ART and Captives

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BermudaThe Future of Offshore, Today

• ART and Captives
• The Bermuda Renaissance

London, January 22, 2001
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ART and CaptivesThe Bermuda Renaissance

• Moderator Raymond Medeiros
• Partner, PricewaterhouseCoopers
• Chairman, Bermuda International Business
  Association
  
• Charlie Collis
• Robin Hamill
• Mike Hardy
• Warren Cabral

London, January 22, 2001
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Charles CollisPartnerConyers Dill
PearmanBermuda
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Bermuda
The Incubator of New Ideas for the Insurance
Industry
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The Changing Market Place

• The Convergence of the Capital Markets and
  Insurance Markets
  
• The Blurring of the Distinction between Insurance
  Products and Capital Markets Products
  
• The Transfer of Risk between the Insurance
  Markets and Capital Markets
  

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New Products

• CAT Bonds
• Weather Swaps
• Credit Derivatives

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New Vehicles

• Special Purpose Insurance Companies
• Transformers
• Separate Account Companies

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Indemnity Catastrophe Bond
Charitable/Purpose Trust
Limited Recourse Loan
Retrocession Agreement
Bankruptcy Remote Special Purpose Reinsurer
Reinsurance Company
Noteholders
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Credit Derivatives

• Credit Default Swaps
• The Buyer pays the Seller a fixed amount in
  consideration for the Seller agreeing to pay the
  Buyer an amount based upon the default amount of
  specified referenced obligations.
• Financial Guaranty Insurance
• The Insured pays the Insurer a premium in
  consideration for the Insurer agreeing to pay the
  losses of the Insured resulting from the default
  of specified referenced obligations.

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Transformers
Financial Guaranty Reinsurance Policy
Credit Default Swap
Financial Guaranty Insurance Policy
Weather Swap
BERMUDA INSURANCE COMPANY
Financial Guaranty Insurance Policy
Financial Guaranty Insurance Policy
Credit Default Swap
Weather Insurance Contract
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Separate Account Companies
Transformations
Derivative Contract
Reinsurance Contracts And Derivatives
Insurance Contract
Separate Account 1
Separate Account 2
Bermuda Insurance Company (General Account)
Insurance Contract
Insurance Policies And Derivatives
Derivative Contract
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Why Bermuda?
1. Legal System

• English Common Law Jurisdiction
• Similar Legal Principles
• Freedom of Contract

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Why Bermuda?
2. Flexible But Effective Insurance Regulation

• Long-Term Business and General Business
• Margin of Solvency
• Based on Net Premiums Written or Loss Reserves
• Liquidity Ratio
• The Only Limitation on Investments
• Few Restrictions on carrying on Other Business

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Why Bermuda?
3. Taxation

• OECD
• Transparency
• Transactions and Structures are not Complicated
  by Bermuda Tax Issues

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Why Bermuda?
4. Adaptability

• Separate Account Companies
• Derivatives as Reinsurance
• Section 57A

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Robin Hamill President Allianz Risk Transfer Ber
muda
ART
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Allianz Risk Transfer The Boutique

• Headquartered in Zurich with offices in Bermuda,
  New York and Amsterdam.
  
• Shareholders Equity as at December 31, 2000
  equal to 330 million
  
• Thirty employees worldwide outsource non-core
  functions
  
• True convergence zone company

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Allianz Group The Mall

• Headquartered in Munich with offices in 85
  countries
  
• Shareholders equity equal to 27 billion
• Market capitalization equal to 91 billion
• Assets under management equal to 650 billion
• Recently listed on NYSE

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ART on ART

• ART (Alternative Risk Transfer) uses a blend of
  financial and insurance techniques to manage a
  client's risk.
  
• ART is most often used when a client has a risk
  which does not lend itself to solutions provided
  by standardized banking or insurance products.
  
