Bermuda: The A.R.T. of Reinsurance in Bermuda: Recent Legal Developments

Bermuda is now the home of nearly 1,500 insurance and reinsurance companies with a combined capital base of some $42.5 billion. It is the world’s leading domicile for captive insurers and a significant provider of catastrophe reinsurance capacity. Bermuda is also a leading jurisdiction for financial reinsurance and alternative risk transfer. The Bermudian legal system combines the conservative traditions of the English common law (which took root upon Bermudian soil in 1612) and forward thinking legislation designed to meet the needs of international business (see: ‘Bermuda is the ideal venue for companies to hold arbitrations’, in ‘International Arbitration: A Guide for Foreign Corporations’ – Supplement to the April 1998 issue of "International Commercial Litigation").

This article describes recent amendments to the Insurance Act 1978 (the 1978 Act) which provide a new legal and regulatory framework for the securitisation of risk. Contracts which provide for the payment of money upon the happening of an event may now be regarded as "designated investment contracts" and statutorily deemed not to be either insurance contracts or wagers. Persons entering into such contracts will not be subject to regulation as insurers.

In a recent press release the Registrar of Companies, Kymn Astwood, described the Insurance Amendment Act 1998 as a unique piece of legislation. Mr. Astwood said:

"Uncertainty as to the legal standing of certain contracts under Bermuda law can adversely affect the ability of companies to raise capital for securitisation deals. For example, linking an investment contract such as a bond to insurance results raises questions about its legal classification. This is important where capital is coming from institutional investors who want to know whether they will be deemed to be conducting business as insurers under Bermuda law."

The 1978 Act provides that any company carrying on "insurance business", in or from Bermuda, must be licensed as an insurer. The 1978 Act defines (Section 1) "insurance business" to mean:

"… the business of effecting and carrying out contracts –

a. protecting persons against loss or liability to loss in respect of risks to which such persons may be exposed; or

b. to pay a sum of money or render money’s worth upon the happening of an event,

It is interesting to compare the Bermudian statutory definition with the traditional common law approach. ‘MacGillivray on Insurance Law’ (9th ed.) observes that, "a satisfactory definition of ‘contract of insurance’ is elusive…" and that "The English authorities do not provide a satisfactory definition of reinsurance, and the evolution of reinsurance in its various forms has made it difficult to achieve a comprehensive definition". The 1978 Act defines as insurance any contract "to pay a sum of money or render money’s worth upon the happening of an event." The statute does not, on its face, require the (re)insured to have an insurable interest of any kind, nor does it require the transfer of any risk to the (re)insurer. The Bermudian statutory definition is broad enough to cover the types of transactions once common at Lloyd’s ("rollovers", "tonners" and "time and distance" policies) from which financial reinsurance evolved and which came under critical scrutiny from tax and regulatory authorities in the United Kingdom. (For further discussion of the definition of reinsurance in English law and the legal aspects of financial reinsurance, see: P.T. O’Neill & J.W. Woloniecki, ‘The Law of Reinsurance in England and Bermuda’)

Nonetheless, there remained some uncertainty as to how certain types of transactions, for example catastrophe bonds, would be regarded under Bermuda law. In the absence of an insurable interest, such transactions appear to fall within the classic common law definition of a bet or wagering contract ("… a wagering contract is one by which two persons, professing to hold opposite views touching the issue of a future uncertain event, mutually agree that, upon the determination of that event, one shall win from the other, and the other shall pay over or hand over to him, a sum of money or other stake …" Carlill v. Carbolic Smoke Ball Co. [1892] 2 QB 484, 490-491, per Hawkins J., cited with approval by Leggatt L.J. in City Index Ltd. v. Leslie [1991] BCLC 643).

The Insurance Amendment Act 1998 adds a new section 57A to the 1978 Act, which provides that the Minister of Finance may direct contracts which fall within the following statutory definition (in Section 57(1)) to be "designated investment contracts":

"any contract (including but not limited to any option contract, futures contract, swap contract, derivative contract, contract for differences or security) the purpose of which is to secure a profit or avoid a loss –

i. by reference to fluctuations in the value or price of property of any description, or in an index, or other factor, specified for that purpose in the contract, or

ii. based on the happening of a particular event specified for that purpose in the contract…"

Section 57(1), also defines "contract" to include, "investment or security, any reference to ‘parties’ in relation to an investment or security shall be taken to be a reference to its issuers and investors…"

To obtain a direction the contract and such other documents as the Minister may require must be submitted to him together with a fee of $1000 (Section 57(2)).The effect of such a direction, which may be retroactive, and may be made subject to conditions or varied (Section 57(3)) is that "Being a party to a designated investment contract shall not constitute carrying on insurance business, and a designated investment contract shall not constitute a contract of insurance, for any purpose." (Section 57(4).)

