Item 1. Business
OVERVIEW
The Company
We are a Bermuda exempted limited liability company that, through our subsidiaries, offered collateralized reinsurance in the property catastrophe market and invested in various insurance-linked securities. We were incorporated under the laws of Bermuda on June 24, 2013 and we commenced operations on November 12, 2013. Our headquarters and principal executive offices are located at Waterloo House, 100 Pitts Bay Road, Pembroke HM 08, Bermuda, which is also our registered office.
Our Common Shares trade on the New York Stock Exchange under the symbol "BCRH" and on the Bermuda Stock Exchange under the symbol "BCRH.BH."
Our largest shareholder, Sompo International, is a holding company headquartered in Bermuda which through its operating subsidiaries focuses on underwriting specialty lines of personal and commercial property and casualty insurance and reinsurance on a global basis. Sompo International together with its wholly owned subsidiary, Endurance Specialty Insurance Ltd. ("Endurance Bermuda"), owned 33.2% of the Company's outstanding Common Shares as of December 31, 2019.
On July 25, 2019, after considering strategic alternatives, the Company announced a plan to cease active operations and pursue an orderly run-off of its liabilities and in-force portfolio and return capital to shareholders. As and when sufficient capital becomes available after settlement of existing liabilities and expenses and receipt of any necessary regulator approvals, the Company expects to declare special distributions to shareholders.
Prior to commencing an orderly run-off, our business strategy was to build and maintain a diversified portfolio of reinsurance risks that were intended to generate underwriting profits, which we intended principally to distribute to our shareholders through the payment of dividends, with returns commensurate with the amount of risk assumed. We provided our shareholders with the opportunity to own an alternative asset class whose returns we believe have historically been largely uncorrelated to those of other asset classes, such as global equities and bonds.
Prior to ceasing active operations, we operated as a single business segment through our wholly-owned subsidiaries: (i) Blue Capital Re, a Bermuda exempted limited liability company registered as a Class 3A insurer in Bermuda under the Insurance Act, which provided collateralized reinsurance; and (ii) Blue Capital Re ILS, a Bermuda exempted limited liability company which conducted hedging and other investment activities, including entering into industry loss warranties and purchasing catastrophe bonds, in support of Blue Capital Re’s operations.
Subsidiaries of Sompo International manage our reinsurance underwriting decisions and provide us with the services of our CEO and CFO. Through this relationship, we leverage Sompo International’s reinsurance underwriting expertise and infrastructure to conduct our business.
The Property Reinsurance Market
Property insurance companies issue insurance policies in exchange for premiums paid by the policyholder. An insurance policy is a contract between the insurance company and the policyholder whereby the insurance company agrees to pay for losses suffered by the policyholder that are covered under that contract. Property insurance typically covers the financial consequences of accidental losses to the policyholder’s property due to natural and man-made catastrophes, subject to deductibles and other policy limitations. Casualty insurance mainly protects a person or a business against legal liability for losses caused by injury to other people or the property of others. Many insurance policies will cover both property and casualty risks. However, given the difference in nature between property and casualty risks, the reinsurance markets for these types of risks tend to be separate and distinct. Our reinsurance activities focused predominately on property risks.
Property reinsurance companies assume, from both insurance companies (known as "ceding companies" or "cedants") and other reinsurance companies (known as "retrocedants"), as well as other property insurance capital providers, such as government or state-sponsored catastrophe funds, all or a portion of the property insurance or reinsurance risks that the ceding company or retrocedant has underwritten under one or more insurance or reinsurance policies. In return, the reinsurer receives a premium for the risks assumed from the ceding company or retrocedant. When reinsurance companies purchase reinsurance to cover their own risks assumed from ceding companies, this is known as "retrocessional reinsurance." Reinsurance or
retrocessional reinsurance can benefit a ceding company or retrocedant, as applicable, in various ways, such as by reducing exposure to individual risks and by providing catastrophe protection from larger or multiple losses. Ceding companies and retrocedants can use reinsurance or retrocessional reinsurance to manage their overall risk profile or to create additional underwriting capacity, allowing them to accept larger risks or to write more business than would otherwise be possible, absent an increase in their capital or surplus.
Our Competitive Strengths
Prior to commencing an orderly run-off, we believe we took advantage of the following competitive strengths:
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Access to a Global Specialty Provider of Property and Casualty Insurance and Reinsurance with an Extensive Infrastructure. We benefited substantially from the Manager’s relationship with Sompo International by accessing and leveraging Sompo International’s management talent, proprietary reinsurance modeling tools, underwriting expertise, proprietary risk management systems and longstanding broker/client relationships. The Manager’s affiliation with Sompo International enabled us to deploy our capital to build a diversified portfolio of reinsurance risks with what we believed to be an attractive risk-adjusted return potential for our shareholders. We also benefited from Sompo International’s scale, experience and reputation in pricing reinsurance contracts and achieving key policy terms and conditions, which we considered a competitive advantage relative to other independent or small reinsurance platforms. We continue to benefit from Sompo International’s existing middle- and back-office support infrastructure.
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Differentiated Approach to Reinsurance Risk Selection. The Manager performed our risk selection process, subject to the oversight of the Board, and primarily targeted counterparties who supplied us with the full spectrum of information associated with each exposure. Our risk selection process included using the Manager’s specific knowledge of the ceding insurer and underlying risks, including detailed portfolio data, such as home type, location, building code and date of construction. Additionally, the Manager analyzed the historical loss performance of the ceding insurer, its market position, its management’s capabilities and its claims mitigation history. The Manager generally acted as a "quoting market" participant, which means that it provided an initial quote to the broker rather than responding to quotes provided by the broker. We believe that this allowed the Manager to be more selective in choosing the reinsurance contracts it selected for us and enhanced its relationship with brokers. We benefited from the Manager’s use of Sompo International’s analytics, risk management and actuarial team, which enabled the Manager to analyze the granular data collected using proprietary analytical systems on our behalf in order to determine the appropriate pricing for the risks assumed. The Manager used its and Sompo International’s proprietary catastrophe pricing and risk management systems, various third-party models and its underwriting judgment in order to build a high quality portfolio. The Manager also sought to exploit pricing inefficiencies that may have existed in the market from time to time.
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Access to Reinsurance Products Not Generally Available to Collateralized Reinsurers. In addition to offering collateralized reinsurance directly to third-party insurance and reinsurance companies, we further benefited from leveraging our relationship with Sompo International in order to gain access to a broader range of reinsurance business than we believe was typically available to most collateralized reinsurers. Through a retrocessional contract (the "BW Retrocessional Agreement"), between Blue Capital Re and Blue Water Re, Blue Water Re had the option to cede to Blue Capital Re up to 100% of its participation in the ceded reinsurance business it wrote, provided that such business was in accordance with Blue Capital Re’s underwriting guidelines. Pursuant to the BW Retrocessional Agreement, we participated in: (i) retrocessional, quota share or other agreements between Blue Water Re and Sompo International or other third-party reinsurers, which provided us with the opportunity to participate in a diversified portfolio of risks on a proportional basis; and (ii) fronting agreements between Blue Water Re and Sompo International or other well capitalized third-party rated reinsurers, which allowed us to transact business with counterparties who prefer to enter into contracts with rated reinsurers. These arrangements enhanced the depth of opportunities available to us, increased the diversification of our portfolio and provided the opportunity to deliver enhanced risk-adjusted returns compared to other collateralized reinsurers.
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Experienced Management Team. Our CEO and CFO, as well as Sompo International’s senior managers responsible for the day-to-day oversight of the Manager, have significant experience in the reinsurance industry, including the supervision of both traditional reinsurance markets and insurance-linked securities. We also benefited from the significant experience of the Manager’s Investment and Underwriting Committees.
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Alignment of Interests Between Our Shareholders and Sompo International. Sompo International has historically owned approximately one third of our outstanding Common Shares. We believe that Sompo International’s significant investment in us and our relationship with the Manager aligned Sompo International’s interests with those of our shareholders and incentivized Sompo International to maximize returns, while managing risks, for our shareholders.
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Our Strategy
Our business strategy was to build and maintain a diversified portfolio of reinsurance risks that would generate underwriting profits, which we intended principally to distribute to our shareholders through the payment of dividends, with returns commensurate with the amount of risk assumed. We implemented our strategy through our subsidiaries Blue Capital Re and Blue Capital Re ILS. Blue Capital Re provided collateralized reinsurance and entered into industry loss warranties in the form of insurance contracts. Blue Capital Re ILS conducted hedging and other investment activities, including investing in insurance-linked securities, in support of Blue Capital Re’s operations.
We aimed to maintain a balanced portfolio of predominantly, but not exclusively, natural and man-made catastrophe risks, diversified by peril, geography and attachment point. The Manager selected risks on our behalf, primarily from the global property catastrophe reinsurance market. Our strategy was to build and maintain a flexible and diversified portfolio of reinsurance risk exposures by pursuing a broad range of reinsurance opportunities. We believe that allocations to traditional reinsurance contracts, either fronted or collateralized by trust account or letter of credit, industry loss warranties, catastrophe bonds and other insurance-linked securities enhanced our overall risk diversification and offered attractive relative value at different points in time, depending on market conditions. The Manager used Sompo International’s sophisticated risk management techniques to monitor correlation risk, and it sought to enhance our underwriting returns through careful risk selection using advanced capital allocation methodologies. We also actively sought to write more business in classes that we considered to be favorably priced based on the risk-adjusted return potential and to avoid those classes that we considered to be comparatively unfavorably priced, such as those suffering from intense price competition or poor fundamentals. We believe a balanced portfolio of risks reduced the volatility of returns and optimized value for our shareholders.
Quota Share Retrocessional Agreements with Sompo International or Other Third-Party Reinsurers
Blue Capital Re has participated in quota share retrocessional reinsurance agreements with Sompo International pursuant to the BW Retrocessional Agreement, or directly with other sophisticated reinsurance or insurance companies (those with either a minimum A.M. Best financial strength rating of "A-" (Excellent) or better (or an equivalent rating with another recognized rating agency)), or insurers and reinsurers that are not rated or do not fall within this threshold on a case-by-case basis . These agreements allowed Blue Capital Re to participate in an agreed percentage of the risks and premiums of certain reinsurance contracts on a proportional basis, with exposure capped at the amount of collateral required to support the contract. In exchange, the ceding reinsurer charged Blue Capital Re a commission override, which is a percentage of the premiums on these contracts, to compensate it for sourcing the business and retaining the tail risk (meaning the amount of proportional contractual limits in excess of collateral required) of these reinsurance contracts. The ceding reinsurer was also reimbursed for acquisition costs, including brokerage and federal excise taxes, and sometimes received a profit commission in the event of favorable loss experience. These arrangements were negotiated on a case-by-case basis, allowing Blue Capital Re to partake either in a portion or the entirety of the reinsurer’s portfolio or only in certain classes of reinsurance, as determined by the Manager, subject to our underwriting guidelines and the oversight of the Board.
Third-Party Reinsurance, Direct with Cedant or via a Fronting Arrangement
Blue Capital Re also provided reinsurance to third-party insurance and reinsurance companies through reinsurance contracts, either directly with the cedant or on a fronted basis. Blue Capital Re’s exposure under these reinsurance contracts was calculated on an ultimate net loss basis, ultimate net loss meaning the actual loss or losses paid out by the cedant or retrocedant and for which the cedant or retrocedant has become liable in respect of insurance policies entered into by the cedant as an insurer or reinsurer. Generally, cedants decide to cede business to a reinsurer based on the quality of a reinsurer’s financial strength rating or, if it is unrated, on the demonstrated ability of a reinsurer to cover claims. Blue Capital Re fully collateralized its reinsurance obligations. The collateral is held in trust for the term of the related contract (or, in the event of a covered loss, until the resolution of any claims under the contract).
As an alternative to the collateralized markets, Blue Capital Re also participated in fronting arrangements, either through the BW Retrocessional Agreement or directly with other well capitalized third-party rated reinsurers that satisfied the Manager’s detailed credit review. Under a typical fronting arrangement, a rated insurer issues an insurance policy on behalf of an unrated, often cash-collateralized, reinsurer without the intention of retaining any of the risk. The economic risk remains with the unrated reinsurer via an indemnity/reinsurance agreement but the contractual and credit risk is assumed by the fronting company since it is required to honor obligations under the policy if the unrated reinsurer fails to indemnify the fronting company.