• ART features include
• Individually tailored solutions,
• Multi-year contracts covering a broad range of
  risk,
  
• A fixed limit over the term of the contract,
  and
  
• Profit sharing to align financial interests

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ART ConvergenceBlending Insurance and Finance

• Bringing Financial Concepts to Insurance
• Time Value of Money (Losses and Profit Share)
• Put and Call Options (Limits and Profit Share)
• Bringing Insurance Concepts to Finance
• Insurance as a form of Contingent Equity
• Bank/Insurance Regulatory Arbitrage
• Utilizing the Financial Markets as a Buyer and
  Seller of Securitized Issues

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Island ART Why Bermuda?

• If Bermuda did not exist some enterprising
  Yank would get a moth-balled WWII aircraft
  carrier and position it where Bermuda is, erect a
  satellite dish and get into the international
  business. Bermudas geographic location, halfway
  between California and Europe, makes it the ideal
  place from which to do business. With friendly
  people and sensible regulation, well policed, you
  would have a success story just like the real
  Bermuda
• Dr. David Saul
• Former Premier of Bermuda

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ART at Work Case Study 1 Finite Risk

• The Opportunity
• Property catastrophe reinsurer seeking an
  alternative to traditional reinsurance

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ART at Work Case Study 1 Finite Risk

• The Solution
• Three year excess of loss
• 1st Loss 75m xs 75m
• 2nd Loss 60m xs 75m
• 3rd Loss 52.5m xs 125m
• Annual limit 135m
• Coinsurance 30 of losses xs 135m
• Profit share

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ART at Work Case Study 1 Finite Risk
1st Layer
2nd Layer
3rd Layer
75m xs 75m

60m xs 75m
52.5m xs 125m
Aggregate losses under the contract during a
three-year term
0
75m
135m
187.5m
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ART at Work Case Study 1 Finite Risk

• The Benefits
• Profit sharing plus interest
• Multi-year capacity at a set price

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ART at Work Case Study 2 Credit Enhancement

• The Opportunity
• Private real estate opportunity fund
• Expensive revolving liquidity facility in place
• Target IPO in late 1998 delayed due to
  disruptions in capital markets
  
• Client desire to replace liquidity facility with
  bond
  
• IPO at future date

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ART at Work Case Study 2 Credit Enhancement

• The Solution
• 150m bond guarantee by ART
• Private placement, no secondary trading
• Five year term
• 30m in premium, plus
• ART received warrants in company

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ART at Work Case Study 2 Credit Enhancement
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ART at Work Case Study 2 Credit Enhancement

• The Benefits
• Reduce debt expense by 200 bps per year
• Extend term of debt, providing operational
  flexibility
  
• Enhance shareholders return management owns
  more than 20 of company
  
• Expand sources of capital

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ART at Work Case Study 3 CLO Restructuring

• The Opportunity
• Investment Bank looking for balance sheet relief

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ART at Work Case Study 3 CLO Restructuring

• The Solution
• Third excess of loss layer to a restructured
  package of CLOs
  
• Diversification of obligors by industry and
  region
  
• Each loan individually underwritten and serviced
  by originating bank
  
• Investment Bank retains some exposure by
  providing equity in the transaction

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ART at Work Case Study 3 CLO Restructuring
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ART at Work Case Study 3 CLO Restructuring

• The Benefits
• Investment Bank accomplishes balance sheet
  relief
  
• Originating banks gain regulatory capital relief
  under the initial structures and are motivated to
  keep loan losses low in order to gain additional
  relief with repeat transactions

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Mike HardyChairmanBermuda Insurance Management
Association
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Captive Definition

• A closely held insurance company whose insurance
  business is primarily supplied by and controlled
  by its owners and in which the original insureds
  are the principal beneficiaries

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Single Parent
Single Insured
Fronting Insurer
Owner
Captive Reinsurer
Reinsurer
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Reasons For Creating Single-parent Captives

• Conventional insurance industry did not meet
  financial needs
  
• Access to reinsurance market
• Control of Destiny
• Lower long-term cost
• Administrative simplicity
• Reduced reliance on traditional market
• Benefits of cash flow and investment control

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Client HistoryWorkers Compensation

