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The Official Journal of the Bermuda Insurance Industry Bermuda Insurance Development Council US fronting for captives now available in Bermuda David Bresnahan President Lexington Insurance Company A unit
The Official Journal of the Bermuda Insurance Industry Bermuda Insurance Development Council US fronting for captives now available in Bermuda David Bresnahan President Lexington Insurance Company A unit of the world s largest insurer has begun offering on-island fronting for captive insurance companies with US parents. Traditionally, the fronting companies are found on the American mainland. But Bermuda captive owners will now be able to take advantage Shelby Weldon Director, Insurance, Licensing & Authorisation - BMA of their annual business trip to the Island to sort out fronting arrangements. The bold move has come from Lexington Insurance Company, a member company of Chartis. Their US-based Captive/ Alternative Risk Transfer (ART) operation has expanded into Bermuda to provide customized fronting arrangements for captives and other ART structures. These solutions will be available in conjunction with other Chartis products or as a standalone option. President of Lexington Insurance Company, David Bresnahan, told Bermuda brokers: Since coming to Bermuda in the 1940s, AIG has been a committed member of the insurance marketplace and community here. We are very proud that AIG is recovered, profitable and closer to the finish line on the US government involvement. In keeping with that continued commitment, Lexington is pleased to announce that our Bermuda branch is now open to assist captives and insureds with their fronting needs. Lisa Lacey has re-located from Boston to Bermuda and is ready to review our capabilities with risk managers as well as brokers and their clients. The Lexington product offering complements Brian McNamara's local risk management fronting unit and Page Rouse's Captive Management services group. Ms Lacey said, We currently provide fronting arrangements for US-driven business out of our Boston office. Quite a lot of that business is either reinsured or managed in the Bermuda market. We feel that having Lexington staff here is an advantage, because when risk managers come to Bermuda, they would like to have the entire business placed, before they leave. They can get their 2012 Vol. 2 reinsurance, talk to their captive managers, law firms and audit partners. They can do all of that right in Bermuda. But there has never been an on-island facility for them to also obtain their fronting. We see this as a growth area for Lexington. No new changes imposed on captives Captive owners were assured by Bermuda regulators that the new European regulatory directive Solvency II would have no negative impact on how the Island regulates captive insurers. The assurance was repeated during a highly successful Bermuda Captive Conference after unfounded rumors and unsubstantiated statements suggested that Bermuda captives could be disadvantaged. Shelby Weldon, the director of insurance, licensing and authorization for the Bermuda Monetary Authority, was quoted as saying, We are of the opinion that the regulatory regime for captives would already meet the high levels of requirements for Solvency II on a proportional basis. There would be no significant changes for how we treat captives. Mr. Weldon added that In the unlikely event that Bermuda's regulations are not deemed to be equal to Solvency II, it still wouldn t have any impact on captives. (See page 2 Solvency II boost expected). A record more than 600 delegates attended the BCC at the Fairmont Southampton hotel and many heard a senior official with top auditors PwC express confidence that Bermuda will Lisa Lacey Lexington Insurance Company Continued on page 6 u Peter Willitts President Bermuda Captive Conference continue to be a leader in the insurance Continued on page 7 u Latest news from The World s Risk Capital 1 Side cars and cat bonds Special Purpose Insurers (SPIs) have become the fastest growing type of Bermuda market insurer as demand for catastrophe bonds soars. And Bermuda has quickly seized 20 percent of the global catastrophe bond market. Amid increasing demand, that share appears set to grow. Leslie Robinson, Assistant Director, Insurance Licensing and Authorisation, at financial regulator the Bermuda Monetary Authority (BMA), revealed that the Island is on track to add even more SPIs this year than the 23 it licensed in Speaking at a session entitled SPIs An Leslie Robinson Emerging Opportunity, Ms Robinson told Assistant Director delegates that the Authority had licensed 10 new Insurance, SPIs so far this year. Five of them were formed in Licensing & May as sponsoring reinsurers built up capacity Authorisation - BMA for the hurricane season. The SPI classification was introduced in Bermuda in 2010 and provides a sound legal and regulatory framework for vehicles used for collateralized reinsurance products, including cat bonds, industry loss warranties and