The reason for these fronting arrangements is that, just as some counterparties may prefer fully-collateralized reinsurance, other counterparties may prefer to enter into reinsurance contracts with a rated reinsurer. Alternatively, there have been situations in which the structure of the reinsurance contract would otherwise render direct collateralization uneconomic (for example, if the contract provided for reinstatable limits, which are described below). By entering into a fronting arrangement, Blue Capital Re was able to participate in reinsurance opportunities that would not otherwise have been available to us, although Blue Capital Re was still required to provide collateral to the fronting reinsurer.
Under typical fronting agreements, all of the reinsurance risks are retroceded to the reinsurer who, in turn, provides the fronting reinsurer with collateral in an amount equal to or greater than the contractual limit less the premium receivable plus any origination fees owed. A fronting fee, which is a percentage of net premiums written, is deducted from premiums paid to the reinsurer.
Other fronting agreements have included subsequent (or reinstated) contractual limits of coverage following a covered loss event in return for an additional premium. Under these agreements, Blue Capital Re was required to fully collateralize both the original limit and the reinstated limits. Reinstatement generally occurs under two circumstances: (i) automatically and with no additional premium other than the original premium; or (ii) automatically with an additional premium that is agreed upon when the policy is written.
Blue Water Re Retrocessional Agreement
Blue Capital Re also provided facultative retrocessional reinsurance to Blue Water Re pursuant to the BW Retrocessional Agreement. The terms of this agreement mirrored those of the original insurance policies. See "Conflicts of Interest" for information about the affiliation between Sompo International and us.
Blue Water Re is Sompo International’s market-facing collateralized reinsurer, and focused on providing reinsurance protection to primary insurance companies globally. Blue Water Re underwrote and entered into collateralized reinsurance contracts with Sompo International and other third-party insurance companies, which transferred all or a portion of the risks and the premiums under these third-party insurance companies’ contracts to Blue Water Re. All or a portion of these risks and premiums were then allocated to Blue Capital Re by way of the BW Retrocessional Agreement. Under this agreement, Blue Capital Re accepted risks from Blue Water Re in exchange for the corresponding premiums relating to the accepted risks.
Industry Loss Warranties
Blue Capital Re or Blue Capital Re ILS bought and sold industry loss warranties as a way to access certain risks. An industry loss warranty is a financial instrument designed to protect insurers or reinsurers from severe losses due to natural and man-made catastrophes and can take the form of either an insurance contract or a swap agreement. Under both forms, a premium is paid at the inception of the contract and, in return, a payout is made if a catastrophic event causes loss to the insurance industry in excess of a predetermined trigger amount. Industry loss warranties may also be triggered by other parametric measurements defined in the contract such as observed wind speeds, measured seismic activity or other factors. Industry loss warranties in the form of an insurance contract (also referred to as the "indemnity form") are typically dual-trigger instruments and, in addition to requiring a loss to the industry, require that the buyer of the protection actually suffer a loss from the triggering event. Blue Capital Re bought and sold industry loss warranties in the form of an insurance contract, and Blue Capital Re ILS bought and sold industry loss warranties in the form of a derivative contract.
Catastrophe Bonds
Blue Capital Re ILS also had the opportunity of purchasing catastrophe bonds to access certain risks. A catastrophe bond provides reinsurance protection in the event of a catastrophic event. The issuer pays the bondholder interest and repays the principal at maturity, but if a specified trigger condition, such as an indemnity, industry or parametric index or modeled loss, are met, then the issuer is no longer required to pay interest or repay some or all of the principal. Blue Capital Re ILS had the ability to buy, sell or, given sufficient scale to do so, issue catastrophe bonds.
Our Underwriting Guidelines
The Manager has had broad discretion to execute our underwriting strategy, subject to our underwriting guidelines and the oversight of the Board.
Our underwriting guidelines have applied in respect of any new underwriting decision at the time of such decision, using the information available to the Manager at that time. This includes information on the existing portfolio contract limits and modeled loss exposures by zone, as well as estimations of the potential impact on portfolio limits and modeled loss exposures from unquantified external factors. These factors have included industry loss events that have had the potential to cause loss to our portfolio and changes in methodology for calculating modeled losses. Based on the information available to the Manager at the time, if a new opportunity being considered would have caused a restriction to be breached, or if a restriction relevant to that new opportunity was already in breach, then that new opportunity was not allocated to us.
Our underwriting guidelines that we operated under are summarized below.
Class of Reinsurance
Our underwriting guidelines established maximum and minimum thresholds for the amount of each class of reinsurance, as follows (each expressed as a percentage of our shareholders’ equity):
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0% to 100% in indemnity reinsurance;
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0% to 50% in indemnity retrocession;
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0% to 100% in quota share retrocessional agreements;
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0% to 50% in industry loss warranties;
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0% to 20% in catastrophe bonds; and
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0% to 20% in other non-property catastrophe risks.
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We typically deployed at least 50% of our portfolio in indemnity reinsurance, indemnity retrocession and quota share retrocessional agreements. Taking into account our underwriting guidelines and the targeted allocation described above, the majority of our portfolio was allocated to traditional indemnity reinsurance (including quota share retrocessional agreements).
Geographic Diversity
We pursued a geographically diversified reinsurance strategy with an emphasis on the 14 individual zones set out below. We sought to maintain a projected net exposure from any one catastrophe loss event in any individual zone at or below 50% of our shareholders’ equity.
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North America
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Europe
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Rest of World
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· U.S. Northeast
· U.S. Southeast
· U.S. Florida
· U.S. Gulf
· U.S. New Madrid
· U.S. Midwest
· U.S. California
· U.S. Hawaii
· Canada
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· Europe
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· Australia
· New Zealand
· Japan
· South America
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Examples of individual zones include: U.S. Florida Windstorm (1st event), U.S. Florida Windstorm (2nd event), European Windstorm (1st event), European Windstorm (2nd event), U.S. California Earthquake (1st event), Japan Earthquake (1st event) and U.S. Midwest Aggregate. The Company, to the best of its knowledge, did not enter into any contacts with any governments or entities targeted by U.S. sanctions including those applicable to Sudan, Syria and Iran.
Other Limitations
We sought to maintain a projected net impact from any one catastrophe loss event at the 1 in 100 year return period for any one zone at or below 35% of our shareholders’ equity. A 100 year return period can also be referred to as the 1.0% occurrence exceedance probability, meaning there is an estimated 1.0% chance in any given year that this level will be exceeded. We sought to maintain a projected net impact from any one earthquake loss event at the 1 in 250 year return period for any zone at or below 35% of our shareholders’ equity. A 250 year return period can also be referred to as the 0.4% occurrence exceedance
probability, meaning there is an estimated 0.4% chance in any given year that this level will be exceeded. For these risks, the projected net impact was determined by the Manager using various systems, including Sompo International’s proprietary systems and data.
We have also purchased retrocessional or industry loss warranty protection to mitigate the impact of large catastrophe events on our portfolio or to optimize the expected return of our portfolio.
Our Reinsurance Risk Selection and Underwriting Process
We employed a granular approach to risk selection and portfolio construction. We targeted reinsurance counterparties through which we were able to access the full spectrum of information associated with each reinsurance loss exposure. In a majority of the reinsurance transactions that we entered into, we were a "quoting reinsurer," meaning that we provided an initial quote to the broker rather than responding to quotes provided by the broker. By contrast, we believe some other reinsurance providers act as price followers and only access exposure at an industry loss level and, accordingly, cannot evaluate specific information related to individual elements of underlying risk or control the underwriting process. We believe this holistic approach enabled us to build and maintain a portfolio of reinsurance contracts with attractive risk-adjusted returns.
The Manager, on our behalf and subject to the oversight of the Board, employed selective underwriting criteria in the contracts it chose to underwrite and spent a significant amount of time with our cedants and brokers to understand the risks and appropriately structure the contracts. As part of our pricing and underwriting process, the Manager assessed, among other factors:
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the client’s and industry historical loss data and current market conditions;
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the business purpose served by a proposed contract;
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the client’s pricing and underwriting strategies;
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the client’s claims management and mitigation practices;
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the expected duration for claims to fully develop;
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the geographic areas in which the client is doing business and its market share;
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the reputation and financial strength of the client;
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the reputation and expertise of the broker;
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proposed contract terms and conditions; and
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reports provided by third party industry specialists
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Our Structure
We conducted our business through our wholly-owned subsidiaries Blue Capital Re and Blue Capital Re ILS.
We conducted our reinsurance business through Blue Capital Re. As a result of the approvals received from the BMA and the terms of our approved business plan, Blue Capital Re was only permitted to enter into reinsurance contracts that were fully-collateralized at 100% of the aggregate limit at the inception of each reinsurance contract. Blue Capital Re has therefore been subject to less stringent regulatory oversight than Class 4 insurers and has been subject to more modest capital and surplus requirements.
We conducted certain hedging and other investment activities through Blue Capital Re ILS, including investing in insurance-linked securities.
The Manager
We rely on the Manager, a wholly-owned subsidiary of Sompo International, for services that are essential to the operation of our business. The Manager manages our assets and makes all of our underwriting and investment decisions, subject to our underwriting guidelines and the oversight of the Board.
The Manager also manages other accounts with areas of focus that overlap with our strategy, and expects to continue to do so in the future. The Manager is not restricted in any way from sponsoring or accepting business or capital from new clients, insurance or reinsurance companies, funds or other accounts, including businesses that are similar to, or that overlap with, our business. Therefore, the Manager’s time and attention may be divided between us and other businesses.
Investment Management Agreement
The Company entered into an investment management agreement with the Manager (the "Investment Management Agreement"). Pursuant to the terms of the Investment Management Agreement, the Manager has full discretionary authority, including the delegation of the provision of its services, to manage our assets, subject to our underwriting guidelines, the terms of the Investment Management Agreement and the oversight of the Board.
Underwriting and Insurance Management Agreement
The Company, Blue Capital Re and the Manager have entered into an underwriting and insurance management agreement (the "Underwriting and Insurance Management Agreement"). Pursuant to the Underwriting and Insurance Management Agreement, the Manager provides underwriting, risk management, claims management, ceded retrocession agreements management and actuarial and reinsurance accounting services to Blue Capital Re. The Manager has full discretionary authority to manage the underwriting decisions of Blue Capital Re, subject to our underwriting guidelines, the terms of the Underwriting and Insurance Management Agreement and the oversight of the Board and of the board of directors of Blue Capital Re.
Administrative Services Agreement
The Company entered into an administrative services agreement (the "Administrative Services Agreement") with the Manager. Pursuant to the terms of the Administrative Services Agreement, the Manager provides us with support services, including the services of our CFO, as well as finance and accounting, internal audit, claims management, policy wording, modeling software licenses, office space, information technology, human resources and administrative support. The Manager has the right to sub-contract the provision of these services (other than the services of our CFO) to a third-party.
Neither our CEO nor CFO receives any compensation directly from us for their services. Rather, the services provided by our CEO are deemed to be encompassed within the management fee we are charged by the Manager under the Investment Management Agreement and the services provided by our CFO are directly charged to us by the Manager under the Administrative Services Agreement.
The following table summarizes the fees payable to the Manager pursuant to the Investment Management Agreement, the Underwriting and Insurance Management Agreement and the Administrative Services Agreement and certain other terms of these agreements:
Summary Description
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Management Fee
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The Manager is entitled to a management fee (the "Management Fee") of 1.5% of our average total shareholders’ equity per annum, calculated and payable in arrears in cash each quarter (or part thereof) that the Investment Management Agreement is in effect. For purposes of calculating the Management Fee, our total shareholders’ equity means: (1) the net proceeds from all issuances of our equity securities since inception (allocated on a pro rata daily basis for such issuances during the quarter of any such issuance), plus (2) our retained earnings as of the end of the most recently completed quarter (without taking into account any non-cash compensation expense incurred in current or prior periods), minus (3) any amount that we may have paid to repurchase our Common Shares on a cumulative basis since inception. It also excludes (x) any unrealized gains and losses and other non-cash items that have impacted shareholders’ equity as reported in our financial statements prepared in accordance with GAAP, other than unrealized gains and losses and other non-cash items relating to insurance-linked securities, and (y) one-time events pursuant to changes in GAAP after discussions between the Manager and our independent directors and approval by both a majority of our independent directors and the Manager for all such adjustments. As a result, our shareholders’ equity, for purposes of calculating the Management Fee, could be greater or less than the amount of shareholders’ equity shown on our financial statements.
