1 February 2011

Bermuda: welcoming shores

The Bermuda captive market continues to display its resilience in the face of softening commercial re/insurance rates, with captive insurance vehicles proving their worth to a host of international companies. Bermuda remains the leading domicile for captives, enjoying a healthy level of new formations as it draws upon its expertise, depth of experience, and a conducive tax and regulatory environment to help to raise itself above the competition.

Topping the list

Speaking with a host of experts on the Island, it is evident that Bermuda’s competitive advantage remains as robust as ever. As Tom McMahon, president of the Bermuda Insurance Management Association (BIMA) made clear, “there is no doubt in my mind that Bermuda will maintain its leading position as the world leader as a captive domicile”. Jill Husbands, managing director of Marsh IAS, Bermuda, echoed McMahon’s sentiments, stating that “when there is a hard market, when there is a crisis in the insurance industry, Bermuda has always come to the forefront with innovative products and solutions for our clients, and I believe that that’s our edge. We have a large number of very bright, intuitive people here who know and understand the business.” It seems that this ability to innovate and the depth of the Island’s bench will help steer Bermuda through the choppy waters of the present soft market.

Oliver Heyliger, managing director of Willis Management (Bermuda), indicated that “Bermuda’s one-stop shopping for captives, direct excess insurance and reinsurance” further sets it apart from the competition, and with further captive growth expected—particularly from the emerging economies—Bermuda will be able to leverage itsinternationally recognised expertise in these developing jurisdictions. Drawing upon its strengths, Bermuda will be able to place itself at the forefront of those domiciles that parent companies consider when establishing a captive, and as McMahon said: “They will be looking for a domicile with a proven track record.” Bermuda boasts just such a history.

Threats nonetheless remain

Asked what threats the captive industry faces in Bermuda, it appears that the soft commercial market, declining investment returns, competition from the US and the imminent arrival of Solvency II top the list. As Heyliger made clear, “the continued soft insurance market slows down new captive formations. The low interest rate environment also makes retaining excess capital in a captive less attractive. Once funds are dividended back to parent companies, the expansion of existing captives into new business is more difficult.” Although such conditions are set to continue into the foreseeable future, there is every expectation that Bermuda captives will be able to strengthen their investment returns as the capital markets recover and benefit from a marked rise in captive formations when the commercial re/insurance market eventually hardens. As Scott Gemmell, senior vice president, captive solutions, at Marsh IAS, made clear: “In every hard market cycle, there has been a huge spike in the number of incorporations and I think next time won’t be any different.” And despite the lower level of formations in the last two years, there is every expectation that there will be a marked rebound as and when the market recovers. When it does, Bermuda’s experience, innovation and strength of expertise mean that it will be ideally positioned to capture any new business.

For Marsh’s Husbands, the key concern is the threat of US captive domiciles “who are aggressively marketing their product”. Addressing the specifics of US competition, Gemmell said that although pricing was a factor in the competition Bermuda faces from US business, it is not significant “rather they focus more on the proximity issue—why would you go elsewhere when you can do your business right on your doorstep”. In the face of such pressures, Bermuda nevertheless continues to capture significant levels of US business—due in part to its proximity—although it is evident that the Island’s captive industry does need to be clued up to the potential threat posed by the growing number and strength of US domiciles.

The final concern is that posed by Solvency II and its implications for the captive sector. As McMahon made clear that “while we [BIMA] agree with the need for equivalency for Bermuda in the case of our Class 4 companies, it is vital that in order to achieve equivalency, there are no changes to the regulatory environment for captives. The Bermuda Monetary Authority (BMA) will be using the principle of proportionality to show that the captive sector is adequately regulated and we support that argument.” McMahon indicated that Europe and a host of non-European jurisdictions will be paying close attention to just how Bermuda deals with the issue. The question will be exactly how the Island approaches the challenge of “balancing the need for increased and appropriate supervision”, McMahon said. He made clear that the forthcoming discussions with the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) would involve the captive sector in Bermuda making its case that current regulation is appropriate and “not in need of change”.

Solvency II: specific concerns

Addressing the specific concerns of Solvency II, McMahon said that the imminent regulatory accord “is the big elephant in the room right now”. He was nevertheless confident that Bermuda—with its inclusion in the first wave of domiciles considered for equivalency—is “leading the way in showing the EU how captives should be regulated within the Solvency II environment”. Addressing the developing process, Husbands said that Bermuda has “gone through various cycles, but each month that we move into this process, it becomes clearer how we will respond to Solvency II”. Asked exactly how Bermuda intends to deal with the issue of equivalence, Husbands indicated that the Island’s take on the regulatory regime would be to set its own Bermuda standards rather than follow Solvency II exactly.

Touching upon the issue of proportionality and whether such an approach would be applied to Bermuda’s captive sector, it is evident from Husbands and others that there is an expectation that it will. And while Solvency II creates definite, immediate uncertainties, Heyliger indicated that “we do not feel that actual solvency requirements for Class 1, 2 and 3 captives will change”. Husbands likewise echoed his sentiments, stating that “with regard to any potential changes to legislation impacting pure captives, we believe quite strongly that there will be no change.” If this proves to be the case, Bermuda’s captive sector will find itself in a strong position—compliant with European regulatory expectations and ahead of the game internationally. However, there are still concerns over the cost of compliance with Pillars 2 and 3 of the accord, concerning risk reporting and transparency, and as McMahon made clear, “captives are a very different animal and need to be treated differently to traditional commercial insurers and reinsurers”.

