industry commentators during a Republican Party presidential debate when he called for the alleged tax loophole on fees earned by hedge fund managers to be closed. “They’ll pay more.”
Bermuda is home to several so-called hedge fund reinsurers—reinsurance entities that use the ‘float’ from reinsurance premiums and leverage it to invest in various asset classes seeking an improved return.
It is not only these operations that would be affected by the IRS proposals. The blanket ban nature of the rules could see more traditional firms scooped up in the IRS net with devastating consequences for the Island’s wider re/insurance sector. That’s why the ABIR is so keen to see its recommendations adopted.
Caught in the net
Hedge funds account for only about 10 percent of the total alternative capital in Bermuda, according to AM Best. Ten to 15 percent of US insurers would be disqualified from carrying on business if the rules were adopted in their current form and applied to them.
“Nevertheless, we are taking it very seriously because the scope of the regulation could affect many insurance legal entities,” says Kading.
He dismissed the Trump intervention as irrelevant. But the curiously coiffured presidential contender’s intervention came two days before the IRS was due to make a statement following a hearing of interested parties on how it intended to proceed with regard to the proposed rule change. It may just have been a coincidence, but statement from the IRS came there none.
Kading explains: “The US Treasury/IRS hearing on the proposed PFIC regulation was on September 18. Treasury offered no public insight into its next steps. They asked no questions of the four presenters.”
He adds that in follow-up conversations it was clear they want to advance a regulation on the insurance exception to the PFIC rules. “They need time to sort through the mechanism of a bright line exception and consider how to make a facts and circumstances test work efficiently,” he adds.
Kading, however, believes the whole issue to be a red herring. “It will not gain the Treasury any extra revenue but it is a huge politicisation of the whole hedge fund issue,” he said. That “politicisation” has just ratcheted up a few notches with Trump’s intervention.
Where Bermuda has made major strides in securing its future as reinsurance and risk management centre is in gaining the confidence of the US National Association of Insurance Commissioners (NAIC).
A memorandum of understanding was signed earlier this year by the Bermuda Monetary Authority (BMA) which will help insurance supervisors in the US and Bermuda coordinate on regulatory issues with the goal of efficient, fair, safe and stable insurance markets.
It will also allow for an exchange of information. Kading describes this collaboration on transparency as “transformative” adding “there will be no secrets in regulated enterprises any more”.
He revealed that the BMA database will have mandatory stress-testing and will hold capital information and will produce a series of reports which will be essentially “benchmarking”.
“The regulators will have all the information and that will cause everyone to up their game,” he warns.