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Performance Fee
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The Manager is entitled to a performance fee (the "Performance Fee") calculated and payable in arrears in cash each quarter (or part thereof) that the Underwriting and Insurance Management Agreement is in effect in an amount, not less than zero, equal to the product of (1) 20% and (2) the difference between (A) our pre-tax, pre-Performance Fee Distributable Income for the then current quarter and (B) a hurdle amount calculated as the product of (i) the weighted average of the issue price per Common Share pursuant to each of our public or private offerings of Common Shares since our inception multiplied by the weighted average number of all Common Shares outstanding (including any restricted share units, any restricted Common Shares and other Common Shares underlying awards granted under our equity incentive plans), as further reduced by the amount, if any, by which our inception-to-date dividends to shareholders exceeds our inception-to-date GAAP net income, and (ii) 2% (equivalent to an 8% annualized hurdle rate); provided, however, that the foregoing Performance Fee is subject to a rolling three-year high water mark.
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Term
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We generally may not terminate the Investment Management Agreement, the Underwriting and Insurance Management Agreement or the Administrative Services Agreement until November 5, 2021, whether or not the Manager’s performance results are satisfactory. Each of these agreements renews automatically on November 5, 2021, and every three years thereafter, unless terminated in accordance with its terms. During the term of these agreements, we may not enter into any other investment management, underwriting and insurance management or services agreement.
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Termination Fee
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Upon any termination or non-renewal of either of the Investment Management Agreement or the Underwriting and Insurance Management Agreement (other than for a material breach by, or the insolvency of, the Manager), we will pay a one-time termination fee to the Manager equal to 5% of our GAAP shareholders’ equity, calculated as of the most recently completed quarter prior to the date of termination.
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Expense Reimbursement
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Under the terms of the Investment Management Agreement and the Underwriting and Insurance Management Agreement, we reimburse the Manager for various fees, expenses and other costs in connection with the services provided under the terms of these agreements. The only fees payable under the terms of the Administrative Services Agreement are to reimburse the Manager for various fees, expenses and other costs in connection with the services provided under the terms of that agreement, including the services of our CFO, modeling software licenses and finance, legal and administrative support.
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Capital Management Policy
The Company intends to continue to make special distributions to shareholders from time to time pursuant to our plans to effect an orderly run-off of the Company.
The declaration of special distributions will be subject to the discretion of the Board and to the consideration of various additional risks and uncertainties, including those discussed under the headings "Risk Factors" and "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Annual Report on Form 10-K. Any future determination to make distributions will remain at the discretion of the Board and will be dependent upon many factors, including: (i) our financial condition, liquidity, results of operations (including our ability to generate cash flow in excess of our expenses) and capital requirements; (ii) general business conditions, (iii) legal, tax and regulatory limitations; (iv) contractual prohibitions and other restrictions; (v) regulatory approval of Blue Capital Re's dividend payments to the Company; and (vi) any other factors that the Board deems relevant. Subject to the "passive foreign investment company" ("PFIC") rules discussed below for U.S. federal income tax purposes, it is expected that U.S. Holders (as defined below) of our common shares generally will recognize gain or loss equal to the difference between (i) the sum of the amount of cash and the fair market value (determined at the time of the distribution) of property, if any, distributed to them and (ii) their adjusted tax basis in our common shares. Such gain or loss generally will be computed on a per-share basis. Accordingly, if a U.S. Holder acquired our common shares at different prices or at different times, the amount that such shareholder receives on each liquidating distribution will be allocated to each different block of our common shares based on the number of shares in each block. Within each block, a cost recovery approach will generally be applied, and a U.S. Holder’s full tax basis of a block will generally be recovered before any gain is recognized with respect to it. When a distribution is one in a series of distributions in complete liquidation, as is expected, these basis recovery rules will apply to the aggregate basis of all of the U.S. Holder's common shares, and any loss generally will be recognized by a U.S. Holder only in the tax year in which the shareholder receives our final liquidating distribution. For these purposes, a "U.S. Holder" is any beneficial owner of our common shares that, for U.S. federal income tax purposes, is (i) a citizen or individual resident of the United States; (ii) a corporation, or other
entity treated as a corporation for U.S. federal income tax purposes, created or organized in or under the laws of the United States or any state thereof, including the District of Columbia; (iii) an estate the income of which is subject to U.S. federal income taxation regardless of its source; or (iv) a trust if such trust has validly elected to be treated as a United States person for U.S. federal income tax purposes or if (1) a court within the United States is able to exercise primary supervision over its administration and (2) one or more United States persons have the authority to control all of the substantial decisions of such trust. Holders of our common shares should consult their tax advisors regarding the tax consequences to them of the receipt of any distributions from us.
The Company has no substantial operations of its own and relies primarily on cash dividends or distributions from its subsidiaries to pay its operating expenses and special distributions to its shareholders. Furthermore, Blue Capital Re, the Company’s wholly-owned reinsurance subsidiary, is regulated as a Class 3A insurer under the Insurance Act by the BMA, and its ability to pay dividends or distributions to the Company is limited under Bermuda law and regulations. In light of the Company's decision to enter run-off and return capital to its shareholders, on October 25, 2019, the BMA amended the license of Blue Capital Re to require Blue Capital Re to obtain the written approval of the BMA prior to the declaration and/or payment of any dividends and/or the making of any capital contributions to Blue Capital Re’s parent, shareholders or affiliates. Accordingly, Blue Capital Re will be obligated to seek the BMA’s advance approval in order to provide the Company with the funds required for each distribution to the Company’s shareholders in connection with the run off of the Company. To the extent Blue Capital Re is unable to obtain the BMA’s approval, distributions to the Company's shareholders may be prevented or delayed until such time as Blue Capital Re receives the BMA’s approval. See "Regulation and Capital Requirements" for more information.
In addition, under the Bermuda Companies Act 1981, as amended (the "Companies Act"), none of the Company, Blue Capital Re or Blue Capital Re ILS is permitted to declare or pay a dividend, or make a distribution out of contributed surplus, if it is, or would after the payment be, unable to pay its liabilities as they become due, or if the realizable value of its assets would be less than its liabilities. See "Regulation and Capital Requirements" for more information.
GROSS PREMIUMS WRITTEN
During the seven month period ended July 31, 2019 and the year ended December 31, 2018, we wrote $11.1 million and $33.2 million of gross reinsurance premiums, respectively.
Upon adoption of the liquidation basis of accounting on July 31, 2019 the Company estimated future gross written and earned premiums associated with its final in-force retrocessional treaty and subsequently adjusted the earnings to actual reported premiums as of December 31, 2019. As a result an additional $7.0 million in earned premiums were incorporated in the liquidation valuation of the Company subsequent to July 31, 2019. As of December 31, 2019 all treaties have expired.
Gross Premiums Written By Broker
Prior to ceasing active operations, we marketed our reinsurance policies worldwide primarily through insurance and reinsurance brokers. The majority of our gross premiums written were sourced by the Manager through a limited number of brokers. The broker was not a party to the reinsurance contract.
We and the Manager sought to build long-term relationships with brokers by providing: (i) prompt and responsive service on underwriting submissions; (ii) innovative and customized reinsurance solutions to their clients; and (iii) timely payment of claims. Brokers received compensation, typically in the form of a commission, based on negotiated percentages of the premium they produced and the performance of other necessary services. Brokerage costs constituted a significant portion of our reinsurance acquisition costs.
The following table sets forth a breakdown of our gross reinsurance premiums written by broker for the seven months ended July 31, 2019 and the year ended December 31, 2018:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven Months Ended
|
|
Year Ended
|
|
($ in millions)
|
|
July 31, 2019
|
|
December 31, 2018
|
|
Aon Benfield
|
|
$
|
4.4
|
|
|
40
|
%
|
|
$
|
6.9
|
|
|
21
|
%
|
|
Marsh & McLennan Companies, Inc.
|
|
3.3
|
|
|
30
|
%
|
|
11.6
|
|
|
35
|
%
|
|
Willis Towers Watson
|
|
1.8
|
|
|
16
|
%
|
|
8.7
|
|
|
26
|
%
|
|
All other brokers
|
|
1.6
|
|
|
14
|
%
|
|
6.0
|
|
|
18
|
%
|
|
Gross premiums written through brokers
|
|
11.1
|
|
|
100
|
%
|
|
33.2
|
|
|
100
|
%
|
|
Gross premiums not written through brokers
|
|
—
|
|
|
—
|
%
|
|
—
|
|
|
—
|
%
|
|
Total gross premiums written
|
|
$
|
11.1
|
|
|
100
|
%
|
|
$
|
33.2
|
|
|
100
|
%
|
The majority of our reinsurance premiums written included in the table above were derived from a quota share retrocessional reinsurance agreement with Sompo International pursuant to the BW Retrocessional Agreement. As illustrated, the majority of our reinsurance premiums written were sourced through a limited number of brokers, with Aon Benfield, Marsh & McLennan Companies, Inc. and Willis Towers Watson providing a total of 86% of our gross reinsurance premiums written for the seven months ended July 31, 2019. We were therefore highly dependent on these brokers and a loss of all or a substantial portion of the business provided by one or more of these brokers either to Sompo International or directly to us could have had a material adverse effect on our financial condition and results of operations. See "Risk Factors" contained in Item 1A herein.
Gross Premiums Written By Geographic Area of Risks Insured
We sought to diversify our exposure across geographic zones around the world in order to obtain a prudent spread of risk. The spread of these exposures is also a function of market conditions and opportunities.
The following table sets forth a breakdown of gross reinsurance premiums written by geographic area of risks insured for the seven month period ended July 31, 2019 and year ended December 31, 2018:
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|
|
|
|
|
|
|
|
Seven Months Ended
|
|
Year Ended
|
|
($ in millions)
|
|
July 31, 2019
|
|
December 31, 2018
|
|
Worldwide (1)
|
|
$
|
0.8
|
|
|
7
|
%
|
|
$
|
6.7
|
|
|
20
|
%
|
|
USA:
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|
|
|
|
|
|
|
|
|
|
Nationwide
|
|
4.7
|
|
|
42
|
%
|
|
13.5
|
|
|
40
|
%
|
|
Florida
|
|
0.1
|
|
|
1
|
%
|
|
4.2
|
|
|
13
|
%
|
|
Gulf region
|
|
—
|
|
|
—
|
%
|
|
0.5
|
|
|
2
|
%
|
|
California
|
|
0.1
|
|
|
1
|
%
|
|
0.3
|
|
|
1
|
%
|
|
Midwest region and other
|
|
—
|
|
|
—
|
%
|
|
0.5
|
|
|
2
|
%
|
|
Northeast
|
|
—
|
|
|
—
|
%
|
|
0.1
|
|
|
—
|
%
|
|
Asia
|
|
1.0
|
|
|
9
|
%
|
|
1.6
|
|
|
5
|
%
|
|
Australia
|
|
0.9
|
|
|
8
|
%
|
|
1.1
|
|
|
3
|
%
|
|
Canada
|
|
0.2
|
|
|
2
|
%
|
|
0.4
|
|
|
1
|
%
|
|
Europe
|
|
3.3
|
|
|
30
|
%
|
|
3.7
|
|
|
11
|
%
|
|
Worldwide, excluding U.S. (2)
|
|
—
|
|
|
—
|
%
|
|
0.6
|
|
|
2
|
%
|
|
Total gross premiums written
|
|
$
|
11.1
|
|
|
100
|
%
|
|
$
|
33.2
|
|
|
100
|
%
|
(1) "Worldwide" comprises reinsurance contracts that cover risks in more than one geographic area and do not specifically exclude the U.S.
(2) "Worldwide, excluding U.S." comprises reinsurance contracts that cover risks in more than one geographic area but specifically exclude the U.S.
CLAIMS MANAGEMENT
Claims are managed by the Manager pursuant to the Underwriting and Insurance Management Agreement and the Administrative Services Agreement. The Manager has access to Sompo International’s experienced, technical claims teams working closely with each of our operating subsidiaries. The Manager reviews and responds to initial loss reports, administers claims databases, identifies and handles coverage issues, determines whether further investigation is required and where appropriate, retains outside claims counsel, establishes case reserves and approves claims for payment. In addition, the Manager may conduct audits of our significant clients throughout the year, evaluating claims handling abilities, reserve philosophies, loss notification processes and the overall quality of our clients' performance.
