Is Bermuda going regulation mad?

A recent report by the International Monetary Fund (IMF) on Bermuda contained 35 recommendations for increasing regulation over (re)insurance in a move that would bring an unprecedented amount of paperwork to the managers of companies incorporated in the world's third-largest reinsurance market.

The recommendations vary from giving more responsibility to auditors to spot checks to scrutiny of specific companies by special investigators from the industry supervisor, the Bermuda Monetary Authority (BMA. It also recommends companies file much more detailed financials and that larger (re)insurers file on a quarterly basis.

One of the many reasons companies cite for setting up in or moving to Bermuda is the light regulatory touch when it comes to reinsurance. They chose Bermuda time and time again over larger and more established centres in the UK and US, where managers complain of having more and more compliance paperwork to file each year.

Killing the golden goose

And reinsurance bosses are worried that if these recommendations pass into law, there will be little to differentiate Bermuda from other jurisdictions, and companies will also feel aggrieved that the goalposts had been moved quite so dramatically after having set up there.

David Ezekiel, chairman of the Association of Bermuda International Companies (ABIC), said: "While there are a number of worthwhile recommendations in the report, many will add nothing meaningful to the current monitoring framework in Bermuda, apart from cost."

ABIC is a hugely influential group, made up of 95% of the international companies in Bermuda that have a physical presence. Ezekiel added: "Full implementation, which I think is impractical and unnecessary, will result in a huge additional cost to the taxpayer and the industry, with a substantial increase in staffing, both in the regulatory regime and in the private sector, and all the inefficiencies that come with it."

The association believes Bermuda currently has a sound regulatory framework and that it should continue trying to use the current compliance regulation as efficiently as possible.

ABIC has historically been quite outspoken on issues, but few managers of individual companies will stick their head above the parapet and speak on the record about the issues, even though business leaders are fuming.

"I think this is a bureaucratic nightmare," said one senior executive.

"Anyone with any knowledge of the insurance business and the auditing profession will see that none of this will add anything meaningful to that process. The idea that ad-hoc investigations without any specific knowledge of wrongdoing are going to yield anything is outlandish. Then there is the whole other topic of the additional responsibility put on auditors. If one cannot rely on what is a very stringent auditing process, the idea that doubling or tripling the staff at the BMA is going to add anything to that process is not reasonable."

Another said that the idea of a fairly low-level BMA member of staff going into the head offices of major companies such as ACE Ltd. or XL Capital and conducting a search for anomalies, seemed pointless. "What would they be looking for? What would they hope to find? How would they know what to look for? If the Securities and Exchange Commission can't find anything, how will some badly paid government official do any better?"

The recommendations were published in the long-awaited IMF Assessment of the Supervision and Regulation of the Financial Sector, which is published in two volumes: Review of Financial Sector Regulation and Supervision and Detailed Assessment of Observance of Standards and Codes.

Overall, Bermuda was found to be compliant or largely compliant with some 85 out of more than 100 individually rated core principles or sub-principles that cover banking, insurance, investment business and anti-money laundering/anti-terrorist financing controls. The assessment was carried out in early 2003 at a time when some far-reaching amendments to standards were just beginning to be implemented internationally and, subsequently, put in place in Bermuda.

However, while the document is generally complimentary about the jurisdiction, it is critical of the level of supervision and documentation provided in the (re)insurance sector.

The IMF assessment of the sector was based on the International Association of Insurance Supervisors (IAIS) principles of 2000, which are not designed to rate reinsurance or captives, and the recommendations were an action plan to improve observance of the IAIS insurance core principles.

The Bermuda market has two main components - captives and reinsurance.

Bermuda is the world's largest captive domicile with around 940 active captives with 1200 registered with total gross premiums of $32.5bn at the end of 2002. Gross premiums for professional (re)insurers totalled $10.2bn in 2001.

So the contention lies in the feeling the wrong set of principles was used to test Bermuda's compliance with international standards simply because there were, at the time, no international standards for reinsurance.

Paula Cox, Bermuda's minister of finance, said: "For insurance supervision, the assessment... recognises the effectiveness of much of our supervisory regime, while also identifying certain areas of weakness. However, the assessment also highlights the difficulties involved in applying the standard rating system, as it was then in place, to the regime that Bermuda has put in place for supervising a sophisticated professional (re)insurance market.

"In point of fact, a great many changes have occurred since the time of the assessment. These relate to amendments and clarifications to the international regulatory standards themselves and their application in particular areas."

Ms Cox went on to say that there have been numerous changes to Bermuda's own regulatory provisions and that the BMA was working on more developments.

Compliance culture already here

These changes include the introduction of the Investment Business Act 2003, designed to enhance compliance with core principles in that area; the introduction of the Insurance Amendment Act 2004 and the related publication of detailed guidance notes on a range of aspects of supervisory standards and requirements; and the introduction of the Anti-Terrorism (Financial and other Measures) Act 2004, designed to update Bermuda with measures agreed internationally after 9/11. There was also the Criminal Code Amendment Act 2004 to introduce offences relating to insider dealing and price manipulation in securities markets.

A top manager in Bermuda said: "The BMA monitors solvency and capital requirements closely but does not go as far as requiring filing of policy forms, rates, etc. - it just hasn't been in our regulatory model.We have to think long and hard about how far down that road we want to go or we will end up like everyone else, with the creation of a paper mountain.

"We have regulation, but it is sensible, high-end, bigger-picture regulation, instead of the onerous compliance form-filling that companies in other jurisdictions face, such as the UK or US, and it is not as if any of this stops problems in these domiciles."