• Guaranteed Cost Program (1980)
• Loss sensitive plan to reap rewards of favorable
  claims experience (1985)
  
• Self-Insurance to reduce premium tax and
  residual market assessment (1989)
  
• Non Owned Captive to re-gain tax deductibility
  and build savings account ( 1993)
  
• Equity Captive to assert control over
  investments - capitalized by profits from NOC
  (1995)
  
• Customer related risks to strengthen tax
  position and make profit (1999)

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Bermuda Captive Alternatives

• Single Parent
• Rent-a-Captive
• Industry Association
• Agency
• Segregated Accounts Company

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Alternatives Rent-a-Captive

• Lower Cost
• No Capital
• Less Control

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Why Bermuda for Captives?

• Environment
• Stable political and social environment
• Business facilities
• Quality service
• Management, including experienced insurance
  personnel
  
• reinsurance facilities
• Banking
• Accounting and Auditing
• legal

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Why Bermuda for Captives?

• Computer expertise and resources
• Communications
• Flexible regulatory environment
• One-stop shopping

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Current Interest and Trends

• Captive Programs will be driven by hardening
  commercial market
  
• SPVs. Segregated Cell Companies
• Rent-A-Captive Entities
• Agency Captives
• Life Captives and Reinsurance Subsidiaries of
  Life Insurers
  
• Captives for E-Commerce Insurance Programs

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Looking Ahead

• Strategic uses for captives
• Funding uninsurable exposures
• Related business
• Cost allocation
• Consistency in coverage/retention
• Employee benefits

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Recent Bermuda Legislation Affecting Insurance
Companies

• The Electronic Transactions Act 1999 (effective
  16 July 1999)
  
• Segregated Account Companies Act 2000

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Electronic Transactions Act Bermuda Online

• Contracts
• Virtual companies
• Encryption
• Liability of intermediaries
• Code of conduct

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Segregated Account Companies Act 2000

• Purpose international recognition of segregated
  accounts
  
• Registration
• Administration accounting
• Insolvency

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Key Factors to consider!

• Regulatory freedom
• Mature and Focused infrastructure
• Innovative service provider
• Up to date, professional tax advice
• Insure customers
• Employee benefits

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Warren Cabral Partner Appleby Spurling Kempe
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THE SEGREGATED ACCOUNTS COMPANIES ACT 2000
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Overview

• The new public registration system for creating
  protected client cells in any industry
  
• Quickly
• Inexpensively
• Simply
• Flexibly
• Effectively

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Advantages
Less Expensive
More Manageable
Avoids issues of time, solvency and perfection
Establishes substantive law
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Substance of Relationships

• Nature of a trust
• Created by way of mandated agreement

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Insurance Uses

• Rent-a-captives
• Life and annuity companies
• Transformer companies
• Financial guarantee companies
• Securitisation and derivatives structures/SPVs

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Non-Insurance Uses

• Mutual fund structures
• Property development companies
• E-commerce companies
• Ship and aircraft companies
• Securitisation and derivative transactions
• Trust company arrangements

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Competitive Fees

• Annual fee of 250 per segregated account
• Maximum annual fee of 1,000

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INSURANCE AMENDMENT ACT 1998
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Contracts

• Designated investment contracts
• Includes
• Options
• Futures
• Swaps
• Derivatives

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Regulatory Approvals

• Application to Minister of Finance
• Through the Registrar of Companies
• Designated investment contracts do not
  constitute
  
• insurance business

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ELECTRONIC TRANSACTIONS ACT 1999BERMUDA ONLINE
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Characteristics

• Governs conduct of e-commerce/processing
  electronic transactions
  
• UNCITRAL Model Law - facilitation of legal
  relations by electronic means/laws of evidence
  and contract
  
• Electronic records
• Signatures
• Virtual companies
• Encryption

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Conclusion

• Bermuda at the forefront international
  recognition
  
• Responsible legislation
• Suited to a wide range of business uses
• Assists development of offshore sector

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THANK YOU !
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