sidecars. SPIs are required to meet several key criteria, allowing the BMA to regulate them less stringently than other insurance entities, the first of which is that they are fully collateralized, meaning that for every dollar of risk, there is a dollar of capital. Other requirements include that their investors are sophisticated, that the SPI s purpose is specific, that there is limited recourse, and that it meets the Authority s standards for transparency and disclosure. She added that the BMA had almost halved SPI fees from $11,600 to $6,000 last year, to sharpen the Island s competitiveness in the ILS market. Fellow panelist Sean McCarty, Managing Director of Aon Benfield Investment Banking, outlined the size of the cat bond market, estimating that there have been $43 billion in placements since 1996 and more than $15 billion worth were active. Bermuda had a 20 percent share of the cat bond market and most, if not all of the sidecar issuances, he added. Jason Carne, Partner, Insurance, KPMG Bermuda, said prior to the enactment of the SPI legislation, the business went elsewhere, but Bermuda now has the edge. He said Bermuda has unmatched insurance expertise, including auditors and attorneys knowledgeable in the industry. Bermuda has the deepest infrastructure, Mr. Carne said. When things don t go according to plan, then you need expertise in place to deal Jason Carne Insurance Partner KPMG Bermuda with it. Brad Adderley, Partner at international law firm Appleby, also opined that Bermuda was now a superior cat bond jurisdiction to those where deals were taking months to go through. In Bermuda, the process is smooth and quick, Mr. Adderley said. Speed to market is very important. Although it might be difficult to win business from sponsors who traditionally placed cat bonds elsewhere, Mr. Adderley felt Bermuda also had the edge because of the Island s reinsurance market and related expertise. Sean McCarty Managing Director Aon Benfield Investment Banking Brad Adderley Partner Appleby Solvency II boost expected Jeremy Cox CEO Bermuda Monetary Authority Bermuda s quest for Solvency II equivalence will bolster the Island s international business reputation, but will not harm its captive sector, Bermuda Monetary Authority CEO Jeremy Cox said. Speaking in the opening session of the Bermuda Captive Conference, Mr. Cox dismissed as wishful thinking rival jurisdictions claims that equivalence would destroy the Island s appeal as the world s leading captive domicile. We have some mischief makers out there some competitor jurisdictions that wish people to believe that Bermuda is following a path that will destroy its captive sector, Mr. Cox said. The reasons for their [misleading] claims are obvious but certainly, as I mentioned before, we re not planning on doing that. He said it was critical for Bermuda to make very clear the impact of equivalence with the new European insurance rules, so as to communicate the reality as opposed to the perceptions. The Authority has argued its case with the EU that equivalence should not mean captive insurers are subject to the same stringent regulations as commercial re/insurers covering third-party risks. The Europeans have suggested that they will consider segmented equivalence for Bermuda that would allow captives to be regulated less rigidly, commensurate with their lower risk profiles. Fellow panelist Leila Madeiros, Deputy Director of the Association of Bermuda Insurers and Reinsurers (ABIR), said the regulatory credibility gained from the process of seeking equivalence Leila Madeiros Deputy Director Association of Bermuda Insurers and Reinsurers would pay dividends. I think it s so significant that Bermuda was selected to be reviewed and assessed in the first wave with Switzerland and Japan, Ms Madeiros said. There is an opportunity in the captive market for equivalence. Not if, but when Bermuda is deemed equivalent, we may see increased interest in captives from Europe because then they can base themselves in Bermuda without a penalty. Lawrence Bird, President of the Bermuda Insurance Management Association (BIMA), said the decision not to pursue equivalence could come back to haunt other jurisdictions. He said that there were noisy mischief makers, including those from competing Lawrence Bird President Bermuda Insurance Management Association jurisdictions, who have denigrated Bermuda and criticized the jurisdiction for embracing Continued on page 8 u Latest news from The World s Risk Capital 2 Taking your investment plan to the next level Carl Terzer Founder & Principal CapVisor Associates, LLC Prospective captive insurance owners learned the ABCs of managing the assets of a captive during a Bermuda Captive Conference session on investment strategy. The focus of the presentation was on strategic asset allocation and optimizing asset results for captives. Strategic asset allocation is responsible for 90 percent of investment results and is the biggest contributor to return. Different asset allocation strategies will be associated with different