Upon receipt, claims notices are recorded by the Manager within our underwriting, financial and claims systems. When we are notified of insured losses or discover potential losses as part of our claims audits, the Manager records a case reserve as appropriate for the estimated amount of the exposure at that time. The estimate reflects the judgment of the Manager based on general reserving practices, the experience and knowledge of the Manager regarding the nature of the specific claim and, where appropriate, advice of outside counsel. Reserves are also established to provide for the estimated expense of settling claims, including legal and other fees and the general expenses of administering the claims adjustment process.
RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
We are required by applicable laws and regulations and GAAP to establish reserves for losses and LAE that arise from our business. These reserves are balance sheet liabilities representing estimates of future amounts required to pay losses and LAE for insured or reinsured claims that have been incurred at or before the balance sheet date, whether already known to us or not yet reported. It is our policy to establish these losses and LAE reserves after evaluating all information known to us as of the valuation date. Actuarial services are provided to us by the Manager pursuant to the Underwriting and Insurance Management Agreement.
The Manager uses statistical and actuarial methods to make a reasonable estimate of ultimate expected losses and LAE. The period of time from the reporting of a loss to us and the settlement of our liability may be several years. During this period, additional facts and trends may be revealed. As these factors become apparent, estimated reserves will be adjusted, sometimes requiring an increase or decrease in our overall reserves, and at other times requiring a reallocation of incurred but not reported reserves to specific case reserves.
Reserves for losses and LAE are based in part upon the estimation of losses resulting from catastrophic events. Estimation of losses from catastrophic events is inherently difficult because of the infrequency and severity of large catastrophes. Therefore, we utilize commercially available models, historical reinsurance industry property catastrophe claims experience and other data and estimates provided by our clients to supplement our own historical claims experience for purposes of evaluating future trends and providing an estimate of ultimate claims costs on large catastrophes.
To assist us in establishing appropriate reserves for losses and LAE, we analyze a significant amount of insurance industry information with respect to the pricing environment, loss trends, and loss settlement patterns. In combination with our individual pricing analyses, this industry information is used to guide our loss and LAE estimates. These estimates are reviewed regularly, and adjustments, if any, are recorded in earnings in the periods in which they are determined. While management believes it has made a reasonable estimate of ultimate losses, there can be no assurance that our future losses and LAE will not exceed our current total reserves. For a description of the Company's current reserves, please refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Review of Orderly Run-Off and Loss and LAE" and Note 3, "Loss and LAE Reserve Movements" in the Notes to the Consolidated Financial Statements of the Company.
CONFLICTS OF INTEREST
There may be conflicts of interest that arise out of our relationship with Sompo International and the Manager. Our Chairman and CEO and our CFO are also employees of Sompo International and the Manager is wholly-owned by Sompo International. As a result, our officers, two of our directors and the Manager may have conflicts between their duties to us and their duties to, and interests in, Sompo International or other parties.
As part of our business model and strategy, we relied on affiliates of Sompo International for access to certain segments of the reinsurance market. In particular, pursuant to the BW Retrocessional Agreement, we have participated in: (i) retrocessional, quota share or other agreements in which Sompo International or its affiliates have an interest; and (ii) fronting arrangements with Sompo International. Although these transactions may have presented conflicts of interest, we nonetheless consummated these transactions.
Our business overlaps with portions of Sompo International’s business. The Manager, in addition to managing some of Sompo International’s accounts, manages other accounts that may compete with us, including other accounts affiliated with Sompo International. The Manager made available to us opportunities to enter into reinsurance contracts and insurance-linked securities and made investments that it determined were appropriate for us in accordance with its allocation policies and our underwriting guidelines. The Manager was not required to allocate any or all such opportunities to us. We understand that the Manager primarily allocated any overlapping opportunities on a proportional basis among the various accounts that they manage.
Service Agreements with Sompo International
We rely on the Manager for services that are essential to the operation of our business. The Manager is a wholly-owned subsidiary of Sompo International. As of December 31, 2019 Sompo International owned 33.2% of our outstanding Common Shares and had two representatives on our Board which consists of five directors.
The Manager manages our assets and has made all of our underwriting and investment decisions, subject to our underwriting guidelines and the oversight of the Board.
The Manager is not restricted in any way from sponsoring or accepting business or capital from new clients, insurance companies, funds or other accounts, including businesses that are similar to, or that overlap with, our business. Therefore, the Manager’s time and attention may be divided between us and other businesses.
See "The Manager" for detailed information concerning each of our service agreements with Sompo International.
REGULATION AND CAPITAL REQUIREMENTS
General
The business of insurance and reinsurance is regulated in most countries, although the degree and type of regulation varies significantly from one jurisdiction to another. Reinsurers are generally subject to less direct regulation than primary insurers. Blue Capital Re is regulated by the BMA.
Bermuda Regulation
The Insurance Act provides that no person may carry on an insurance business in or from within Bermuda unless registered as an insurer under the Insurance Act by the BMA. In deciding whether to grant registration, the BMA has broad discretion to act as it thinks fit in the public interest. The BMA is required by the Insurance Act to determine whether the applicant is a fit and proper body to be engaged in the insurance business and, in particular, whether it has, or has available to it, adequate knowledge and expertise. The registration of an applicant as an insurer is subject to the insurer complying with the terms of its registration and such other conditions as the BMA may impose at any time. The Insurance Act also grants to the BMA powers to supervise, investigate and intervene in the affairs of insurance companies.
The BMA has enacted various legislative and regulatory amendments to the Insurance Act to aid in Bermuda’s achievement of regulatory equivalence with that of the European Commission's Solvency II framework in relation to commercial insurance entities. Bermuda was awarded full equivalence for commercial insurers under Europe's Solvency II regime applicable to insurance companies, which regime came into effect on January 1, 2016. The Insurance Act now : (i) requires certain classes of insurers (including the Company) to maintain their head offices in Bermuda; (ii) requires insurers to notify the BMA, in addition to any increase, of any reduction or disposal of shares taking a shareholder controller below 10%, 20%, 33% or 50%; (iii) permits certain classes of insurers to submit condensed audited GAAP financial statements; and (iv) establishes the minimum criteria of matters of material significance whereby the approved auditor is required to provide written notice to the BMA of those matters that would impact the BMA’s discharge of its functions under the Insurance Act. The Insurance Returns and Solvency Regulations 1980 also now include the items and the content of the documents to be submitted as part of the required statutory financial returns for insurers carrying on special purpose business. The Insurance Act requires insurers and insurance groups to meet regulatory capital and reporting requirements on a statutory economic capital and surplus basis. All insurers are also required to implement corporate governance policies and processes as the BMA considers appropriate given the nature, size, complexity and risk profile of the insurer and all insurers, on an annual basis, are now required to deliver a declaration to the BMA confirming whether or not they meet the minimum criteria for registration. All Class 4, Class 3B and Class 3A insurers are required to produce and publish a Financial Condition Report on their website, or provide a copy to the public on request if they do not have a website, as part of its annual Bermuda Capital and Solvency Requirement. The Financial Condition Report provides particulars on the business performance, governance structure, risk profile, solvency valuation, and capital management of the insurer.
In January 2018, the BMA implemented a requirement for an alternative capital schedule to be filed for December 31, 2017 year-end filings and onwards. The Company is required to complete and file with the BMA this schedule with respect to any of its alternative capital structures. The BMA has confirmed that alternative capital is where insurers conduct business that is financed by a mechanism other than shareholders’ capital of the (re)insurance company. This may take various forms such as catastrophe (cat) bonds, industry loss warranties, sidecars, collateralized reinsurers, longevity and mortality bond/swaps, hybrid securities such as preference shares, swaps, and contingent capital such as letters of credit, among others. The filings are confidential, but the BMA may produce valuable aggregate statistics for publication from the information provided in the filings.
The Bermuda Insurance Code of Conduct (the "Bermuda Insurance Code"), which is a codification of best practices for insurers provided by the BMA, was also amended in 2015 and all insurers had to be in compliance by December 31, 2015. Substantive revisions to the Bermuda Insurance Code included a new requirement for the board of an insurer to ensure that its insurance manager is both fit and able to carry out its duties to ensure that the insurer operates in a prudent manner and a
clarification that only limited purpose insurers will be allowed to outsource the CEO and senior executive roles to an insurance manager.
Insurance Manager Code of Conduct
In 2016, the BMA implemented the Insurance Manager Code of Conduct, which establishes duties, requirements and compliance standards to be adhered to by all insurance managers registered under the Bermuda Insurance Act, including the procedure and sound principles to be observed by insurance managers. Insurance managers were required to implement the Insurance Manager Code of Conduct into their operations by December 31, 2016. Failure to comply with the requirements of the Insurance Manager Code of Conduct will be taken into account by the BMA in assessing whether the insurance manager has satisfied its requirement under the minimum criteria for registration to conduct its business in a prudent manner.
However, the BMA takes a proportionate approach to compliance, taking into consideration the nature, scale and complexity of an insurance managers’ business. The Manager is subject to the Insurance Manager Code of Conduct and is required to file annually prior to June 30 an annual return including management financial statements for the previous financial year and a business plan for the upcoming financial year, and a statutory declaration confirming its compliance with the Insurance Manager Code of Conduct.
The BMA utilizes a risk-based approach when it comes to licensing and supervising insurance and reinsurance companies. As part of the BMA’s risk-based system, an assessment of the inherent risks within each particular class of insurer or reinsurer is used to determine the limitations and specific requirements that may be imposed. Thereafter the BMA keeps its analysis of relative risk within individual institutions under review on an ongoing basis, including through the scrutiny of audited financial statements, and, as appropriate, meeting with senior management during onsite visits.
Regulation of Brokers and Agents
In addition to being registered as an insurance manager under the Insurance Act, the Manager is registered as an agent under the Insurance Act. Insurance brokers and insurance agents have historically been lightly regulated in Bermuda. However, in line with international standards in this space, the BMA has implemented more rigorous regulation. The Insurance Act has been amended to extend certain provisions to regulated insurance brokers and agents. These changes were effective of as December 31, 2018 and include that: (i) the BMA may make rules prescribing prudential standards in relation to insurance brokers and agents (which will include an annual report) and apply penalties for failure to file statutory returns; (ii) brokers and agents are required to maintain lists of insurers for which they act, (iii) brokers and agents are required to notify the BMA within 14 days of any change of shareholder controller or officer; and (iv) brokers and agents are required to have sufficient indemnity insurance cover. The BMA has provided a template annual reporting form and a draft Code of Conduct for insurance brokers and agents which establishes the duties, requirements and standards to be complied with by all insurance brokers and agents registered under Section 10 of the Insurance Act, including the procedures and sound principles to be observed by such persons.
The BMA has also mandated that insurance brokers and agents are annually required to file: (i) a return accompanied by a copy of the insurance broker or agent’s management accounts for the financial year and business plan for the next financial year; and (ii) a declaration signed by two directors (one of whom may be the chief executive officer) of the insurance broker or agent confirming that to the best of their knowledge and belief the information in the annual return is fair and accurate. Insurance brokers and agents, including the Manager, were required to comply with the Code of Conduct by June 30, 2019.
Regulatory Framework
The Insurance Act imposes solvency and liquidity standards on Bermuda insurance companies, as well as auditing and reporting requirements. Certain significant aspects of the Bermuda insurance regulatory framework are set forth below.
Classification of Insurers. The Insurance Act distinguishes between insurers (which term includes reinsurers) carrying on long-term business, general business (being everything except life, annuity and certain types of accident and health insurance) and special purpose business. There are six main general business classifications for insurers ranging from Class 1 (pure captives) to Class 4 (very large commercial underwriters), with Class 4 insurers being subject to the strictest regulation. There is only one classification of special purpose insurer, although special purpose insurers have been categorized effective as of December 31, 2018 into unrestricted special business insurers and restricted special purpose insurers. Insurers carrying on "restricted special purpose" business may only conduct special purpose business with specific insureds approved by the BMA. Insurers carrying on "unrestricted special purpose" can conduct special purpose business with any insureds. The Insurance Act also provides for other additional categories of insurers with limited licenses to encourage innovation in the insurance industry.
