6 November 2006
The announcements by Hiscox and Omega that they plan to redomicile their respective headquarters to Bermuda have shocked the London market, even after Catlin's similar move in 1999. Much of the recent focus has been on Hiscox, considered a Lloyd's 'poster child'. That one of biggest and most successful managing agents will redomicile to Bermuda has contributed in part to Lloyd's current self-examination and to sweeping predictions that more London market participants will follow in order to remain competitive.
Many of the larger Lloyd's participants are watching Omega and Hiscox very closely. As it now appears that neither has encountered significant regulatory or procedural hurdles thus far, it can be reasonably predicted that others will follow suit in the near future. But what are the advantages? Why does Bermuda seem an attractive proposition? And will the recent announcements mark the beginning of a rush from Lloyd's to Bermuda?
The most obvious reason is the tax benefit. Hiscox predicts that it will cut its tax rate to approximately 10 per cent, down from its current UK rate of 30 per cent.
Lloyd's is keenly aware that the current UK tax structure places it at a competitive disadvantage and in October chairman Lord Peter Levene announced that he was seeking tax breaks from the UK Government.
The degree to which Lloyd's may be able to persuade the Chancellor to reduce its effective tax rate must be in question. Governments are not well known for reducing their tax rates, and even if Lloyd's was successful, would any reduction be sufficient to compete with Bermuda's structure, which does not impose any corporation, withholding or capital gains tax.
The efficiency of Lloyd's is also being examined. Recently Financial Services Authority chief executive John Tiner questioned how London can retain its pre-eminent reputation as the optimal platform of choice for wholesale and commercial insurance if it does not become more efficient and orderly. This was highlighted by a recent report by JPMorgan, which estimated that 38 per cent of insurance premiums went to covering costs. This compares with a 26 per cent coverage of cost rate in Bermuda.
Lloyd's is only just installing a computer claims system to replace a hugely paper-intensive back-office infrastructure. While this is a useful step to bringing some greater efficiency into line, it begs the questions of what took Lloyd's so long, and is it too late to reverse the cycle away from jurisdictions such as Bermuda, where participants invest heavily in technology?Lloyd's has unveiled plans to change its structure in order to alter the way individual investors have traditionally contributed capacity into the market. It is predicted that these changes will be implemented in the near to medium future. However, as with the tax change, a question mark remains over the ability of Lloyd's to make such wholesale changes.
Bermuda has developed a regulatory regime that enables its reinsurers to effectively respond to competitive pressures. The ability of Bermuda-based reinsurance companies to raise capital quickly is one clear competitive advantage. By way of example, in the past year Lloyd's attracted around $2.1bn (£1.1bn) of new capital into its syndicates, while Bermuda attracted more than $18bn (£9.46bn). Of that capital, approximately 40 per cent is attributable to various start-up ventures and the rest was required to refinance existing players in the market to cover losses arising as a result of hurricanes Katrina, Rita and Wilma in 2005.
The geographical advantages of Bermuda have received less attention. Hiscox derives more than half of its global business from Bermuda and the US, and both Hiscox and Omega have opened US operations in order to gain access to US business that it is not being exposed to within Lloyd's. This demonstrates an important shift from a local to a global mindset. Standard & Poor's reported that the recent Bermuda start-ups demonstrated to the industry as a whole that there were potentially material gains to be made from managing businesses with a global, rather than local, market mindset.
While seemingly an oxymoron, competing within the same markets as your major competitors has measurable advantages. Not surprisingly Bermuda now boasts 13 of the world's top 40 reinsurers according to Standard & Poor's '2005 Global Reinsurance Highlights Report'. Standard & Poor's also highlights that, for the first time in 2004, Bermuda-based reinsurers' aggregate net written reinsurance premiums exceeded those of London-based reinsurers.
Despite all this it is unlikely that more than a small number of the Lloyd's managing agents will opt to follow Hiscox, Catlin and Omega. Bermuda is primarily a reinsurance market with a heavy emphasis on catastrophe risks. For those participants who focus on marine and aviation risks, for example, Lloyd's continues to be a leading market.
The Lloyd's defence
Cost is a considerable deterrent. Relocating to any jurisdiction and opening a fully staffed office is extremely capital and management intensive. Hiscox undertook a rights offering to raise the necessary capital to fund its Bermuda reinsurance operation and Omega announced plans to raise $156m (£82.01m), both to increase syndicate capacity and to capitalise its Bermuda reinsurance operation. Professional expenses will also contribute significantly to the overall costs.
It is important to note that critics of the Lloyd's market tend to ignore that both Hiscox and Catlin have not closed down their Lloyd's operations. On the contrary, Hiscox recently announced that it was entering into a sidecar arrangement with a special purpose vehicle Bermuda reinsurance company to provide additional capacity to Syndicate 33.
Ultimately, Bermuda is a jurisdiction that is pushing the traditional reinsurance markets and Lloyd's is feeling the pressure and is attempting to respond. However, it may not be possible to respond in a manner to prevent the large managing agents redomiciling to Bermuda.
David Lines is a partner at Appleby Hunter Bailhache