1 March 2012Re/insurance

A captive 'carve-out'

Despite competition from other offshore and onshore domiciles, which has at times been acrimonious, Bermuda remains the leading domicile for captive insurance. Bermuda is able to leverage its depth of expertise and a one-stop-shop approach to captive insurance in order to set itself apart from the competition. As Lawrence Bird, chairman of the Bermuda Insurance Management Association (BIMA) indicated, international competition is nothing new for the Island and, despite mounting rhetoric, new pressures are not presenting a graver threat to Bermuda’s continued dominance.

Rather, it is macroeconomics and international regulation that appear to be the leading concerns for the captive sector in Bermuda. As Ernest Morrison, director, head of corporate at Cox Hallett Wilkinson (CHW) indicated, “troubled macroeconomic conditions are not just a cloud, but a reality”, and one that has significant implications for all sectors of the economy. Jonathan Betts, senior associate at CHW concurred, arguing that conditions have encouraged firms to “look very closely at the cost of doing business”, a situation that has encouraged service providers in Bermuda to “make their clients’ continued existence economically viable by delivering the best value for money”.

Anna Pereira, head of captive and insurance banking at HSBC Bermuda, agreed, adding that the “increasing costs of doing business are always a challenge. Any captive owner has to consider the total costs they will incur from their service providers (such as legal, accounting, banking and fees)”. As Morrison made clear, “Bermuda needs to remain the best in breed in all aspects of captive insurance.” Price will, inevitably, form a component part of such calculations.

Addressing the issue of US and international regulation, Bird said that the main challenge is from the Dodd-Frank Act and—if it is established—the self-procurement tax, which would affect US parent companies. Pereira, for her part, said that “there are numerous potential regulatory changes that we have our eye on, including the Foreign Account Tax Compliance Act (FATCA). There are also potential regulatory changes on the horizon for segregated account companies”.

Morrison said that in the case of both US and EU regulation, “we are, and need to remain, extremely attentive to the needs of both sets of regulators”. Such attention is all the more pressing with Solvency II on the horizon and equivalency in the works. Bermuda’s regulatory approach will need to be carefully calibrated. Fortunately, with the Bermuda Monetary Authority (BMA) at the helm, the industry has every confidence that the right regulatory balance will be struck. As Pereira indicated: “The BMA are doing a great job in their efforts to convey the benefits and strength of Bermuda’s position. They should be commended for the work being done to continue developing both Bermuda’s captive and commercial insurance markets.”

The carve-out

Perhaps the most significant development in the captive space has been a move by the BMA to institute a ‘carve-out’ for captive insurers under the Solvency II framework. Initially, captives had expected to face the full force of Europe’s regulatory guidelines. However, the BMA is hoping to apply a differentiation approach in which captives would be excluded from the full force of equivalency.

As Bird made clear, “Bermuda has never sought equivalency for its captive sector”. Rather, it seems that the BMA and Bermuda’s captive industry would prefer a segmented approach that recognises the differing nature of the captive and commercial re/insurance sectors. Bird said that following discussions with the European Insurance and Occupational Pensions Authority (EIOPA), the Bermuda captive sector could be “cautiously optimistic” that segmentation under Solvency II could become a reality.

"Many regulatory measures were already in the pipeline prior to Solvency II, but the European regime had encouraged further positive development."

Morrison said that such a carve-out would enable “classic captives to avoid the direct impact and significant expense associated with Bermuda becoming a third party country under equivalence. This is a huge step that will benefit Bermuda for a number of years, in terms both of credibility and a differentiation approach to regulation”. Bird added that Bermuda’s existing classification system had helped to make the carve-out a reality, with the intention being to “keep the solvency and capital requirements for captives the same”, while strengthening reporting. Bird said that he hoped that other domiciles would follow the example set by Bermuda as “it would be good for those domiciles and captives generally”, with Bermuda already finding itself “in a strong position as regards Solvency II”.

The carve-out should also help head off any fears that the burden of Solvency II will scare captives from Bermuda’s shores. As Morrison indicated: “I don’t doubt that some captive owners will have taken a view on the longer term effects of Solvency II equivalence as regards the overall expense of the jurisdiction and considered others, but given the carve-out, the overwhelming advantages of being in Bermuda continue to be a reality.”

Regulatory excellence

The carve-out isn’t the only regulatory measure Bermuda is looking to put in place to strengthen its position internationally. Morrison indicated that the BMA has already introduced a code of conduct for insurers, “which will help to impose good governance from a regulatory and corporate standpoint throughout the space. Ironically, it is regulation that is setting the stage for continued effective growth for a jurisdiction with a credible regulatory framework”. At the same time, the BMA has taken steps to improve new admissions with the establishment of a “technical committee that considers all applications, streamlining and increasing confidence in the process”, Betts said.

Bird added that many regulatory measures were already in the pipeline prior to Solvency II, but that the European regime hadencouraged further positive development. He said that enhanced reporting would help provide the BMA with a “still better view of the market”, while the new designation of limited purpose insurer (a term that denotes captive re/insurers) was instituted in part to “help Europe better understand the captive concept”.

Promoting Bermuda

The carve-out—if successful—will be “extremely good news for the captive sector”, with the next, not insignificant, step being to make the reality of differentiation more well known internationally, said Morrison. Helping matters will be the range of tax information exchange agreements (TIEAs) that Bermuda has signed in recent years. As Betts outlined, there are significant opportunities emanating from Canada, Mexico and South America, with recent TIEAs opening up potential business for Bermuda’s captive sector. Additionally, the “continuing development of emerging market economies also provides potential for captive growth”, said Pereira. “As the business markets in these countries grow, risk management and insurance solutions will inevitably become more sophisticated. Increasing usage of captives within risk management strategies should be expected,” she said.

These are opportunities that Bermuda can take full advantage of as an established centre of captive excellence. Business Bermuda is already taking a leading role in promoting the Island, Betts said, with the whole captive sector working to promote its strengths internationally. And as Pereira outlined: “Direct access to the reinsurance market and a high sovereign rating are key benefits for Bermuda captive owners, in terms of both the breadth of products and services available and the financial strength and stability of the jurisdiction.” Such strengths, coupled with the likely carveout, should make conveying the strength of Bermuda’s captive story a simple task as the Island looks to maintain its leading position.

Greater international cooperation and a differentiated carve-out will position Bermuda at the forefront of the industry, and it seems likely that the Island’s proactive approach, to what some had worried would be a regulatory burden, will pay dividends in the future.