Bermuda is the world’s leading domicile for ‘captive’ insurance companies, insurance companies set up to insure or reinsure the risks of their parents or the risks of their owners, while a ‘multi-parent’, or ‘association’ captive.
Bermuda is the domicile for more than 1,600 insurance companies (the majority of which are captive insurers) with total assets estimated at more than $170bn (£100.62bn). With the current economic climate and the hard insurance market, there is increasing emphasis on alternative ways to finance captive insurers. These include using capitalising assets of captives to make loans to, or invest in, affiliates. In doing so, owners of Bermuda captives should be aware of the requirements of Bermuda’s Insurance Act 1978 (the act), which may determine what financing arrangements are possible.
Under the act, most captives are registered as a ‘Class 1’ or ‘Class 2’ general business insurer. Class 1 insurers are single parent captives, which are not permitted to write any unrelated business. Class 2 insurers are multi-parent or association captives, which are permitted to write up to 20 per cent unrelated business.
Under the act there are no express restrictions on the types of assets in which Class 1 and Class 2 insurers may invest. However, there are solvency and liquidity requirements which restrict the types of investment that such insurers may make and still meet those requirements. The solvency and liquidity requirements under the act are found in the Insurance Returns and Solvency Regulations 1980 (the solvency regulations) and require reference to the Insurance Accounts Regulations 1980 (the accounts regulations).
The solvency regulations require general business insurers to maintain at all times a minimum margin of solvency, which is the minimum margin by which the value of the “general business assets” must exceed the “general business liabilities” (these terms are defined by reference to lines of the statutory balance sheet for general business insurers prescribed under the accounts regulations). For a Class 1 or Class 2 insurer, the margin of solvency must be the greatest of (i) BD$120,000 (£84,400) in the case of a Class 1 insurer and BD$250,000 (£175,800) in the case of a Class 2 insurer, (ii) 20 per cent of net premiums less than BD$6m (£4.2m) or, if net premiums are greater than BD$6m, BD$1.2m (£844,000), plus 10 per cent of net premiums greater than BD$6m, and (iii) 10 per cent of loss and loss expenses provisions and other reinsurance reserves.
Because ‘general business assets’ include all items that would normally appear as assets on the statutory balance sheet for general business insurers (prescribed by the accounts regulations), provided the insurer’s margin of solvency is maintained at least at the greatest of the three figures described above (and assuming such assets are valued fairly), then the margin of solvency requirement would not generally be an impediment to the types of investment a Class 1 or Class 2 insurer could hold. However, assets that are ‘sundry assets’ (ie assets not attributable to other lines of the statutory balance sheet), must have a readily realizable value. Also, where an insurer secures additional fixed capital by way of a letter of credit, guarantee or other instrument, then such an asset must be approved by the Bermuda Monetary Authority (BMA) prior to being recorded as a general business asset and accounted for in calculating the margin of solvency.
The solvency regulations also require all general business insurers (such as Class 1 and Class 2 insurers) to at all times maintain a minimum liquidity ratio. To meet the minimum liquidity ratio required of general business insurers, “relevant assets” must be not less than 75 per cent of the amount of “relevant liabilities” (these terms are defined by reference to lines of the statutory balance sheet for general business insurers prescribed under the accounts regulations).
The solvency regulations provide for applications to be made to the BMA to have others’ assets accepted as relevant assets. In the past, applications have been approved for loans to affiliates and for other relatively liquid investments to be accepted as relevant assets for the purpose of calculating the liquidity ratio. However, consideration of these applications is made by the BMA on a case-by-case basis.
The structure of financing arrangements could have a negative effect on a Class 1 or Class 2 insurer’s ability to meet the minimum liquidity ratio for general business insurers required by the solvency regulations.
For example, two common alternative financing arrangements are where the captive makes a direct loan of contributed funds back to the parent or to another subsidiary of the parent, and where the captive purchases debt or equity issued by the parent or by another subsidiary of the parent.
A direct loan of contributed funds to the parent or another subsidiary of the parent would not be counted as a relevant asset for the purposes of calculating the liquidity ratio without being accepted by the BMA pursuant to an application under the solvency regulations. Such an arrangement would have a negative impact on that insurer’s ability to meet the minimum liquidity ratio unless an application to the BMA was approved.
Where a captive purchases equity or debt from the parent or another subsidiary, the effect of such a purchase on the calculation of the liquidity ratio under the act would depend on whether or not the debt or equity is a quoted investment. All quoted investments are relevant assets for the purposes of calculating the liquidity ratio, although of unquoted investments only bonds and debentures are counted as relevant assets.
Thus, usually any debt will be a relevant asset regardless of whether or not it is quoted. However, where a captive purchases shares in an affiliate, such a purchase will only result in the captive acquiring a relevant asset if the shares are quoted. If the shares are not quoted, the captive would have to make an application to the BMA under the solvency regulations to have the shares accepted as a relevant asset for the purposes of calculating the liquidity ratio.
In any particular case, alternative financing should be carefully considered to ensure that the captive will continue to maintain the required margin of solvency and the minimum liquidity ratio.
Benjamin Dyer is an associate at Conyers Dill & Pearman