These include Class IGB insurers, meaning insurers carrying on general business in an innovative or experimental manner, and Class ILT insurers, meaning insurers carrying on long-term business in an innovative or experimental manner.
An entity such as Blue Capital Re is registrable as a Class 3A insurer when: (i) it intends to carry on general insurance business in circumstances where (a) 50% or more of the net premiums written or (b) 50% or more of the loss and loss expense provisions, represent unrelated business; and (ii) its total net premiums written from unrelated business are less than $50.0 million. Class 3A insurers are required to maintain fully paid-up share capital of $120,000.
Following the announcement of the Company's plan to pursue an orderly run-off, on October 25, 2019, the BMA amended Blue Capital Re's license to restrict it from entering into any new contracts of insurance or reinsurance without obtaining the prior written approval of the BMA.
Principal Representative, Head and Principal Office. Every registered insurer or reinsurer is required to maintain a principal office in Bermuda and to appoint and maintain a principal representative in Bermuda, subject to certain prescribed requirements under the Insurance Act. Further, any registered insurer that is a Class 3A insurer or above is required to maintain a head office in Bermuda and direct and manage its insurance business from Bermuda. The 2015 amendments to the Insurance Act provided that in considering whether an insurer satisfies the requirements of having its head office in Bermuda, the BMA may consider (i) where the underwriting, risk management and operational decision making occurs; (ii) whether the presence of senior executives who are responsible for, and involved in, the decision making are located in Bermuda; and (iii) where meetings of the board of directors occur. The BMA will also consider (i) the location where management meets to effect policy decisions; (ii) the residence of the officers, insurance managers or employees; and (iii) the residence of one or more directors in Bermuda. Additionally, the BMA may look to the location of the insurance manager for determining whether a head office is in Bermuda.
For the purpose of the Insurance Act, Blue Capital Re's principal office is the Company's executive offices at Waterloo House, 100 Pitts Bay Road, Pembroke HM 08, Bermuda. The Manager, a wholly-owned subsidiary of Sompo International has been appointed and approved as the principal representative for Blue Capital Re. The principal representative has statutory reporting duties under the Bermuda Insurance Act for certain reportable events, such as threatened insolvency or non-compliance with the Insurance Act or with a condition or restriction imposed on an insurer.
Where there has been a significant loss that is reasonably likely to cause a Class 3A insurer to fail to comply with its enhanced capital requirement (as described in more detail below), the principal representative must furnish the BMA with a capital and solvency return reflecting an enhanced capital requirement prepared using post-loss data. The principal representative must provide this within forty-five days of notifying the BMA of the loss.
In addition, where a notification has been made to the BMA regarding a material change to an insurer's business or structure (as described in more detail below), the principal representative has thirty days from the date of such notification to provide to the BMA unaudited interim statutory financial statements in relation to such period if so requested by the BMA, together with a general business solvency certificate in respect of those statements.
Loss Reserve Specialist. Generally, a Class 3A insurer is required to submit annually an opinion of its approved loss reserve specialist with its financial statements and return in respect of its loss and LAE provisions. However, an insurer may file an application under the Insurance Act to waive the aforementioned requirements. In this instance, Blue Capital Re has obtained such a waiver from the BMA.
Cancellation of Insurer’s Registration. The BMA may revoke or suspend Blue Capital Re’s license in certain circumstances, including circumstances in which: (i) false, misleading or inaccurate information has been supplied to the BMA by Blue Capital Re or on its behalf; (ii) we have ceased to carry on business; (iii) Blue Capital Re has persistently failed to pay fees due under the Insurance Act; (iv) Blue Capital Re has failed to comply with a condition attached to its registration or with an applicable requirement under the Insurance Act; (v) we are convicted of an offense against a provision of the Insurance Act; (vi) Blue Capital Re has, in the opinion of the BMA, not been carrying on business in accordance with sound insurance principles; or (vii) any of the minimum criteria for registration under the Insurance Act is not or will not have been fulfilled. If the BMA were to suspend or revoke Blue Capital Re’s license, we could lose our exemption under the U.S. Investment Company Act of 1940, as amended (the "Investment Company Act").
Annual Statutory Financial Statements and Return; Independent Approved Auditor. The Insurance Act generally requires all insurers to: (i) prepare annual statutory financial statements and returns; (ii) submit a declaration certifying compliance with the minimum criteria applicable to it including the minimum margin of solvency, enhanced capital requirements and any restrictions or conditions imposed on its license; and (iii) appoint an independent auditor who will annually audit and report on such financial statements and returns.
The independent auditor of the insurer must be approved by the BMA and may be the same person or firm that audits the insurer’s financial statements and reports for presentation to its shareholders. If the insurer fails to appoint an approved auditor or at any time fails to fill a vacancy for such auditor, the BMA may appoint an approved auditor for the insurer and shall fix the remuneration to be paid to the approved auditor. The approved auditor is required to issue written notice to the BMA of matters of material significance for the discharge of the BMA’s functions as established under the Insurance Act.
An insurer may file an application under the Insurance Act to have the requirement to file audited statutory financial statements annually with the BMA waived. In this instance, Blue Capital Re has obtained such a waiver from the BMA. However, Blue Capital Re is required to prepare and file annual condensed consolidated audited GAAP financial statements with the BMA.
Blue Capital Re’s independent auditor has been approved by the BMA.
Minimum Liquidity Ratio. The Insurance Act provides a minimum liquidity ratio and requires Blue Capital Re to maintain the value of its relevant assets at not less than 75% of the amount of its relevant liabilities. Relevant assets include, but are not limited to, cash and cash equivalents, investments, investment income due and accrued, accounts and premiums receivable, reinsurance balances receivable and funds held by ceding companies. Relevant liabilities include, but are not limited to, loss and LAE reserves, other liabilities, letters of credit and guarantees.
Minimum Solvency Margin. The Insurance Act provides that the value of the assets of an insurer must exceed the value of its liabilities by an amount greater than its prescribed minimum solvency margin.
The minimum solvency margin that must be maintained by a Class 3A insurer is the greatest of: (i) $1.0 million; (ii) 20% of net premiums written where such net premiums do not exceed $6.0 million and $1.2 million plus 15% of net premiums written where such net premiums exceed $6.0 million; (iii) 15% of net undiscounted aggregate loss and loss expense provisions and other insurance reserves; and (iv) 25% of that insurer’s enhanced capital requirement ("ECR").
An insurer may file an application under the Insurance Act to waive the aforementioned requirements. In this instance, Blue Capital Re has obtained such a waiver from the BMA so that its minimum solvency margin shall remain at $1.0 million at all times, provided that: (i) Blue Capital Re only enters into contracts of reinsurance that are fully-collateralized; and (ii) each transaction represents no material deviation from the original business plan filed with BMA at the time of Blue Capital Re’s registration.
ECR and Bermuda Solvency Capital Requirements ("BSCR"). Class 3A insurers are required to maintain available capital and surplus at a level equal to or in excess of the applicable ECR, which is established by reference to either the BSCR - Small and Medium-Sized Entities model or an approved internal capital model. Furthermore, to enable the BMA to better assess the quality of the insurer’s capital resources, a Class 3A insurer is required to disclose the makeup of its capital in accordance with its 3-tiered capital system.
An insurer may file an application under the Insurance Act to have the aforementioned ECR requirements waived. In this instance, Blue Capital Re has obtained such a waiver from the BMA and instead is required to submit a modified version of the BSCR model without an ECR.
Restrictions on Dividends and Distributions. In addition to the requirements under the Companies Act (as discussed below), the Insurance Act limits the maximum amount of annual dividends and distributions that may be paid or distributed by a Class 3A insurer without prior regulatory approval. However, the Insurance Act general limitations no longer apply to Blue Capital Re following the Company's decision to enter run-off and return capital to its shareholders which prompted the BMA to amend the license of Blue Capital Re to require it to obtain the written approval of the BMA prior to the declaration and/or payment of any dividends and/or the making of any capital contributions to Blue Capital Re’s parent, shareholders or affiliates.
The Companies Act also limits Blue Capital Re’s ability to pay dividends and make distributions to its shareholders. Blue Capital Re is not permitted to declare or pay a dividend, or make a distribution out of its contributed surplus, if it is, or would after the payment be, unable to pay its liabilities as they become due or if the realizable value of its assets would be less than its liabilities.
Reduction of Capital. Registered insurers may not reduce their total statutory capital by 15% or more, as set out in its previous year’s financial statements, unless they have received the prior approval of the BMA. Total statutory capital consists of paid in share capital, contributed surplus (sometimes called additional paid in capital) and any other fixed capital designated
by the BMA as statutory capital. In Blue Capital Re's case, the 15% limitation rule no longer applies following the amendment to Blue Capital Re's license requiring it to obtain the written approval of the BMA prior to the declaration of any return of capital to Blue Capital Re’s parent, shareholders or affiliates.
Supervision, Investigation and Intervention. The BMA may appoint an inspector to investigate the affairs of an insurer or a designated insurer (as detailed in "Group Supervision" below) if the BMA believes that an investigation is required in the interest of the insurer’s or insurance group’s policyholders or potential policyholders. In order to verify or supplement information otherwise provided to it, the BMA may direct an insurer or designated insurer to produce documents or information relating to matters connected with the insurer’s or insurance group’s business. Further, the BMA has the power to appoint a professional person to prepare a report on any aspect of any matter about which the BMA has required or could require information.
If it appears to the BMA that: (i) there is a risk of the insurer or designated insurer becoming insolvent; (ii) there is significant risk that the insurer will be unable to meet its policyholder obligations; (iii) the insurer or designated insurer is in breach of the Insurance Act; (iv) any conditions imposed upon its registration, or the minimum criteria stipulated in the Insurance Act are not or have not been fulfilled in respect of a registered insurer; (v) a person has become a Controller (which for this purpose means a managing director, chief executive or other person in accordance with whose directions or instructions the directors of the insurer are accustomed to act, including any person who holds 10% or more of the shares carrying rights to vote at any general meeting, or is entitled to exercise 10% or more of the voting shares or voting power or is otherwise able to exercise a significant influence over the management of the insurer) without providing the BMA with the appropriate notice or in contravention of a notice of objection; (vi) the registered insurer is in breach of its enhanced capital requirement; or (vii) a designated insurer is in breach of any provision of the Insurance Act or the regulations or rules applicable to it, the BMA may issue such directions as appear desirable for safeguarding the interests of policyholders or potential policyholders of the insurer or the insurance group. The BMA may also direct the insurer or designated insurer: (i) not to effect further contracts of insurance business; (ii) not to vary any insurance contract when the direction is given if the effect would be to increase the insurer’s liabilities; (iii) not to make any investments of a specified class; (iv) to realize any existing investments of a specified class; (v) to maintain in, or transfer to the custody of, a specified bank assets of the insurer that are specified in the direction; (vi) not to declare or pay any dividends or other distributions or to restrict the making of such payments; (vii) to limit its premium income; (viii) to remove a Controller or officer; or (ix) to file a petition for the winding-up of the insurer.
The BMA may also make rules prescribing prudential standards with which the insurer must comply. Blue Capital Re may make an application to be exempted from such rules.
Winding-up. The BMA may present a petition for the winding-up of an insurer on the grounds that: (i) the insurer is unable to pay its debts within the meaning of sections 161 and 162 of the Companies Act; (ii) the insurer has failed to satisfy an obligation to which it is or was subject by virtue of the Insurance Act; or (iii) the insurer has failed to satisfy the obligation imposed upon it by section 15 of the Insurance Act as to the preparation of accounts or to produce or file financial statements in accordance with section 17 of the Insurance Act, and that the BMA is unable to ascertain the insurer’s financial position. In addition, if it appears to the BMA that it is expedient in the public interest that an insurer should be wound up, it may present a petition for it to be so wound up if a court thinks it just and equitable for it to be so wound up.
Disclosure of Information. In addition to powers under the Insurance Act to investigate the affairs of an insurer, the BMA may require certain information from an insurer (or certain other persons) to be produced to it. The BMA has also been given powers to assist foreign regulatory authorities with their investigations involving insurance and reinsurance companies in Bermuda, subject to certain restrictions. For example, the BMA must be satisfied that the assistance being requested is in connection with the discharge of regulatory responsibilities of the foreign regulatory authority. Further, the BMA must consider whether cooperation with the foreign regulatory authorities is in the public interest. The grounds for disclosure by the BMA to a foreign regulatory authority without consent of the insurer are limited and the Insurance Act provides sanctions for breach of the statutory duty of confidentiality.
