Private equity: in it for the long term

Life reinsurers welcome private equity capital to raise capacity as they meet rising demand from an aging global population. At the same time, a prolonged period of ultra-low interest rates and competitive factors requires pension and annuity providers to adopt new strategies to achieve higher levels of capital efficiency and the returns they need to meet their obligations to retirees.

Private equity investors offer underwriters sophistication in non-traditional investments and access to investments not directly impacted by the low-yield environment.

Life reinsurers’ large pools of assets are matched to long-term liabilities, given the significant time lag between premium collection and policyholder benefit payouts, compared with the shorter-term property and casualty (P&C) industry. This provides a longer window for investment strategies, the “permanent capital” concept, which is a highly attractive aspect for private equity.

Need for transformation

This convergence is happening against the backdrop of a life insurance industry facing unique challenges and opportunities. The EY NextWave Insurance series posits that a combination of the COVID-19 pandemic, uneven economic recovery, technological advances, demographic shifts, climate change and racial inequality are making the industry’s purpose more relevant than ever.

As mentioned in EY’s October 2020 “Six megatrends defining the next wave of life insurance and retirement”, with vastly underfunded government-sponsored retirement programmes and rising insecurity about the future, more people are looking for protection and income solutions. But to meet the moment, life insurers must simultaneously navigate multiple challenges: persistently low-interest rates, modernising technology, updating product and service offerings, refining distribution models and retooling the workforce.

A projected $240 trillion retirement gap by 2030 points not only to the industry’s growth potential, but also its ability to make a great contribution to the wellbeing of society. Bermuda’s life reinsurers have a role to play in the transformation that their primary insurance clients must undergo over the next decade to meet these challenges.

The Bermuda entities can shoulder the risk and investment management responsibilities, allowing onshore direct insurers to focus on what they do well. Reinsurance coverage and innovation leads to more competitive pricing and tailored insurance solutions, creating greater agility for the primary writer.

Technology advancements will enable insurers to build new ecosystems to connect directly with customers. Smooth data-sharing systems and technological integration will be key to seizing the opportunity. Some of the Bermuda startups, driven by digital-savvy, data-driven workforces, are showing the way forward.

Why Bermuda?

While the reasons for the mutual attraction of life reinsurers and private equity firms are evident, what is behind their preference for marrying in Bermuda?

As capital rushes in, the Island’s long-term reinsurance sector has grown to the point that its total assets dwarf those of the P&C and captive insurance sectors, which Bermuda is better known for.

At the end of 2018, there were 148 long-term reinsurers with total assets of about $492 billion, according to the Bermuda Monetary Authority (BMA), the financial services regulator. Another 13 were registered in 2019 and another nine in 2020, even amid the economic stress triggered by the pandemic.

For underwriters, the lead attraction is the sophisticated reinsurance regulatory regime, and the BMA’s flexibility, which allows speed to market for startups.

Provided that new business applications are compliant and accurate, and meet the minimum criteria set out in the Bermuda Insurance Act 1978, the larger and more complex long-term writers that apply for a class E licence can be up and running within three to four months. Simpler structures and captives can get to market within a few weeks. Bermuda prides itself on its friendly approach to new business.

Bermuda has an innovative and developing regulatory environment. The Island is one of seven countries to have earned US Qualified Jurisdiction status from the National Association of insurance Commissioners. And, since the start of 2020, it has been one of only three jurisdictions of the seven that has Reciprocal Jurisdiction status, making reinsurance provided by Bermuda commercial insurers eligible for full regulatory recognition without the need to provide collateral.

It also means deals with Bermuda reinsurers are more readily able to obtain approval from state insurance regulators in the US, and this is a well-trodden path.

Bermuda was also only the second non-EU jurisdiction to qualify for Solvency II equivalence, which means the Island’s reinsurers can compete on an equal footing when vying for business in the EU and the UK.