risk and reward results. It is important for captives to find the right balance. The panel agreed that having several investment managers with conflicting strategies can create over diversification and diminishing returns. Moderated by Carl Terzer, Founder and Principal of CapVisor Associates, LLC, the speakers included Howe and Rusling President Craig Cairns and Chief Investment Officer for PRP Performa David Kilborn. Craig Cairns President Howe and Rusling They examined the role of analytic systems as tools for deciding on strategic asset classes for an investment portfolio. Asset allocation will be impacted by the risk tolerance profile of the shareholders and the purpose and maturity stage of the captive. For a newly formed captive or a small captive, the risk should be low and assets should be highly liquid, especially for startups with no claims history. Further, new captives are generally focused on building surplus and preserving capital. During the formation stage, a more reserved investment allocation strategy would be appropriate. As the captive reaches the advanced or mature stage, more risk can be tolerated. During the development stage, captives should have a more liquid growth allocation strategy and a durable growth strategy would be recommended for the maturity stage. The presenters discussed the difference between strategic vs. tactical asset allocation. Strategic would have a longer time horizon three to five years and would not be adjusted frequently. The allocation would be based on projections and would take a broader approach. It would include assets types such as cash, US Bonds, TIPs, high yields, hedge funds and equities. The tactical allocation would have a three to18-month time frame and be focused on current results. It would include Treasuries, Corporates, MBS, CMBS, ABS and would be detailed on a more granular basis. The panel also discussed the asset allocation process taking client inputs, constructing the portfolio and creating a dynamic asset allocation. Each captive should have a clearly defined investment strategy and should know what they want out of their investments. Client inputs are defined as risk tolerance levels, liquidity and surplus needs, restrictions and life cycle stage. Customized software tools are available on the market to help captives with strategic asset allocation. The three main model types are: the asset only method; the actuarially based method; and, Dynamic Financial Analysis. The first method will only take into consideration the investments on the balance sheet in order to produce an asset allocation. The second method is based on actuarial projections and computer models designed to run various economic scenarios. The output is projected balance sheets and income statements based on the different scenarios and asset allocations. The third model is the most comprehensive and is most suitable for very large captives. This model creates thousands of probability distributions using various asset allocations. The panel weighed-in on when captives should think about revising their strategic asset allocation. David Kilborn Chief Investment Officer PRP Performa Generally, unless a major change in the captive occurs such as a merger or changes in underwriting lines of business, the strategic asset allocation should not be revised before three to five years. The tactical allocation should be revised to capture new market opportunities or changes in the markets as they occur. Don Kramer Founder ILS Capital Management Ltd. Capital strategy employs new model Lingering low interest rates have changed the economics of reinsurance and led to a boom in insurance-linked securities (ILS), reinsurance industry legend Don Kramer told delegates at the Bermuda Captive Conference. Investment income has plunged as a result of low yields on the conservative assets traditionally held by property and casualty re/insurers and reinsurance rates have not risen sufficiently to make up for the shortfall, Mr. Kramer said in a keynote address. This has led to lower return on equity and stock valuations well below book value for many reinsurers. Capital coming into the industry recently has tended to be in the form of catastrophe bonds and sidecars, as opposed to new company formations, Mr. Kramer said. Nobody s starting new companies to be in the catastrophe business at 80 percent of book value, Mr. Kramer said. It should bring about a rise in prices, but instead it s created a new industry insurancelinked securities. Mr. Kramer, who has started up five reinsurance companies including Ariel Re during a stellar career, last year founded ILS Capital Management Ltd., which aims to attract new capital into this increasingly popular space. When Mr. Kramer launched Tempest Re in Bermuda in 1993 after Hurricane Andrew, at a time when seven other reinsurance companies also started up in business on the Island, he said the economics were much more favorable than those faced by reinsurers today. The people at Lloyd s said the first blow and we d be out of