Bermuda Insurance Code. The Bermuda Insurance Code contains the duties, requirements and compliance standards to be adhered to by all insurers. The Bermuda Insurance Code stipulates that insurers are to develop and apply policies and procedures capable of assessment by the BMA. The board of directors of Blue Capital Re has the responsibility to ensure that Blue Capital Re is compliant with the Bermuda Insurance Code and is required to file annually a statutory declaration confirming compliance with the Bermuda Insurance Code.
Insurance Manager Code of Conduct. The Insurance Manager Code of Conduct establishes duties, requirements and compliance standards to be adhered to by all insurance managers registered under the Bermuda Insurance Act, including the procedure and sound principles to be observed by insurance managers. The Manager is subject to the Insurance Manager Code
of Conduct and is required to file annually prior to June 30 an annual return, and a statutory declaration confirming its compliance with the Insurance Manager Code of Conduct.
Group Supervision. The BMA may, in respect of an insurance group, determine whether it is appropriate for it to act as its group supervisor. An "insurance group" is defined as a group of companies that conducts exclusively, or mainly, insurance business.
None of the Company, Blue Capital Re or Blue Capital Re ILS is currently subject to group supervision, but the BMA may exercise its authority to act as our group supervisor in the future if we were to form an overseas entity.
Notifications to the BMA
Notification of Material Changes. All registered insurers are required to give notice to the BMA of their intention to effect a material change within the meaning of the Insurance Act. For the purposes of the Insurance Act, the following changes are material: (i) the transfer or acquisition of insurance business that is part of a scheme falling under section 25 of the Insurance Act or section 99 of the Companies Act; (ii) the amalgamation with or acquisition of another firm; (iii) engaging in unrelated business that is retail business; (iv) the acquisition of a controlling interest in an undertaking that is engaged in non-insurance business which offers services and products to persons who are not affiliates of the insurer; (v) outsourcing all or substantially all of our actuarial, risk management or internal audit functions; (vi) outsourcing all or a material part of an insurer’s underwriting activity; (vii) the transfer, other than by way of reinsurance, of all or substantially all of a line of business; (viii) the expansion into a material new line of business; (ix) the sale of an insurer; or (x) outsourcing of an officer role.
No registered insurer shall take any steps to give effect to a material change unless it has first served notice on the BMA that it intends to effect such material change and, before the end of 30 days, either the BMA has notified such company in writing that it has no objection to such change or the period has lapsed without the BMA having issued a notice of objection.
Before issuing a notice of objection, the BMA is required to serve upon the person concerned a preliminary written notice stating the BMA’s intention to issue a formal notice of objection. Upon receipt of the preliminary written notice, the person served may, within 28 days, file written representations with the BMA which shall be taken into account by the BMA in making its final determination.
Change of Shareholder Controller, Controller or Officer. In the event that the share capital of an insurer (or its parent) is traded on any stock exchange recognized by the BMA, then any shareholder must notify the BMA within 45 days of becoming a 10%, 20%, 33% or 50% shareholder of such insurer. Additionally, an insurer is also required to submit in writing to the BMA within 45 days, notification of a Shareholder Controller's (as defined in the Insurance Act) disposal or acquisition of shares whereby their proportion of voting rights held would reach or fall below 10%, 20%, 33% or 50%. An insurer or reinsurer must also provide written notice to the BMA that a person has become, or ceased to be, a Controller (as defined in the Insurance Act) of that insurer or reinsurer.
Blue Capital Re is also required to notify the BMA in writing in the event any person has become or has ceased to be a Controller or an officer of it, an officer being a director, chief executive or senior executive performing duties of underwriting, actuarial, risk management, compliance, internal audit, finance or investment matters.
In addition, the Manager, as an insurance manager licensed under the Insurance Act, is required to give written notice to the BMA of the fact of any person having become or ceased to be a shareholder controller or officer of the Manager within 14 days of the insurance manager becoming aware of the relevant facts related to such change.
Failure to give any required notice is an offense under the Insurance Act.
Certain Other Bermuda Law Considerations. Although the Company is incorporated in Bermuda, it is designated as non-resident for Bermuda exchange control purposes by the BMA. Pursuant to its non-resident status, the Company may engage in transactions in currencies other than Bermuda dollars, and there are no restrictions on the Company’s ability to transfer funds (other than funds denominated in Bermuda dollars) in and out of Bermuda.
Each of the Company, Blue Capital Re and Blue Capital Re ILS is incorporated in Bermuda as an "exempted company." Under Bermuda law, exempted companies are companies formed for the purpose of conducting business outside Bermuda from a principal place of business in Bermuda. As a result, they are exempt from Bermuda laws restricting the percentage of share capital that may be held by non-Bermudians, but they may not participate in certain business transactions, including: (i) the acquisition or holding of land in Bermuda (except that required for their business and held by way of lease or tenancy for a
term of not more than 50 years, or, with the consent of the Minister of Economic Development, that which is used to provide accommodations or recreational facilities for its officers and employees and is held by way of lease or tenancy for a term of not more than 21 years) without the express authorization of the Bermuda legislature; (ii) the taking of mortgages on land in Bermuda to secure an amount in excess of $50,000 without the consent of the relevant Ministers; (iii) the acquisition of any bonds or debentures secured by any land in Bermuda, other than certain types of Bermuda government securities; or (iv) the carrying on of business of any kind in Bermuda, except in furtherance of their business carried on outside Bermuda or under license granted by the Minister of Economic Development.
Blue Capital Re is a licensed insurer in Bermuda, and so it may carry on activities from Bermuda that are related to and in support of its insurance business. Effective as of January 1, 2019, the Insurance Act was amended to prohibit the entry into non-insurance business by both commercial and non-commercial insurers. However, all insurers will continue to be able to engage in non-insurance business where such business is ancillary to the insurance business carried on by the insurer.
Exempted companies, such as the Company, Blue Capital Re and Blue Capital Re ILS, must comply with Bermuda resident representation provisions under the Companies Act. Securities may be offered or sold in Bermuda only in compliance with the provisions of the Investment Business Act 2003 and the Exchange Control Act 1972 and related regulations of Bermuda which regulate the sale of securities in Bermuda. In addition, specific permission is required from the BMA, pursuant to the provisions of the Exchange Control Act 1972 and related regulations, for all issuances and transfers of securities of Bermuda companies, other than in cases where the BMA has granted a general permission. The BMA, in its policy dated June 1, 2005, provides that where any equity securities of a Bermuda company, which would include the Company’s Common Shares, are listed on an appointed stock exchange, general permission is given for the issue and subsequent transfer of any securities of the company from and to a non-resident, for as long as any equity securities of the company remain so listed.
Notwithstanding the above general permission, the Company has received permission from the BMA to issue, grant, create, sell and transfer freely any of our Common Shares, stock, bonds, notes (other than promissory notes), debentures, debenture stock, units under a unit trust scheme, shares in an oil royalty, options, coupons, rights and depository receipts to and among persons who are either resident or non-resident of Bermuda for exchange control purposes. The Company has applied for an additional permission to permit the free transferability of Common Shares once they are delisted from the New York Stock Exchange and the Bermuda Stock Exchange.
The Contracts (Rights of Third Parties) Act 2016 became operative in Bermuda on March 28, 2016 and permits third parties, who are expressly identified in a contract but not specifically party to such contract, to be entitled to enforce and benefit from the terms of the contract, subject to certain requirements. The Bermuda legislation closely resembles the existing UK rights of third parties legislation.
The Bribery Act 2016 (the "Bribery Act") became operative on September 1, 2017. The Bribery Act is largely based on the UK's Bribery Act 2010, and aims to provide a modern and comprehensive scheme of bribery offenses in order to allow investigators, prosecutors and the courts to tackle bribery effectively, whether committed in Bermuda or overseas. The Bribery Act applies to any Bermuda individuals, or incorporated companies or other corporate entities (including partnerships) conducting business, whether in or outside of Bermuda, and any non-Bermuda incorporated companies, corporate entities (including partnerships) or individuals conducting business in Bermuda. The Company and its Bermuda subsidiaries have reviewed the Bribery Act and have in place a comprehensive Anti-Bribery Policy.
The Companies and Limited Liability Company (Beneficial Ownership) Amendment Act 2017, Exchange Control Amendment Act 2018 and the Partnership, Exempted Partnerships and Limited Partnership (Beneficial Ownership) Amendment Act 2018 came into operation on March 23, 2018, and created a requirement for entities (that are not exempt) to maintain and file a register of beneficial ownership with the BMA. There was a six-month transition period for this legislation, which has been further extended, and entities were required to have a beneficial ownership register in place by February 28, 2019. The BMA has confirmed that regulated entities (e.g. insurers registered under the Insurance Act) and listed-entities and their subsidiaries are exempt and do not need to maintain a beneficial ownership register. Therefore, no further action is required by the Company or its Bermuda subsidiaries in respect of the beneficial ownership requirements.
The Economic Substance Act 2018 and the Economic Substance Regulations 2018 (the "ESA") came into effect on December 31, 2018, and apply to all Bermuda registered companies, limited liability companies and partnerships with separate legal personality engaged in relevant activities. Existing Bermuda entities had until June 30, 2019 to comply. The ESA provides that all registered entities (which includes Bermuda companies, limited liability companies and partnerships that have elected to have separate legal personality) engaged in relevant activities must maintain a substantial economic presence in Bermuda. A relevant activity is defined in the ESA as "banking, insurance, fund management, financing, leasing, headquarters, shipping, distribution and service centre, intellectual property and holding entities". For companies registered under the Insurance Act as commercial insurers which already have a substantive economic connection to Bermuda, the ESA will mean little change in
practice other than the filing of an annual economic substance declaration six months after their fiscal year end. With respect to holding companies, an entity engages in business as a holding company if it is a "pure equity holding entity". An entity is a "pure equity holding entity" if it is an entity which as its primary function acquires and holds shares or an equitable interest in other entities, performs no commercial activity and which: (a) holds the majority of the voting rights in another entity; (b) is a shareholder, member or partner in another entity and has the right to appoint or remove a majority of the board of directors, managers or equivalent of that other entity; or (c) is a shareholder, member or partner in another entity and controls alone, under an agreement with others, a majority of the voting rights in that other entity. The ESA specifies that holding entities only need to meet the minimum substance requirements, which means compliance with the Companies Act 1981, as amended, the filing of an annual economic substance declaration, and confirmation that such holding companies have "adequate employees for holding and managing equity participations and adequate premises in Bermuda". The term "adequate" is not defined in the ESA. However, it is defined in the Guidance Notes on the ESA issued by the Minister of Finance, which state that "adequacy" has its ordinary dictionary meaning, which means "enough or satisfactory for a particular purpose". What will be adequate for each registered entity to comply with the ESA will depend on the particular facts of the registered entity and relevant activity having regard to the nature, scale, and complexity of the registered entity and/or the relevant activity undertaken. The Company has confirmed in its annual filings that it is a holding company and, as it has a year-end of December 31, will need to file an economic substance declaration by June 30, 2020 confirming that it complies with the ESA.
EMPLOYEES
We do not have any employees. Our CEO and CFO are employees of Sompo International and they provide us with these services pursuant to the Administrative Services Agreement and Investment Management Agreement.
We do not have the staff or capability to manage our underwriting or investment practices within our organization. Instead, we have outsourced these functions to the Manager, subject to oversight by our CEO, our CFO and the Board. As a result, the performance of the Manager is critical to our business.
INTELLECTUAL PROPERTY
There are no aspects of our business that require a patent, trademark or copyright. We do not own any patent, trademark or copyright. Sompo International owns the registered Blue Capital® trademark and we have entered into a trademark license agreement with Sompo International providing for a royalty-free license of this trademark. Under the terms of the trademark license agreement, we generally must indemnify Sompo International and its affiliates, directors, officers, employees, agents, successors and permitted assigns for, from and against losses: (i) on account of any third-party claim or proceeding arising out of the performance of the trademark license agreement; or (ii) from any breach of, or failure to perform, any covenant or obligation of ours contained in the trademark license agreement.
