The mood music deepens (regulation and corporate governance)
Few would argue that the level of new captive formations has in recent years declined when compared with four or five years ago. Nevertheless, the decline in actual formations is set against a steady level of interest in captives and captive programmes. The continuing soft commercial insurance markets, as well as the financial crisis and the worldwide economic downturn have all played their part in what I believe is merely a postponement in the formation of a number of captive entities. Bermuda is no exception to this trend, with the level of new incorporations falling to 50 percent of those levels recorded between 2000 and 2005. However, one statistic has remained constant—as it has done so for many decades—Bermuda remains the world’s number one domicile for captive insurance companies, with 845 captive entities as of December 31, 2010.
At a Bermuda financial services conference held in London in April, the Premier of Bermuda, Paula Cox MP, referred to an African proverb that says “when the music changes, so too does the dance”. She used it as a lead into how Bermuda has adapted over the years to the everchanging global business climate within which the Island competes. In recent years, the music within the worldwide insurance industry has changed, clearly evidenced by the regulatory obligations required by new international standards. Addressing its reputation and obligation as a major insurance and reinsurance domicile and the world’s number one captive domicile, Bermuda has evolved its dance in tune with the new music through a series of regulatory changes. These developments are not being made for the sake of change, but to provide a regulatory environment that is in accordance with international standards and maintains the Island’s position as a reputable and efficiently regulated place to do business.
Before addressing some of these changes, it is worth noting that the changes impact the insurance industry as a whole, of which captives are a part. Recognising that Bermuda is not just a captive domicile, but a leading commercial insurance hub, the key issue for the authorities in Bermuda is to ensure that any changes do not prove to be too onerous for the captive sector and yet achieve the ultimate goal of regulatory change. I believe all will agree that, over the years, Bermuda has been adept at applying the principle of proportionality to changes to its regulatory environment, beginning with the introduction of the class system of insurance licensing back in 1995. The risk-based approach to insurance regulation, adopted by Bermuda is consistent with the principle of proportionality, which is explained in the European Union’s Lisbon Treaty as “the content and form…of action shall not exceed what is necessary to achieve the objectives”.
There is no area where the music has changed more than in the area of corporate governance. Change did not however happen overnight. In 2003, the International Association of Insurance Supervisors, when adopting a number of Insurance Core Principles (ICPs), issued ICP no. 9, which dealt with corporate governance. At the same time, ICP no. 7 was issued dealing with suitability of persons. In March 2005, the Bermuda Monetary Authority (BMA) issued its Guidance Note no. 12 dealing with corporate governance. In October 2009, the BMA issued an information bulletin dealing with fit and proper persons, and in February 2010, it issued the Insurance Code of Conduct (the Code). No discussion on captive insurance can be held at the moment without reference to the European Union’s Solvency II proposals. Pillar II of Solvency II contains significant reference and requirements dealing with corporate governance.
"The key issue for the authorities in Bermuda is to ensure that any changes do not prove to be too onerous for the captive sector and yet achieve the ultimate goal of regulatory change."
Whether we are talking about the Code or Solvency II, there is now greater emphasis on corporate governance and specifically on the role and responsibility of the board of directors. The Code specifically states that “the ultimate responsibility for sound and prudent management of the insurer rests with its board of directors. In this regard, the board is responsible for ensuring corporate governance policies and practices are developed and applied in a prudent manner.” It also notes that this ultimate responsibility cannot be delegated to board committees, senior executives or external parties. The board will be required to ensure that an appropriate risk management system is in place.
The composition of boards of directors now requires greater attention than may have been the case in the past. Not only does the number— if any—of independent directors need to be determined, but also the fitness and propriety of those serving as directors needs to be assessed. Persons serving as directors must have the appropriate experience, qualifications and personal integrity to ensure that the board as a whole can fulfil its responsibilities.
It is worth noting that the Code applies to all insurance and reinsurance undertakings in Bermuda. However, an entity’s compliance with the Code will be assessed by the BMA in a proportionate manner relative to the nature, scale and complexity of its operations. Once again, the BMA is applying the principle of proportionality.
Solvency II will usher in another change to the music. At this stage, it is still unclear what impact Solvency II will have on the captive sector in Europe. Most people would agree that the full application of the Solvency II provisions to captives will have a negative impact on the captive industry. The Bermuda Insurance Management Association (BIMA) has joined the lobbying efforts on behalf of captives, and we made a presentation to the European Insurance and Occupational Pensions Authority (EIOPA) in March regarding the issue. We hope that additional lobbying efforts by other organisations on behalf of captives will yield benefits and will see a proportional application of the provisions to captives. That said, Bermuda is preparing for its review by EIOPA for equivalency with Solvency II.
In preparing for equivalency with Solvency II, we are anticipating some changes to the regulatory environment for the captive sector in Bermuda. While no specific changes have been outlined by the BMA at the time of writing, possible changes could include captives preparing an Own Risk and Solvency Assessment (ORSA) and perhaps some additional filing requirements. We would expect the ORSA requirement to be a simplified model of that required for commercial insurers. We believe that the captive regulatory environment, with some minor enhancements noted earlier, will be in accordance with international standards and appropriate to the sector that it is regulating—it does not exceed what is necessary.
Bermuda is well positioned to continue its role as the world’s number one domicile. Those organisations now considering including a captive insurance programme in their risk management structure will be looking for a quality domicile with an effective regulatory environment and a reputation on which they can rely.
In her speech, Premier Cox highlighted the importance of Bermuda’s reputation in its efforts to continue to attract quality business to the Island. Bermuda’s reputation as an effective place to do business will only be enhanced by the changes currently taking place in the regulatory environment.
Tom McMahon is president of the Bermuda Insurance Managers Association. He can be contacted at: firstname.lastname@example.org