The View from Barbados

Periodically critics have questioned the adequacy of the way international insurers are regulated. The perception is that domiciles that encourage the business of international insurance – including those special purpose insurers referred to as “captives” – have inadequate regulations.

The regulation of international reinsurance has also come under recent scrutiny, with the introduction of a Reinsurance Directive designed by the European Commission to introduce uniform regulatory standards for all European Union members. The impact of such harmonization remains to be seen. But it’s important to remember why the regulations for international insurers and reinsurers may differ from those applicable to domestic insurers. Contrary to prevailing mythology about Barbados being a loosely regulated “tax haven,” Barbados does ensure adequate regulatory oversight of its international insurance and reinsurance sector.

PURPOSE OF REGULATIONS

Commercial insurance regulation is undertaken to protect consumers from insurer insolvency and from insurance companies and brokers that take advantage of uninformed consumers. As has been demonstrated in the recent “bid-rigging” scandals uncovered by New York’s attorney general, criminal activity can be directed against large corporate buyers of insurance and be perpetuated by those operating in some of the most highly regulated jurisdictions. Regulatory oversight of primary insurance transactions is therefore justified to protect not only individuals but also commercial buyers of insurance.

An equally important purpose of insurance regulations is to ensure adequacy of capacity. Consumers want and need affordable coverage; it is in the public interest to ensure access to insurance. Again, the regulatory responsibility extends not only to the personal lines – such as homeowners insurance – but the commercial lines purchased by business entities. Organizations as well as individuals need insurance protection – it is a requirement for a stable economy.

The unfortunate reality, however, is that regulatory oversight can disrupt the insurance marketplace. For example, regulation of premium rates and coverage forms in certain U.S. states – undertaken to protect consumers – can lead to insurers withdrawing from the market and result in unavailability of coverage. Additionally, the cost of regulatory bureaucracy is passed on to the consumer. This is a major reason why large commercial buyers of insurance have sought “offshore” domiciles to operate their captive insurance companies from. Their objective is to find a regulatory environment that will increase, rather than reduce operating efficiency.

This brings us to an important question: How effective is the regulation of international insurers and reinsurers?

Insurers and reinsurers are regulated principally by their domicile country, state or province, and as such different standards have historically been the norm, even amongst “onshore” jurisdictions. For example, insurance and reinsurance companies doing business in Canada find many different and often conflicting regulatory practices in different provinces. To what extent is it necessary or desirable to have uniform regulations – often referred to as “harmonization” – remove a domicile’s ability to set its own practices and standards? Would it also be beneficial to remove the differences that currently exist between the regulation of domestic companies (licensed or “admitted” to sell insurance to the general public) and the regulation of captives and international reinsurers that typically operate on a non-admitted basis?

INTERNATIONAL REGULATIONS

Decades of tax reform and, more recently, anti-money laundering and anti-terrorism legislation have very effectively leveled the playing field between onshore and offshore domiciles. As those who do captive insurance business well know, the “know-your-customer” business practices adopted by financial institutions, auditors and attorneys in offshore jurisdictions exceed anything in place in the U.S. and Canada. The development of international accounting standards is also leading to a reduction in many of the different business practices that formerly existed between onshore and offshore jurisdictions. The exchange of information agreements between countries makes it increasingly possible for regulators to access information relating to international insurance. Yet many domiciles that actively encourage the formation of captives and international reinsurers remain stereotyped as “loosely regulated tax havens.”

The key question is whether adequate regulatory controls are in place to protect consumers from the illegal activities of international insurer and reinsurers. Surely, it is only the illegal activities that society must be concerned about? It is not the purpose of insurance regulation to protect insureds from insurers that operate more efficiently, and can therefore deliver products and services that better meet the needs of their customers. Nor is it the purpose of an insurance regulator to regulate insurers domiciled in another jurisdiction. This is a fundamental principle of insurance regulation: the domicile has primary authority over the company it licenses.

