Long-term insurers have been attracted to Bermuda for its flexible regulatory environment, which gained Solvency II equivalence in 2016, potentially lower capital requirements and operating costs. But recent and impending regulatory changes have sparked concern among U.S. life and annuity reinsurers with a stake or interest in the island territory.
On one hand, there are the changes to the corporate tax rate and an increase in the excise tax for offshoring business as a result of U.S. tax reform. And soon to be on the other, changes from the Bermuda Monetary Authority (BMA) that will gradually increase the solvency requirement for reinsurers doing business on the island. We also saw a material increase in U.S. National Association of Insurance Commissioners (NAIC) risk-based capital (RBC) requirements as a result of tax reform.
So, will these changes significantly reduce the advantages of offshoring operations to Bermuda?
While there are challenges, overall, we believe the outlook for operating in Bermuda remains hopeful. To illustrate the differences between post-tax reform U.S. and the evolving Bermuda Solvency Capital Requirements (BSCR), we compared capital requirements for a run-off block of deferred and payout annuities under the prior and impending Bermuda capital rules. We chose common target capital levels of 150% for the Bermuda-based capital and 350% for the U.S. NAIC RBC.
Figure 1: Illustrative target capital requirement for a block of deferred and payout annuities in U.S. vs. Bermuda
In this example, the prior Bermuda capital requirement is lower than it would be under the new rules, and significantly lower than the post-tax reform U.S.-based capital, due to the favorable interest rate risk treatment and covariance benefits available under the BMA regulation.
When we factored in the new Bermuda capital requirements, the covariance benefits were reduced, and operational risk doubled. This resulted in a higher capital requirement, but it’s still lower than what’s required in the U.S. Further good news is that insurers will be able to grade to the new BSCR rules over 10 years (as illustrated in the “phased-in” portion on the graph).
If we were to add reserves to the picture and look at the full balance sheet, the total asset requirement would be even lower in Bermuda versus the U.S., provided there’s a good asset-liability match, but that’s not necessarily a given for every product line.
However, before moving onshore business to Bermuda – either through an affiliate reinsurance transaction or a standalone acquisition vehicle – we believe reinsurers should carefully evaluate the following:
- Optimal business mix (considering risk covariance implications
- Tax considerations
- Volatility of financial results
- Staffing costs
- Local expertise capabilities
You’ll also want to make sure your assets and liabilities are well-matched. If they’re not, the Bermuda market value balance sheet may be more volatile than the one based on the U.S. statutory framework. While the Bermuda-based solvency capital may be lower than the U.S. risk-based capital at common target level, the aggregation of risks is different from the NAIC approach, evoking different considerations for capital optimization.
While current and impending regulatory changes will impact some of the business benefits of operating in the island territory, there’s still an upside in the form of reduced capital strain and a more economically balanced reserve solution. That said, reinsurers will need to carefully weigh their options before deciding to offshore business – especially those without existing operations on the island.
Anna Apgar, Dan Kim and Nick Komissarov are directors within the Insurance Consulting and Technology Life Insurance practice at Willis Towers Watson.