The Adams Lounge in Bermuda's Hamilton Princess Hotel seems an unlikely place for the start of a modern day 'know your client' regime. However, it was there, during the turmoil of World War II, that Bermuda received UK Government censors who were seeking to learn about how the island discovered the ultimate beneficial owners of companies.
The island has had such a system in place since the early 1940s. But as its international finance sector economy grew between the 1970s and 1990s, successive pieces of legislation extended the scope of information sought.
By the time the UK Government sent censors out in 2000, this time in the guise of accountancy firm KPMG, to write a report on the UK's overseas territories and the strength of their financial regulatory systems, Bermuda was easily able to satisfy the most exacting standards. Indeed, the Foreign Office must have been somewhat embarrassed to discover that Bermuda's standards exceed the home country's. KPMG gave top marks to Bermuda's company formation practices, saying the island is at “the highest level of compliance with good practice in this area”.
However, some recommendations did lead to changes to Bermuda's insurance sector. It recommended establishing independent regulatory bodies, enhancing existing anti-money laundering laws, and giving authorities powers to obtain information and share it with overseas regulators.
In relation to the insurance industry, which supplies about one third of the world's reinsurance capacity, the report recommended that there should be an independent supervisor. Until the report's publication, insurance companies were supervised by the Registrar of Companies, a delegate of the Minister of Finance. This system had been in place since the 1970s. As a result of the KPMG report, responsibility for oversight of the insurance sector was hived off in late 2001 to a newly created office, the Supervisor of Insurance, which came under the umbrella of super-regulator the Bermuda Monetary Authority. The authority is a quango with a government-appointed chief executive officer, although it effectively works independently. The staff of the previous structure have been transferred to the new authority.
For Bermuda, consolidating financial services industry regulation under one independent regulatory body will provide more transparent regulation of the insurance sector. This is because it removes the spectre of undue influence over the regulators by government when, for instance, insurance regulators were within the Ministry of Finance – a theoretical possibility which in reality has never happened, but KPMG felt it necessary to block even the possibility. Another advantage is the enhanced efficiencies of regulating Bermuda's financial services sector through one organisation.
The authority is now responsible for regulating Bermudian banks, deposit companies, collective investment schemes, investment business service providers and the Bermuda Stock Exchange, as well as insurers and insurance intermediaries. The authority's permission must be obtained for the issue or transfer of any securities of Bermudian international companies. Essentially, the authority is Bermuda's equivalent to the UK Financial Services Authority.
Day-to-day oversight of the insurance industry should not change dramatically due to the authority taking over control of its regulation. Although in 2002 an amendment to the Insurance Act further enhanced the powers of the authority to obtain information from insurers, previously, failure to supply information on request to the Registrar of Companies under the old regime could have resulted in ministerial orders to freeze assets, suspend underwriting or even wind up. There were ample powers of investigation under the Companies Act 1981 and through the offices of the Principal Representative under the Insurance Act 1978. So historically, the regulators could always find out what they needed to know.
Nevertheless, the authority has new powers to seek information and commission reports, which it proposes to exercise in accordance with as yet unpublished principles. The authority also proposes to conduct biannual visits to insurers, essentially to ensure that they know their customer.
The KPMG report excluded money laundering and tax evasion from areas that should be subject to regulatory-related information exchanges with foreign powers. It also found Bermuda to be at the forefront of anti-money laundering. The island's long-established habit of diligence has made it difficult to conduct monkey business in Bermuda without being detected very swiftly. In the interest of securing blue chip business, and thus the cream of the offshore sector, Bermuda's businesses voluntarily developed extensive 'know your customer' practices during the 1980s. Enactment of the Proceeds of Crime Act 1997 formalised the regime, and businesses have accepted the need to institute appropriate procedures.
Bermuda's existing regime amply anticipated the recommendations of KPMG. That said, arising out of a separate inquiry being conducted by the Organisation for Economic Cooperation and Development (OECD), the Proceeds of Crime Act was amended to extend the criminal conduct upon which money laundering could be based to include all indictable offences. These include offences under Bermuda's Taxes Management Act 1976, which had not previously been caught.
For all the satisfaction that bureaucrats will have had from the recent regulatory innovations, none of them account for the extraordinary success of Bermuda's insurance market. For that, credit is due to 'cluster theory'. In other words, ordinary market forces have been the best regulator. For example, the business desire for the cream of the crop led to an early detection system for the losers who would spoil Bermuda's reputation and thus drive away the good business. Steady growth in the insurance infrastructure since the 1960s ultimately passed what social theorists call the 'tipping point' at the end of the 1980s and early-1990s.
From then on, Bermuda rapidly became the place to be, with a high concentration of financial and intellectual capital that has fuelled subsequent growth in the local insurance sector. The cluster of insurance entities attracted further entrants. The result? The abrupt contraction of insurance capacity following 11 September produced an immediate response from the venture capitalists and large insurance conglomerates to whom Bermuda was a known and ready-built 'cluster' of insurance entities. They used Bermuda to sponsor a roster of new insurance companies, such as Endurance Speciality Insurance and Axis Speciality Insurance. Between them, the various new entrants to the Bermuda market have added some $15bn (£9.28bn) in reinsurance capacity.
Simultaneously, capacity decreased in the two main competing markets, New York and particularly London, resulting in the appearance of London market sponsors among the new companies that have arrived in Bermuda, such as Goshawk Insurance Holdings, Benfield Group, Wellington and the Catlin Group. In the earlier wave of capacity following Hurricane Andrew in 1992, most sponsors came from the US. Clearly, London is alive to the competition from Bermuda and is wisely responding by joining the cluster. There is talk that next year, the London market will have begun to reorganise itself to replace lost capacity and distance itself from Bermuda. Certainly, Bermudian company ACE has said that although it is reducing its capacity at Lloyd's, where it owns nearly a quarter of the capital, it is going to match, or even exceed that in its other London market companies.
This optimism is not borne out by other players, such as Patrick Thiele, the chief executive officer of PartnerRe, itself one of the class of 1993. Thiele stated in an in-house publication that there was still a worldwide shortage of capacity that is not going to be replaced any time soon. Certainly, it will be difficult for existing London market entities to increase capacity other than by way of fresh offerings of equity, as new insurance company formation is agonisingly slow under the UK regulatory regime, compared with Bermuda.
But public offerings in the insurance sector are generally fraught, given the general weakness of the financial markets. That said, there have been some offerings, for example, to support insurance brokerages, but these are unlikely to produce the capital volume necessary to match the missing capacity. For now, the cluster theory will favour Bermuda because so many others have done it and entrance is relatively easy, notwithstanding the new compliance requirements. Once there, Bermuda's neutral fiscal regime makes it easier to return profits to investors, even in these hard times.
Warren Cabral is a partner at Appleby Spurling & Kempe