UNIFORM STANDARDS: PROS AND CONS

It may be possible to allow a domicile to retain authority over the insurers or reinsurers it licenses, while achieving the benefits to be realized by more uniform regulatory standards. The proposed EU Reinsurance Directive is intended to reduce reinsurer collateral and administrative burdens, and make it easier for regulators to access financial information produced in a consistent way. Consumers may ultimately benefit from harmonization if cost savings are passed back through lower rates, and uniform accounting standards and filings make it easier to detect potential insolvencies.

Harmonization could, however, hurt consumers if it is used to eliminate a domicile’s ability to customize regulation in a manner appropriate to the business objectives of the type of insurer or reinsurers it licenses. To protect the general public and ensure a healthy insurance marketplace, insurance regulators have a number of regulatory tools at their disposal. Key methods include:

* The insurer must file a business plan with financial projections and operate in accordance with that plan.

* Detailed statutory reports are filed on an annual basis or more frequently.

* Insurers must file an annual audit, including a certification of the adequacy of reserves by a qualified actuary.

* Examiners periodically inspect books and records.

Each jurisdiction has minimum capital requirements and key operating ratios that monitor variables such as the amount of risk retained versus the amount of capital available to support the risk.

The amount and quality of reinsurance purchased is subject to approval and non-admitted reinsurance may need to be collateralized.

Each of these regulatory tools can be applied differently depending upon whether the insurer is a domestic company licensed to sell insurance to the general public, or an international insurer that operates on a non-admitted basis in the country where its insured risks are located, or as a reinsurer.

For example, a domestic insurer may be required to file premium rates and policy forms as part of the business plan, whereas international insurers and reinsurers have historically set their own rates and forms. It is assumed the owners and users of captives and buyers of reinsurance are sophisticated and do not require a significant amount of regulatory protection. Harmonization can improve the efficiency of the regulatory process, but it should not necessarily be used in a way to eliminate valid regulatory distinctions between domestic companies – both onshore and offshore – that insure the general public. Nor should they be used in a way that impedes international insurers or reinsurers from providing coverage to financially sophisticated entities – such as multinational corporations – that manage and finance risks on a worldwide basis.

BARBADOS: A GOOD FRAMEWORK

Consideration of the procedures used by Barbados to regulate its international insurers and reinsurers (including captives) allows one to see how differences in regulatory standards between domestic and international insurers and reinsurer can be appropriate. For example, Barbados, like many other leading captive domiciles, has statutory solvency ratios that are less extensive than those used in the regulation of commercial insurers. Barbados has only one ratio – premium to capital. Certain other major captive domiciles do not have any statutory ratios at all, which provides those regulators a greater degree of flexibility to approve lower or higher amounts of capital than would be required under a ratio. Because captives are regulated primarily based on the business plan they file in order to become licensed, lack of statutory ratios does not lead to less financially sound companies.

Barbados statute also requires GAAP, not statutory accounting, and therefore a separate statutory statement re-stating information presented in the audited statements is not necessary. Like most domiciles, Barbados requires the captive audit to be undertaken by a CPA that is approved by the Supervisor of Insurance, and places reliance upon the high quality of its auditors rather than routinely conducting statutory examinations.

Barbados does retain the right to inspect an exempt or qualified insurer, but is not required to do so unless deemed necessary by the Supervisor of Insurance. This difference can be defended because of the requirement that a captive must hire licensed or authorized captive managers. Barbados, as with regulators in most captive domiciles, relies upon the captive manager to ensure that the captive is operated in a financially sound way, and remains in compliance with applicable regulations. A copy of the captive management agreement has to be filed with the regulator.

In addition, there is a process in which a resident representative is appointed. The Barbados resident representative has to notify the regulator of actual or potential financial impairment of a captive. Therefore, although the international insurance sector has less statutory compliance requirements than the domestic insurance sector, an effective system is in place to ensure that the regulator is informed of solvency or liquidity problems.