IMPLICATIONS OF BEING A SMALLER REPORTING COMPANY
We qualify as a "smaller reporting company" as defined in Item 10(f) of Regulation S-K of the Securities Act of 1933. As a result, we are eligible to take advantage of scaled disclosure requirements and financial reporting requirements made available in Regulation S-K for smaller reporting companies and Article 8 of Regulation S-X. These scaled disclosure requirements include, but are not limited to:
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Selected financial data, under Regulation S-K, Item 301 is not required;
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No requirement to provide supplementary financial information, under Regulation S-K, Item 302;
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Financial statement schedules, under Regulation S-X, Article 12 are not required;
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Item 8. Financial Statements and Supplementary Data and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations are only required to present two years rather than three years of financial results;
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No risk factors required to be disclosed in filings under the Securities Exchange Act of 1934, as amended (the "Exchange Act").
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We intend to take advantage of some, but not all, of the scaled disclosure requirements available to smaller reporting companies. Accordingly, the information contained herein may be different from the information you receive from other public companies in which you invest.
We will continue to qualify to be a smaller reporting company provided we meet the following criteria (i) Public float of less than $250 million; or (ii) Less than $100 million of annual revenues and no public float, or public float of less than $700 million. In addition, we are deemed to be a "non-accelerated filer," effective as of the end of the 2019 fiscal year as defined under the Exchange Act having previously qualified as an "accelerated filer," in previous filings. As a result we are subject to the requirements that apply to non-accelerated filers, including the timing of the filing of periodic reports. Now that we are no longer an accelerated filer we are no longer subject to the requirement that accelerated filers provide the auditor's attestation of management's assessment of internal control over financial reporting required by Section 404(b) of the Sarbanes-Oxley Act of 2002.
AVAILABLE INFORMATION
We are subject to the informational reporting requirements of the Exchange Act. In accordance therewith, we file reports, proxy statements and other information with the U.S. Securities and Exchange Commission (the "SEC"). These documents are electronically available at www.bcapre.bm and www.sec.gov at the same time they are filed with or furnished to the SEC. In addition, our Code of Conduct and Ethics as well as the various charters governing the actions of certain of our Committees of the Board, including our Audit Committee and our Compensation and Nominating Committee ("Compensation Committee") charters, are available at www.bcapre.bm. Updates to, as well as waivers of, our Code of Conduct and Ethics will also be made available on our website. Our website is not part of this Annual Report on Form 10-K and nothing from our website shall be deemed to be incorporated into this report.
We will provide to any shareholder, upon request and without charge, copies of these documents (excluding any applicable exhibits unless specifically requested). Requests should be directed to Investor Relations, Blue Capital Reinsurance Holdings Ltd., Suite No. 784, 48 Par-la-ville Road, Hamilton, Bermuda HM 11, telephone (441) 278-0988 or investorrelations@sompo-intl.com. All such documents are also physically available at our principal office at Waterloo House, 100 Pitts Bay Road, Pembroke HM 08, Bermuda.
Item 1A. Risk Factors
Before investing in any of our securities, you should carefully consider the following risk factors and all other information set forth in this Form 10-K. These risks could materially affect our business, run-off performance or financial condition and could cause the trading price of our securities to decline. You could lose all or part of your investment. The headings used in this section are solely to aid the reader as to general categories of risks related to investing in the Company. Many of the risk factors listed apply to more than one category or to the Company generally. Accordingly, the headings used in this section should not be construed as limiting in any manner the general applicability of any of the risk factors included in this section. Additional risks not presently known to us or that we deem immaterial may also impair our business or run-off performance.
UNDERWRITING RISKS
As a catastrophe reinsurer, we are particularly vulnerable to losses from catastrophes.
We are exposed to claims arising out of catastrophes on our business in run-off. Catastrophes can be caused by various unpredictable events, including earthquakes, hurricanes, hailstorms, severe weather, floods, fires, tornadoes, volcano eruptions, explosions and other natural or man-made disasters. Many scientists believe that the earth’s atmospheric and oceanic temperatures are increasing and that, in recent years, changing climate conditions have increased the unpredictability, severity and frequency of natural disasters in certain parts of the world.
The global geographic distribution of our business has subjected us to catastrophe exposure for natural events occurring in a number of areas throughout the world, including, but not limited to, windstorms in the United Kingdom and continental Europe, hurricanes in Florida, the Gulf Coast and the Atlantic coast regions of the United States, typhoons and earthquakes in Japan, New Zealand, Australia and other parts of Southeast Asia, earthquakes in California and the Pacific Northwest and New Madrid region of the United States, wildfires in the forested regions of the United States, Canada and Australia and hail, tornado and flooding in the Midwestern United States. From time to time, we may have had greater exposures in one or more of these geographic areas than our overall share of the worldwide market might suggest. Accordingly, when and if catastrophes have occurred in these areas, we may have experienced relatively more severe negative results from such events than our competitors.
The estimation of reserves related to catastrophic events can be affected by the inability to access portions of the affected areas, the complexity of factors contributing to the losses, legal and regulatory uncertainties and the nature of the information available to establish the reserves. Complex factors include but are not limited to: determining whether damage was caused by flooding versus wind; evaluating pollution exposures; estimating additional living expenses; the impact of demand surge; infrastructure disruption; fraud; the effect of mold damage; business interruption costs; and reinsurance collectability. The timing of a catastrophe’s occurrence, such as at or near the end of a reporting period, can also affect the information available to us in estimating reserves for that reporting period. The estimates related to catastrophes are adjusted as actual claims emerge and additional information becomes available.
The Manager has managed some of our key quantifiable risks using a combination of proprietary risk management models and systems, various third-party models and its underwriting judgment. The models utilized by the Manager have helped it to control risk accumulation, to inform our management and to improve our risk/return profile; however, these models may prove to be inaccurate and may understate our exposures and loss reserves.
Profitability may be adversely impacted by inflation.
The effects of inflation could cause the cost of claims from catastrophes or other events to rise in the future. Our reserve for losses and LAE includes assumptions about future payments for settlement of claims and claims handling expenses. To the extent inflation causes these costs to increase above reserves established for these claims, we will be required to increase our loss reserves with a corresponding reduction in our net income in the period in which the deficiency is identified.
We are subject to institutional credit risk that may adversely affect our business because we do business with institutions such as brokers, banks, custodians and other counterparties.
In the event of the insolvency of the institutions, including brokers, banks, custodians and other counterparties, with which we do business, or to which our assets have been entrusted, we may be temporarily or permanently deprived of the assets held by or entrusted to that institution, which may affect our performance.
In accordance with industry practice, we frequently pay amounts owed on claims under our reinsurance contracts to brokers, and these brokers, in turn, pay these amounts to the clients that have purchased reinsurance from us. If a broker fails to make such a payment, in a significant majority of business that we write, it is highly likely that we will be liable to the client for the deficiency because of local laws or contractual obligations, notwithstanding the broker’s obligation to make such payment. Likewise, when the client pays premiums for these policies to brokers for payment over to us, these premiums are considered to have been paid and, in most cases, the client will no longer be liable to us for those amounts, whether or not we have actually received the premiums. Consequently, we assume a degree of credit risk associated with brokers around the world with respect to most of our reinsurance business. To date we have not experienced any losses related to such credit risks.
We rely on information provided by cedants and brokers in determining whether amounts are due following the occurrence of a covered event.
The determination of whether amounts are due following the occurrence of a covered event is typically based on reports and may be based upon information provided by cedants, brokers or an independent source, such as an index. If any of this information or data is incomplete, not genuine or inaccurate, our performance may be adversely affected as we run-off the Company.
The effects of emerging claim and coverage issues on our business are uncertain.
As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either broadening coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until sometime after we have issued reinsurance contracts that are affected by the changes. As a result, the full extent of liability under our reinsurance contracts may not be known for several years after a contract is issued. For example, an emerging claim and coverage issue is a growing trend of plaintiffs targeting property and casualty insurers relating to claims-handling practices in the adjustment of losses relating to natural disasters.
We may also be deemed liable for losses arising out of a matter that we had not anticipated or had attempted to contractually exclude. Moreover, irrespective of the clarity and inclusiveness of reinsurance contract language, there can be no assurance that a court or arbitration panel will limit enforceability of reinsurance contract language or not issue a ruling adverse to us. The effects of these and other unforeseen emerging claim and coverage issues are extremely hard to predict and could have a material adverse effect on our financial condition or run-off performance.
OPERATING RISKS
We do not have any employees of our own, and we depend on service providers to perform substantially all of our executive, administrative and other functions, and termination of any of these relationships may materially disrupt our business.
We do not have any employees of our own. Our CEO and our CFO are employees of Sompo International and their services are provided to us through the Investment Management Agreement and Administrative Services Agreement.
Our CEO is the President and CEO of the Manager, the CFO of Sompo International and does not dedicate all of his time to running our business and is not required to dedicate any specific amount of time to running our business. As a result of his other obligations, our CEO may not be able to dedicate as much time to running our business as would a typical CEO, and he may face conflicts of interest that may make it difficult for him to operate our business.
Our CFO also serves as the Controller and Vice President of Sompo International and is the Treasurer of the Manager, and, therefore, does not dedicate all of his time to running our business and is not required to dedicate any specific amount of time to running our business. As a result of his other obligations, our CFO is not able to dedicate as much time to running our business as would a typical CFO, and he may face conflicts of interest that may make it difficult for him to operate our business.
We rely on service providers to perform many of our executive, administrative and other functions. In particular, affiliates of Sompo International provide us with accounting, legal, internal audit, administrative and other services that are integral to our
day-to-day operations. Failure by any service provider, whether or not an affiliate of Sompo International, to carry out its obligations to us in accordance with the terms of its agreement or to perform its obligations to us as a result of insolvency, bankruptcy or other causes could make it difficult, or in some cases impossible, for us to operate our business. In addition, the termination of any of these service relationships or any delay in appointing or finding a suitable replacement provider (if one exists) could make it difficult for us to operate our business.
Our Chairman and CEO, CFO and the officers of the Manager are compensated by Sompo International.
Our Chairman and CEO, CFO and the officers of the Manager are employees of Sompo International and are compensated by Sompo International, including through membership in Sompo International’s incentive compensation plans. As a result, they may, consciously or unconsciously, favor Sompo International in dealings among us, Sompo International and the Manager.
We rely on the Manager for services that are essential to the operation of our business, and the loss of the Manager would make it difficult to operate our business.
The Manager manages our assets, subject to our underwriting guidelines and the oversight of the Board. Because we have no full-time employees, we are not able to manage our assets without the benefit of the services of the Manager, which has significant discretion as to the management of such assets.
The Manager provides underwriting services to Blue Capital Re, including loss control, claims, actuarial and administrative support services. Because we do not have any employees of our own, we cannot implement our run-off strategy without the benefit of these services, and the Manager has significant discretion as to our underwriting services with the oversight of the Board.
In the event that these services were to cease to be available from the Manager, we would be required to replace the Manager with one or more third-parties or to hire employees. In addition, the performance of the Manager depends heavily on the experience and availability of a limited number of individuals, all of whom are affiliated with Sompo International. Any loss of these individuals, for example, to death, incapacity, termination or resignation, could adversely affect the performance of the Manager. We cannot assure you that we could find a suitable replacement for the Manager quickly or at all, and any replacement may increase our expenses. The loss of the Manager could materially impair our ability to successfully operate our business.
We are dependent on Sompo International and if Sompo International were to experience difficulties, we could be materially adversely affected.
Since the Manager is an affiliate of Sompo International, and our CEO and CFO are both employees of Sompo International, if Sompo International’s business were to experience difficulties, the attention and time of Sompo International’s management would likely be directed to dealing with those difficulties. In these circumstances, there may not be sufficient management attention to our business, and our operations could suffer. It may be difficult, costly or time-consuming to replace the Manager or the other services Sompo International provides.
There may be conflicts of interest that result from our relationships with Sompo International and the Manager, which could result in decisions that are not in the best interests of our shareholders.
There may be conflicts of interest that arise out of our relationship with Sompo International and the Manager. Our Chairman, CEO and CFO are employees of Sompo International. In addition, the Manager is wholly-owned by Sompo International. As a result, our officers, our directors or the Manager may have conflicts between their duties to us and their duties to, and interests in, Sompo International or other parties.