Called to the board

Captives are unique entities, with very specific applications and needs, and the make-up of the captive board is no different. Addressing the needs of the captive board, Heyliger made clear that “captives are closely held insurance vehicles, and therefore the board expertise is different from that required by the conventional market”. Whilst the expertise required for straightforward captives should be relatively easily found within the parent company, those interviewed agreed that vehicles dealing with niche risks require specific expertise and individuals with a real interest in captive development. For healthcare liability captives, for example, Heyliger suggested that “external directors with specific healthcare experience...add significant value”.

And it seems likely that developments in the provision of US healthcare insurance as a result of healthcare reform will provide further impetus for physicians to be included on healthcare captive boards, with Kimberly Morgan, Bermuda healthcare practice leader at Endurance, indicating that “US hospitals are employing more physicians where previously their relationship was contractual in nature. Physicians are in a lot of key leadership roles now within hospitals and are frequently effective drivers of change, and including them on the captive board can add significant value, especially if you select those ones that are very energetic, data driven, passionate about quality and are respected by their fellow physicians. With the changes coming with healthcare reform, we think it important that the physician voice and perspective be well represented on the captive board.”

Expertise from within the parent can add significant value to the captive, although the exact needs differ from captive to captive and can be drawn from a range of departments within the parent—from the chief risk officer’s suite to the office of the general counsel. The kind of people that would be a good fit for the captive board are “the people who can make informed decisions about the risks that are going to be accepted, the investments that are going to be made and the overall value that the captive can bring to the company as a whole”, according to Husbands. Having such people on the board will help give the captive the necessary firepower it needs to perform and excel in its function as a key risk mitigant for the parent. Building a competent and appropriate captive board will then bring with it its own benefits.

Bermuda captives: still buoyant

While the soft cycle in the commercial market has “lasted a lot longer than...anticipated”, according to McMahon, formations in Bermuda have nevertheless continued in the past couple of years—if at a lower level than before. Parents that have looked to the commercial arena have continued to maintain their captives, and interest in captives has been sustained. With new geographies such as Canada and South America looking to the potential of captive insurance, it seems that not even the sluggish economic recovery that continues to afflict Europe and the United States can derail the continuing attractions of captive re/insurance entities.

And with Bermuda an established and pre-eminent domicile in the sector, those who Bermuda Re spoke to are confident that the Island will continue to maintain its leading position. Addressing the issue of outside competition—particularly from the US—Gemmell said that “we are seeing business coming here that hasn’t even considered [other] domiciles. There is advice and expertise that they just can’t get in those other jurisdictions, where they don’t have the infrastructure, the regulatory bodies, the law firms and the captive managers that enable firms to innovate. This is what sets Bermuda apart.” By continuing to differentiate itself from the competition, Bermuda can expect to remain at the top of a lengthy destination list as the captive domicile of choice for international business.

Endurance: a key captive player

Endurance is one of Bermuda’s re/insurers with an active relationship with the healthcare captive sector—reinsuring approximately 100 healthcare captives primarily domiciled in Cayman and Bermuda. Kimberly Morgan, Bermuda healthcare practice leader at Endurance, stated that “we underwrite hospitals, primarily large integrated delivery systems with sophisticated risk management departments that fund their selfinsured retention via a captive, and then structure their excess coverage as reinsurance of the captive. We participate in this excess structure, reinsuring the captive with up to $25 million in net capacity.”

She indicated that Endurance’s team, while familiar with the cyclical nature of the industry, is cautious about present soft market conditions, although with a greater than 90 percent renewal retention rate, Endurance feels that its clients value the key differentiators that help shift the focus from pure price. Morgan stated that “the majority of our clients have been with us since our inception in 2002, so they have built very strong relationships not only with our underwriters, but also our claims department. They value the relationship and the value-added services in the form of benchmarking from our claims database of over 3 million data points, as well as the risk management and enterprise risk management expertise we offer for our lead clients.

“The area where we see the most competition currently is on the high excess layers where the coverage is viewed as more of a commodity and there is a lot of pressure on minimum premiums. We understand that we need to be competitive, but we also value and protect the cost of our capital.”

Concerning specific measures that Endurance and the industry have taken to strengthen the captive sector in Bermuda, Morgan said that “Endurance has worked with a consortium of carriers and brokers in the Bermuda market to develop a short follow form healthcare policy for those clients seeking continuity of coverage. While not all of these markets will use the form for reinsurance of a captive due to the unique terms and conditions of most captive forms, it provides an attractive alternative for those clients seeking large blocks of Bermuda capacity and represents a further source of strength and differentiation for Bermuda re/insurers in the captive arena.”

Finally, addressing the issue of changes to US healthcare insurance provision and its impact on business, Morgan said that “there are a lot of unknowns with respect to US healthcare reform”. Irrespective of what is happening in Washington, reform is going to proceed in some format. “Three trends that we are already seeing” according to Morgan “are that hospitals are consolidating, with larger systems purchasing smaller, communitybased organisations; hospitals are employing significant numbers of physicians; and lastly, there is more of a shift towards an accountable care model of healthcare delivery.” What impact these changes will have is yet to be fully realised within the industry, but as Morgan made clear, Endurance and others are “analysing these developments and trying to understand how our clients’ risks and exposures will change in the future so that we are ready to respond as their reinsurance partners.”

Change, it seems, is afoot, but what impact this will have on ceded premiums and captive vehicles remains to be seen. Regardless of how things pan out however, it seems that the strength, depth and experience of captive reinsurers such as Endurance will mean that Bermuda will be in a strong position to respond to any developments.