Further strengthening its international recognition, the BMA is also group supervisor for more than 20 insurance groups, whose primary operations are controlled and managed from Bermuda. The BMA’s group supervision framework reflects international developments in this area and principles for insurance group supervision adopted by the International Association of Insurance Supervisors.

The BMA’s flexibility and innovation has spurred Bermuda’s track record as a trailblazer in the industry—the world’s first true offshore captive centre, the first true excess liability carriers, the first property catastrophe insurers and the launch pad for catastrophe bonds. The regulation is constantly evolving. The BMA has introduced new classes of Limited Purpose Insurers; Collateralised Insurers, a fully collateralised reinsurer class; Class IIGB, an innovation class; and a new category of intermediary, insurance marketplaces.

For life reinsurers, the Bermuda regulatory setup is more practical and accessible than in Europe or the US. It also provides an ample reinsurance pipeline opportunity to provide statutory relief for US and UK primary carriers. Bermuda’s best estimate approach to calculating liabilities can provide significant benefits when reinsuring certain products, relative to the prudent US statutory reserves.

Similarly, relative to Solvency II, the more flexible asset strategy allows Bermuda’s reinsurers to take credit for higher investment yields in the calculation of the reserves.

Strong industry groups such as Bermuda International Long Term Insurers and Reinsurers and the Association of Bermuda Insurers and Reinsurers add to the sense of an industry centre of excellence in which local specialist knowledge has built up over the decades.

Investor appeal

For private equity firms, investing in a life reinsurer offers portfolio diversification, as returns are generated from both sides of the balance sheet and life insurance risks have a low correlation to the financial markets.

The ease of new company formation provides one good reason for investors to base their startup in Bermuda. The Island’s solvency regime provides another, as it allows the use of a broad range of assets to match liability cashflows, and for the reinsurance business to take credit for the risk-adjusted returns these assets are expected to generate.

Due to Bermuda’s market-consistent Economic Balance Sheet regime, assets are valued market to market and market gains can be realised compared to the book value nature of US statutory reserving, which means that assets and liabilities are valued consistently.

This eliminates the concept of an Interest Maintenance Reserve—a reserve of assets which, in the US, is required to be held in order to deal with fluctuations in the interest rate to help ensure that insurers are financially stable and able to meet their obligations to policyholders in almost all economic conditions.

Further benefits are seen, both from the release of the prudence in the reserves from the US statutory accounts and also in the favourable impact on collateral requirements when the assets are locked into an increased book value on the reinsurer’s balance sheet.

The EY NextWave Insurance series highlights the purpose of the insurance industry in terms of delivering long-term value to customers, employees, society and shareholders. Intangible assets such as intellectual property; talent; brand reputation; innovation; and environmental, social and corporate governance (ESG) impacts, now carry greater weight.

The BMA aims to integrate sustainability into its regulatory framework as it focuses on ESG and climate risk issues. This makes Bermuda the perfect long-term investment as companies and investors seek long-term value.

Growth potential

Will Bermuda’s life reinsurance sector continue its vigorous growth of recent years? There are reasons to believe it will. The Island’s life reinsurance reach is already expanding beyond its traditional UK and US markets and is becoming more popular in Canada and continental Europe and making inroads into Japan and other parts of Asia.

It is truly becoming the choice global hub for life reinsurance. As the Bermuda solution is adopted more widely and its proven track record is introduced to new markets, there is every chance that the growth story will continue its momentum.

Read the EY report on life insurance megatrends here.

The views reflected in this article are those of the authors and do not necessarily reflect the views of EY Bermuda Ltd or other members of the global EY organisation.

Philip Burrill is a partner leading the life and captives re/insurance subsectors at EY Bermuda Ltd, part of the EY Region of the Bahamas, Bermuda, British Virgin Islands and Cayman Islands. He can be contacted at: philip.burrill@bm.ey.com

James Claxton, senior manager, EY Bermuda Ltd, contributed to this article.