Bermuda: Alternative Uses For Your Bermuda Captive

Many companies are discovering that they may use their Bermuda captives to transfer more than the traditional property and casualty risks for which the captive was originally established. Bermuda’s flexible regulatory environment and a legal system primarily based on English common law gives Bermuda insurance companies and their insurers a great deal of freedom to contract as they think fit. In this article Charles Collis, a partner of Conyers Dill & Pearman in Bermuda, considers just two of the opportunities to Alternative Risk Transfer.

In many jurisdictions insurance companies are not permitted to insure against losses arising from punitive (or exemplary) damages awards. However, Bermuda insurance companies are not generally subject to such a restriction under the Bermuda Insurance Act 1978 and the recent English case of Lancashire County Council v. Municipal Insurance 1996 WLR 493 which confirmed that an insurance contract protecting against punitive damages is enforceable except in very narrow circumstances.

In this case the Court of Appeal considered whether a policy which provides an indemnity against liability for exemplary damages would be rendered unenforceable as a matter of public policy. The policy in question related to vicarious liability of the Lancashire County Council for damages arising in relation the conduct of various employees of the County Council. The Court accepted the principle that a person cannot insure against a liability which is consequent on the commission of a crime but there was no English law which clearly established that it was contrary to public policy for an insured to recover under the contract of insurance in respect of a punitive damage award for its own conduct or for conduct for which he is vicariously liable. The Court also thought such a rule would be wholly inappropriate. The argument that the deterrent quality of exemplary damages would be reduced if one could insure against them was outweighed by the fact that it would greatly improve the plaintiff’s prospects of recovering the sum awarded. In addition such an award would continue to have a deterrent effect as the insured would probably be subject to a higher premium in the future. The Court also referred to a separate public interest in holding parties to their contracts, particularly where it is open to insurers to exclude liability for punitive damages.

Accordingly, under Bermuda law a parent company may use its Bermuda captive to insure its punitive damage exposures which it could not buy coverage for in it own jurisdiction. However, please note if it is illegal to buy such coverage in the jurisdiction of the parent company a Bermuda Court may not enforce the terms of a punitive damages policy.

The Bermuda Insurance Act does not limit the lines of insurance business a Bermuda insurance company may write provided it has the correct licence. Nor does the Insurance Act limit the other businesses or investments that a Bermuda insurance company may enter into (subject to complying with a liquidity ratio requirement). Accordingly, a parent company may transfer all sorts of risk to its Bermuda captive through the use of swaps and other derivative contracts.

For example, an energy producing company may wish to protect itself against a fall in profits due to low consumption during a warm winter. The Bermuda captive could enter into a heating degree day weather swap with the parent and then either retain that exposure or obtain insurance coverage for all or a portion of its exposure under the weather swap.

Alternatively, a parent company looking to hedge its debt portfolio could enter into a credit default swap with its Bermuda captive which in turn could obtain financial guarantee insurance to cover its loses on the credit default swap.

As risk transfer needs change and the line between insurance products and capital market products Bermuda is well placed to continue its lead position in the Alternative Risk Transfer Market.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.