business, Mr. Kramer said. They were wrong, of course. Now, Bermuda dominates the catastrophe business. In those days, you could expect to make 17 or 18 percent return on equity, and trade at 120 percent of book. If you were writing long-tail business, you could have a combined ratio of 100 or 103 percent and you d still be making money because interest rates were high and you were getting an investment return of five to seven percent. In the catastrophe business, you had to make money from Continued on page 15 u Latest news from The World s Risk Capital 3 A Bermuda advantage for Canadian risks Trevor Mapplebeck Managing Director Alternative Risk Solutions Marsh Canada A session moderated by Trevor Mapplebeck, Managing Director, Alternative Risk Solutions of Marsh Canada and accompanied by Mark Allitt, Senior Manager of KPMG Advisory Limited and Kevin McCredie, President of Sylvite Financial Services Inc. discussed the changing landscape for Canadian captive owners and provided first-hand insights into an innovative use of a segregated account company to meet the needs of Sylvite. Sylvite Financial Services manages some of the largest agriculture risk management programs in Canada and acts as insurance consultant to the largest Insurance Purchasing Group called the Risk Management Alliance (RMA). Mr. Mapplebeck opened the session by providing an overview of the trends in the Canadian captive market and shared the results of Marsh s 2012 Captive Benchmarking Report. He noted that as the world s largest captive domicile, Bermuda has more than half of all offshore captives and he believes this is a trend that will continue, especially as a result of the opportunities arising from Canada. Mr. Mapplebeck went on to discuss the profile of a typical Canadian captive owner, explaining that most key Canadian industries use captives, although to a much lesser extent than the US. But he believes the number of Canadian captives will grow significantly, and those domiciled in Barbados will re-evaluate their domicile selection as a result of the Canada/Bermuda Tax Information Exchange Agreement (TIEA). There have already been a number of high profile re-domestications from Barbados to Bermuda and the captive industry anticipates that Bermuda has become the preferred domicile for future incorporations. Mr. Allitt agreed that the TIEA opened the opportunity for Canadian companies to use offshore captives. In addition, he added that the opportunity is not limited to captives and can provide significant benefits to non-insurance applications where Canadian companies have foreign operations or assets. Mr. Allitt did however importantly note that while the TIEA provides significant tax planning opportunities for Canadian companies it is important to remember that tax should not drive the decision as to whether a captive is the correct risk management strategy. Mark Allitt Senior Manager KPMG Advisory Limited When the decision is made to form a captive, Bermuda will be at the front of Canadian s minds as a result of its many differentiators. They include the tax opportunity, the Island s highly regarded regulatory regime, access to reinsurance markets and proximity to Canada the combination of which makes Bermuda the front-runner as the leading domicile for future Canadian captives. Mr. Allitt guided the audience through a number of the key tax considerations for Canadian captives explaining that the most significant benefits derive from Canadian companies foreign risks. The premium paid from the foreign group entity, together with investment income generated from the captives required capital, is recharacterized in the captive as active business income which under the TIEA is treated as exempt surplus and can be repatriated to Canada without incurring any Canadian tax. Canadian risks are likely to fall within Foreign Accrual Property Income (FAPI) rules, which mean that the income is taxed in Canada as it is earned. However, he explained that there are a number of potential benefits of a captive for Canadian risks, including a tax deferral in respect of loss reserves held by the captive plus a host of other non-tax benefits, such as the ability to insure the uninsurable and access the reinsurance markets. Mr. McCredie then provided an overview of Sylvite s activities with captives and how they use Risk Management Alliance (RMA), an organization that provides segregated cell solutions to meet the needs of numerous Canadian companies in the agriculture sector. The insightful discussion shared RMA s objectives and experiences in serving their members risk management and risk transfer needs by providing them with an integrated solutions platform. Mr. McCredie explained this is achieved by grouping Kevin McCredie President Sylvite Financial Services Inc. agricultural companies with best in class risk management practices and offering them access into the captive solution when individually they may not have had sufficient critical mass. The benefits enjoyed
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