Bermudian businesses cannot ignore the impact Solvency II will have on Europe

Speedy start-ups, favourable tax rates, lighter regulation, sun, sea and sand... surely these factors make Bermuda the destination of choice for insurance capital? While many have made the move to the island during the last decade, a school of thought is emerging that suggests the future for the Bermudian market may not be as golden as it once seemed

With Europe now gripped by the process of adapting to Solvency II and London continuing to bemoan the impact of high corporation tax, Bermuda is still viewed in some quarters as a cheaper and easier alternative.

But the island’s isolated position in the North Atlantic ocean does not mean it will escape feeling the impact of the changes taking place across other international insurance markets. The global nature of the modern insurance industry means that Bermudians will need to adapt and meet the standards being set in tougher regulatory regimes such as Europe if they are to continue to compete.

Although the Bermudian authorities are now considering introducing their own risk-based capital regime, some believe reinsurers on the island would be helping themselves if they were to take the appropriate steps now to match the standards being employed by their European counterparts.

Raj Ahuja, a partner at actuarial consultants EMB, says some Bermudian firms currently lack the understanding of risk-based capital ideas already prevalent in the UK and across Europe. "In the UK, the regulatory capital regime is very far-reaching and brings benefits," he says.

‘Risk-based capital regime’

"The shift towards a risk-based capital regime has been continuing in the UK for a number of years, and has led to a degree of understanding from UK insurers. Businesses in the UK have gained a tremendous amount by having this kind of risk- based capital regime early on," Ahuja says.

"The regulatory regime in Bermuda is not a risk-based capital regime, so Bermuda has not embraced some of those benefits that this type of regime brings."

According to Ahuja, many Bermudian companies have a long way to go before their understanding of risk-based capital ideas reach the level seen in the UK. "In Bermuda, there is not that degree of regulatory touch. The regime is not in place in Bermuda, but this is not the problem," he explains. "The problem is that in Bermuda, people are not embracing risk-based capital ideas."

Ahuja believes that this leads to a poorer understanding of where risks sit, the size of risks and the way in which these risks are allocated.

"In the UK, understanding these features has led to other business benefits. Businesses have had to get the house in order to understand data and parameters. Parameters sit in models. To understand parameters, they need to understand the data. In Bermuda, a lot of firms have a way to go to understand data and parameters."

"There are discussions taking place to try to understand how to move this regime forward," he adds.

Ahuja believes there would be many benefits to firms if Bermuda could introduce a risk-based capital regime. He says that meeting the regulatory requirements would bring many opportunities to improve the way businesses operate on the island.

‘Much better understanding’

"You get a much better understanding of what is driving your company and where the risks really are," he says. "If you follow the letter of the law for regimes around the world, you will find out a lot about your firm. This can put in place a risk-management strategy that helps discussions with shareholders. Another benefit is that it will create much more meaningful discussions with rating agencies. Meeting regulatory demands can give companies a competitive advantage. If rolled out properly and deployed around a company, implementing risk-based capital ideas can have a positive impact on reserving, pricing and the reinsurance buying process," he says.

The changes taking place to Europe’s risk-based capital regime via the introduction of the Solvency II project is also set to have implications for Bermuda, as it will significantly change European insurers’ buying practices.

"Solvency II will introduce the whole principle of risk-based capital across Europe. This means holding the appropriate capital for risks on a principles basis," Ahuja says. He believes this is already leading to a fundamental shift in the way senior executives think about their business across underwriting, credit and liquidity risks.

"A number of European insurers will buy their reinsurance from Bermuda. In continental Europe, some are very sophisticated buyers of reinsurance but these are in the minority. The vast majority have a very traditional approach to buying reinsurance. That attitude will change now because of Solvency II. This will affect those selling reinsurance, including those in Bermuda," Ahuja explains.

Buyers’ attitudes changing

"Because buyers’ attitudes are starting to change in continental Europe, this will have an impact on how Bermuda thinks and operates. The reason is that there is a very close relationship between capital and reinsurance buying. Although Solvency II is about capital, it is also about buying reinsurance.

"We’re convinced that in continental Europe the attitude towards capital and buying reinsurance will change because of Solvency II, and this will affect the Bermudians selling reinsurance," Ahuja continues. "This should provide a reasonable degree of challenge to Bermudians selling reinsurance and is a challenge to everyone selling reinsurance to continental Europe."

Ahuja warns that Bermudians will not be able to ignore Solvency II as a day-to-day issue when they sell reinsurance to France, Italy, Germany or Spain.

PricewaterhouseCoopers’ Melanie McLaren says that because Solvency II is still embryonic it is difficult to work out what the impact will be on both European and Bermudian market players.

"The European Commission has not said whether its intention is that the overall level of capital needs to stay the same, increase or decrease," she explains. "The best guess is that it may mean a number of players in the market may need higher capital and a relationship with the regulator that is more intrusive than at the moment."

"What worries European insurers is that if this happens to them and the same pressure is not applied to Bermuda, we’ll see an increased flight of capital to Bermuda and out of Europe," she continues.

‘A seismic shift’

"The counter to that is that to write business in Europe you have to be authorised in Europe. So the threat of Bermuda only really works if you don’t want to write business in Europe," McLaren says. "You’d have to have a seismic shift as a result of Solvency II for people to say they no longer want an underwriting presence in London and will not write European Union business."

Because a large number of Bermudian companies also have authorised European vehicles, with a number of those in the London market, pressure to conform to Europe’s capital regime is likely to be significant.

"Current capital requirements in Bermuda are not very stringent at all," McLaren continues.

This article appeared in Insurance Day in March 2007