According to the explanatory memorandum which accompanied the Insurance Amendment Bill: "This provision clarifies that persons who are not registered insurers may enter such contracts, and counters any argument that such a contract is unenforceable as an insurance contract" (as noted above that the statutory definition of insurance contracts in Bermuda does not refer to insurable interest). It is further provided, "for the avoidance of doubt", that "a designated investment contract shall not constitute a bet for the purposes of the Betting Act 1975" (Section 57(5)). Section 57(6) empowers the Minister, after consulting the Insurance Advisory Committee, to amend the definition of "designated investment contract" by order, "so as to cover future developments in the insurance derivative market" (according to the Bill’s explanatory memorandum).

Views as to what kinds of transactions are commercially and morally acceptable change over time. In the eighteenth century gambling was widespread in the London coffee houses. One could "insure" the life of a total stranger, or goods aboard a ship in which one had no interest, until statute prohibited such transactions. Reinsurance contracts were made illegal by the Marine Insurance Act 1745 (and – subject to very limited exceptions – remained illegal in England until 1864). Mr. Justice Park justified the prohibition of reinsurance in prose worthy of Gibbon:

"… the law of England … permitted the underwriters upon policies to insure themselves against those risks for which they had inadvertently engaged to indemnify the insured; or where perhaps they had involved themselves to a greater amount than their ability would enable them to discharge. Although such a contract seems perfectly fair and reasonable in itself, and might be productive of very beneficial consequences to those concerned in this important branch of trade; yet, like many other useful institutions, it was so much abused, and turned to purposes so pernicious to a commercial nation, and so destructive of those very benefits it was originally intended to promote and encourage, that the Legislature was at last obliged to interpose, and by a positive law to cut off all opportunity of practising those frauds in future, which were become thus glaring and enormous." (‘A System of the Law of Marine Insurances’, 8th ed., 1842, reprinted 1987: Professional Books, pp. 596-597)

"Tonners" were once common in the marine and aviation markets at Lloyd’s in the 1960’s and 1970’s. Certain syndicates at Lloyd’s were prepared, in exchange for a premium, to pay a sum certain to the insured if the total tonnage of vessels (or number of aircraft hulls) which became a total loss in a particular year exceeded a fixed number. In the 1980’s tonners were outlawed as gambling (see: Moran v. Lloyd’s [1983] 1 Lloyd’s Rep 51, aff’d [1983] 1 Lloyd’s Rep 472). Yet, just as reinsurance is commercially sensible (although open to abuse) so too is the concept which underlies the "tonner": the certainty of significant, known, sums of money being available to an insurer from a reinsurer at a critical time when the reinsured needs them. An insurer who insures many vessels or aircraft against total loss may wish to have immediately available to him, in the event that in any one year there is a catastrophic number of such losses, a large sum of money, and not have to wait to have claims made on him, adjusted, and perhaps aggregated, before he is able to claim upon his reinsurers. An insurer covering property against the risk of earthquake is in a similar position. Such insurers may now look to the capital markets to provide them with a form of contractual protection against loss. However, one does not have to be an insurer or reinsurer, or to have any insurable interest in property, to trade on CBOT or the Bermuda Commodities Exchange (which opened for business in November 1997).

One suspects that Mr. Justice Park would not have approved of the modern reinsurance market. But, just as in his day, statute defines the boundary between what is legally acceptable as an "investment contract" and what is an unlawful speculation. The form of the transaction governs its legal substance. The eighteenth and nineteenth century players were "underwriters" because they signed a slip. The twentieth and twenty-first century players are "investors" because they provide equity for "special purpose vehicles" incorporated in a tax-benign jurisdiction. Bermuda’s new legislation makes it the natural cross roads for reinsurance and the capital markets (the only thing that the island lacks is a decent coffee house).