The government of Bermuda and the insurance watchdog are both listening to the industry and have been in dialogue with the heads of various bodies to make sure they do not kill the goose that lays the golden egg.

One manager said: "I think there will come a breaking point in Bermuda when companies say we could be anywhere if this is what we have to put up with. It will make people think twice about coming here. It is all relative. If we put one fifth of this in place, we will be moving towards much of the meaningless bureaucracy of other onshore jurisdictions. You certainly can't say it would be good for business development. If I believed any of this would make a difference, I would have a different view."

There is a lot at stake for the government to consider. Bermuda's insurance industry includes 1,600 (re)insurance companies with actively writing companies having $172bn in assets and writing over $48bn in annual gross premiums in 2001 (latest figures available). And overseas companies, most of which are (re)insurers, make up 70% of the island's economy and are an extremely influential group.

So the Bermuda government has hinted that it will shun the international body's recommendations and stick to the light regulatory touch that has made it the envy of other jurisdictions when it comes to (re)insurance.

Ms Cox said the government was acutely aware of the need to strike a careful regulatory balance - effective, but always appropriate.

"We want an effective and an efficient system of regulation,"Ms Cox said.

"A supervisory system that is overly conservative - designed to avoid failures at any cost - will stifle competition and give rise to excessive supervisory expense. Generally, those jurisdictions which introduce regulatory systems that attempt to regulate every aspect of corporate activity have proven unsuccessful, as they overlook the necessity of innovation and creativity."

Can balance be achieved?

She said Bermuda's objective has always been to develop a set of rules that balance strong financial institutions and competitiveness, entrepreneurial spirit and efficiency.

"This also means that we need to avoid needless or damaging over-regulation, which," she said, "can too easily result in a world in which standards are being constantly enhanced and reinforced to meet new risks."

However, the minister stops short of denouncing the IMF recommendations, saying instead: "We will carefully consider their suggestions, as part of our regular and ongoing review of our regulatory framework."

Mr Ezekiel and the international companies agree with the government's caution: "What we can't have, though, is the whole nature of business in Bermuda changed for us. Companies came here with a certain expectation of how business is conducted and we have to keep that in mind.

"Our primary responsibility as a jurisdiction is to people and companies who currently do business in Bermuda and we have got to keep that in our sights when implementing this. We don't want to fall into the trap of putting legislation in place just for the sake of it. "

The right stuff

He added: "The Bermuda model is based on a strong know-your-customer ethic, with a requirement that the right people run the companies domiciled here and the right people are investors in those companies."

BMA Chairman, Cheryl-Ann Lister, said that the regulator would be considering what to do about the recommendations, but would not jeopardise the Bermuda market by blindly following them. "We felt it (the IMF review) was very useful. They saw that Bermuda's reinsurance system is very sophisticated but identified some deficiencies."

She said that the greatest challenge was captives and added that there was no international code that applied at the time to the reinsurance business. What there was in place for insurance was of questionable relevance to captives as self insurers.

Ms Lister said: "Even now, many jurisdictions do not regulate reinsurance because they are not required to do so, but we had opted to regulate all our insurance business, given the sophistication of the market."

She said the IMF recommendations would not be applied "lock, stock and barrel" to the Bermuda market but the "core principals" would be adopted.

"Some points we were not comfortable with because they were not appropriate.

But there are many valuable points in the IMF report. And we are actively making amendments and we are in the initial stages of revising it."

Ms Lister said that in 2003, the IAIS expanded its principles from 17

to 28 and put in place a new standard on reinsurance. Bermuda, she said, was adapting its laws to make sure they comply with the international framework.

Mrs Lister said that the recommendations taken on board would be worked on over the next 18 to 24 months. This process has already started with updating laws, such as the Insurance Amendment Act 2004, which empowers the BMA to give guidance to insurance firms. It also provides the legal framework to produce guidance notes, the roles of auditors and actuaries and what constitutes fair and proper conduct and corporate governance measures.

REGULATION, REGULATION, REGULATION: THE IMF'S KEY FINDINGS: Corporate governance: The flow of information between the BMA and the auditor should be more detailed and more frequent. The supervisor should require the auditor to do specific checks (including the review of internal controls) and the auditor should systematically provide the supervisor with a detailed written report.

Stronger verification procedures: The authorities should contract independent reviewers to verify the information received from companies. The supervisor should have access to their working papers and the capability of checking these, either directly or indirectly.

Controls over balance sheet items: The authorities should also set minimum rules on the calculation of liabilities and on the adequate cover of technical provisions by secure assets.

More data: Financial reporting should be more detailed, distinguishing direct and assumed insurance, lines of business, and type of contracts for reinsurance.

Supervision: The BMA should provide guidance to the auditors conducting onsite visits to insurance entities in respect of aspects of AML/CFT risk to be assessed during visits.Corporate governance: The flow of information between the BMA and the auditor should be more detailed and more frequent.

The supervisor should require the auditor to do specific checks (including the review of internal controls) and the auditor should systematically provide the supervisor with a detailed written report.

Stronger verification procedures: The authorities should contract independent reviewers to verify the information received from companies. The supervisor should have access to their working papers and the capability of checking these, either directly or indirectly.

Controls over balance sheet items: The authorities should also set minimum rules on the calculation of liabilities and on the adequate cover of technical provisions by secure assets.

More data: Financial reporting should be more detailed, distinguishing direct and assumed insurance, lines of business, and type of contracts for reinsurance.

Supervision: The BMA should provide guidance to the auditors conducting onsite visits to insurance entities in respect of aspects of anti-money laundering/terrorist financing risk to be assessed during visits.