The officers and employees of the Manager devote as much time to us as the Manager deems appropriate. However, these officers and employees may have conflicts in allocating their time and services among us, Sompo International, affiliates of Sompo International and other accounts. During turbulent conditions in the reinsurance industry or other times when we need focused support and assistance from the Manager, Sompo International and entities affiliated with Sompo International will likewise require greater focus and attention, placing the Manager’s time and resources in high demand. In this situation, we
may not receive the support and assistance we require or would otherwise receive if we were completely internally managed or if the Manager did not act as a manager for other entities. Although we believe the Manager has established appropriate procedures to manage any actual or potential conflicts of interest, these procedures do not provide assurance that such conflicts will be avoided.
The agreements from which the Manager’s compensation is derived may not be as favorable to us as if they had been negotiated with an unaffiliated third-party.
Neither the Investment Management Agreement nor the Underwriting and Insurance Management Agreement was negotiated between unaffiliated third-parties, and these agreements may not be as favorable to us as if they had been negotiated with an unaffiliated third-party and may be costly and difficult to terminate.
The Investment Management Agreement that we have entered into with the Manager was negotiated between related parties, and although approved by the Board, its terms, including fees payable, may not be as favorable to us as if this agreement had been negotiated with an unaffiliated third-party. Various potential and actual conflicts of interest may arise from the activities of the Manager by virtue of the fact that the Manager is controlled by Sompo International.
Similarly, the Underwriting and Insurance Management Agreement that we and Blue Capital Re have entered into with the Manager was negotiated between related parties, and although approved by the Board, its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third-party. Various potential and actual conflicts of interest may arise from the activities of the Manager by virtue of the fact that the Manager is controlled by Sompo International. The Manager does not assume any responsibility other than provision of the services called for under the Underwriting and Insurance Management Agreement.
We generally may not terminate either the Investment Management Agreement or the Underwriting and Insurance Management Agreement other than at three year intervals, whether or not the Manager’s performance is satisfactory, and under certain circumstances we will have to pay a termination fee if either the Investment Management Agreement or the Underwriting and Insurance Management Agreement is terminated or not renewed. We may not amend or modify any provision of either the Investment Management Agreement or the Underwriting and Insurance Management Agreement without the prior written consent of the Manager.
Under both the terms of the Investment Management Agreement and the terms of the Underwriting and Insurance Management Agreement, the Manager (and any person to whom the Manager has delegated or sub-contracted any of its functions) will not be liable for any losses except to the extent such losses are determined to be the direct result of an act or omission of the Manager that constitutes gross negligence, fraud, dishonesty or willful misconduct of the Manager.
In addition, we generally must indemnify the Manager and its affiliates, directors, officers, employees, agents, successors and permitted assigns for, from and against losses: (i) arising out of or relating to any demand, charge or claim in respect of acts, omissions, transactions, duties, obligations or responsibilities; or (ii) arising out of any acts or omissions by us arising out of the Investment Management Agreement or the Underwriting and Insurance Management Agreement, as applicable, of the Manager and its affiliates, directors, officers, employees, agents, successors and permitted assigns.
As a Bermuda company, we may be unable to attract and retain employees.
We do not have any employees of our own. If we were to hire any employees in the future, they would likely be employed in Bermuda. We also rely on services from other Bermuda companies, including the Manager. It may be difficult for us or the Manager to attract and retain experienced personnel in Bermuda, particularly if we are unable to secure Bermuda work permits for our personnel or if the Manager’s personnel are unable to secure Bermuda work permits. In addition, Bermuda is a highly competitive location for qualified staff, especially in the reinsurance and insurance industry, making it harder to attract and retain employees. As the successful run-off of our business depends on our, and the Manager’s, ability to hire and retain personnel, any future difficulties in hiring or retaining personnel in Bermuda or elsewhere could adversely affect our business.
We cannot assure you that any liquidating distribution will be made to our shareholders or, if made, the exact amount or timing of distributions.
Our winding up and liquidation process will be subject to uncertainties. It is possible that there will be no liquidating distribution made to our shareholders. The amount and timing of any liquidating distribution to our shareholders will depend on the following factors, among others:
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whether any potential claimants against us and currently unknown to us could present claims relating to our prior operations that we may ultimately have to satisfy;
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the payment of expenses to be incurred for the operation of the business through our winding-up and liquidation;
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the costs we may have to incur to defend claims, including possible claims against us relating to our winding up and ultimate liquidation;
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the amounts that we will need to pay for general administrative and overhead costs and expenses prior to our ultimate liquidation;
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the revenues that we will receive from investment income earned on collateral supporting our insurance liabilities and premiums from reinsurance treaties;
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the costs attendant on us as a publicly held reporting company under SEC regulations, including legal and auditing fees, during the period we are obligated to continue preparing and filing our annual, quarterly and current reports;
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how much of our funds we will be required to reserve to provide for contingent liabilities, and how long it may take to finally determine whether and how much of those liabilities may have to be paid.
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our dependence on regulatory approvals for special distributions.
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We will continue to incur expenses that will reduce any amounts available for distribution to our shareholders.
Claims, liabilities and expenses from operations will continue to be incurred by us as we wind down. While we have estimated future expenses and wind up costs as part of adopting the liquidation basis of accounting, these estimates are subject to significant uncertainty and actual costs may exceed these estimates. These expenses will reduce the amount of funds available for distribution to our shareholders.
We may be subject to litigation, which is expensive and could divert our attention.
We may be subject to litigation in connection with our winding-up and liquidation. Litigation against us could result in substantial costs and divert our management's attention from the winding-up and liquidation, which could decrease the amount available for distribution to our shareholders.
Our Board may abandon implementation of the winding-up and liquidation of the Company.
Our board of directors has the right to abandon the winding-up and liquidation prior to its completion. While our board of directors does not currently intend to do so, it will do so if it determines, based on intervening circumstances, that it is not in the best interest of the Company and its shareholders to continue with the winding-up and liquidation.
Further, our board of directors has the right to abandon the winding-up upon the receipt of an offer from a third party to purchase the Company. Upon receipt of an offer to purchase the Company, we would seek shareholder approval prior to consummating any such sale.
Operational risks, including the risk of fraud and any errors and omissions, are inherent in our business and could have a material adverse impact on our business or run-off performance.
Operational risks that are inherent in our business can result in financial losses, including those resulting from fraud or errors and omissions by any employees or by our third-party service providers, including the Manager. Although we believe that we have established appropriate controls and mitigation procedures to prevent significant fraud, errors and omissions and other potential irregularities from occurring, these controls and procedures do not provide absolute assurance as to the absence and mitigation of these risks.
Technology breaches or failures, including, but not limited to, those resulting from a malicious cyber attack on us, the Manager or our third-party service providers, could disrupt or otherwise negatively impact our business.
We, the Manager and our third-party service providers rely on information technology systems to process, transmit, store and protect the electronic information, financial data and proprietary models that are critical to our business. Furthermore, a significant portion of the communications between us, the Manager and our third-party service providers depends upon information technology and electronic information exchange. The information technology systems of the Manager and our third-party service providers are vulnerable to data breaches, interruptions or failures due to events that may be beyond their control, including, but not limited to, natural and man-made disasters, theft, terrorist attacks, computer viruses, hackers and general technology failures.
Any information technology systems that we may develop in the future would also be vulnerable to these same risks. Despite safeguards we and our service providers may take to protect the information systems that we rely on, disruptions to and breaches of such information technology systems are possible and may negatively impact our business, including our reputation in the insurance and reinsurance marketplace.
It is possible that insurance policies we have in place would not entirely protect us in the event that we were to experience a breach, interruption or widespread failure of the information technology systems we rely on. Furthermore, we have not secured insurance coverage designed to specifically protect us from an economic loss resulting from such an event.
Although we have never experienced any known or threatened cases involving unauthorized access to the information technology systems we rely on or unauthorized appropriation of our data contained within such systems, we cannot assure you that such technology breaches will not occur in the future.
As part of the winding-up and liquidation, we intend to delist our common shares from the New York Stock Exchange and the Bermuda Stock Exchange prior to March 31, 2020 and terminate the registration of our common shares and suspend our reporting obligations under the Securities Exchange Act of 1934, as amended, shortly thereafter. The delisting from the New York Stock Exchange and the termination of the registration of our common shares would likely cause the liquidity and market price of our common shares to decline.
Our common shares currently trade on the New York Stock Exchange under the symbol BCRH and on the Bermuda Stock Exchange under the symbol BCRH.BH. As part of the winding-up and liquidation, we intend to delist our common shares from the New York Stock Exchange and the Bermuda Stock Exchange prior to March 31, 2020 and terminate the registration of our common shares and suspend our reporting obligations under the Securities Exchange Act of 1934, as amended, shortly thereafter. If we delist our common shares from the New York Stock Exchange and Bermuda Stock Exchange and terminate the registration of our common shares under the Securities Exchange Act of 1934, as amended, it could potentially impair the liquidity of our common shares, not only in the number of common shares that could be bought and sold at a given price, which might be depressed by the relative illiquidity, but also through delays in the timing of transactions and the potential reduction in media coverage. As a result, an investor might find it more difficult to dispose of our common shares and the market price of our common shares may decline.
As a result of the plan for an orderly run-off and liquidation, certain institutional shareholders may be required to sell their shares of our common stock.
Upon the adoption of the plan for an orderly run-off and liquidation, the governing documents of certain of our institutional investors may prohibit them from holding shares of our common stock. If that were to be the case, such institutional investors would be required to divest of the shares of our common stock they hold which would create downward pressure on the trading price of our Common Shares. If this were to occur, shareholders who sell shares of common stock prior to the completion of the liquidation may receive less than shareholders who receive all liquidating distributions ultimately made.
If actual claims exceed our reserve for losses and LAE, our financial condition and run-off performance could be adversely affected.
Our success depends upon our ability to accurately assess the risks associated with the businesses that we reinsure. We establish loss reserves to cover our estimated liability for the payment of all losses and LAE incurred with respect to premiums
earned on the policies that we write. Loss reserves do not represent an exact calculation of liability. Rather, our loss and LAE reserves are estimates of what we expect the ultimate settlement and administration of claims will cost. These estimates are based upon actuarial and statistical projections and on our assessment of currently available data, as well as estimates of future trends in claims severity and frequency, judicial theories of liability and other factors. Loss reserve estimates are refined continually in an ongoing process as experience develops and claims are reported and settled. Establishing an appropriate level of loss reserves is an inherently uncertain process. Moreover, these uncertainties are greater for companies like us than for those with a longer operating history because we do not yet have an extensive loss history. Because of this uncertainty, it is possible that our reserves at any given time will prove inadequate.
To the extent we determine that actual losses and LAE exceed our expectations and loss reserves recorded in our financial statements, we will be required to increase our reserve for losses and LAE. This could cause a material reduction in our capital available for return to shareholders.
We are subject to loss settlements made by ceding companies and fronting carriers, which could materially adversely affect our performance.
Where Blue Capital Re entered into reinsurance contracts, all loss settlements made by a ceding company, provided they are within the terms of the underlying policies and within the terms of the relevant contract, will be unconditionally binding upon us. While we believe that the ceding companies will settle such claims in good faith, we are bound to accept the claims settlements agreed to by the ceding companies. Under the underlying policies, each ceding company bears the burden of proving that a contractual exclusion applies to a loss, and there may be circumstances where the facts of a loss are insufficient to support the application of an exclusion. In such circumstances, we assume such losses under the reinsured policies, which could materially adversely affect our performance.
Operational risks, including systems or human failures, are inherent in business, including ours, and could adversely affect our financial condition and run-off performance.
We are subject to operational risks including fraud, employee errors, failure to document transactions properly or to obtain proper internal authorization, failure to comply with regulatory requirements or obligations under our agreements, information technology failures, or external events. Losses from these risks may occur from time to time and may be significant.
While we and our Manager has implemented disaster recovery and other business continuity plans, a defect or failure in our internal controls or information technology systems could result in higher than expected losses, management distraction, or harm to our operations. We believe appropriate controls and mitigation procedures are in place to prevent significant risk of defect in our internal controls and information technology systems, but internal controls provide only reasonable, not absolute, assurance as to the absence of errors or irregularities and any ineffectiveness of such controls and procedures could have a material adverse effect on the run-off of our business.
LEGAL AND REGULATORY RISKS
Regulatory restrictions on dividends and the return of capital may impact our ability to fund special distributions to shareholders.
In order to distribute capital to our shareholders when it becomes available after the settlement of existing liabilities and expenses, the Company will be reliant on the ability of Blue Capital Re to dividend adequate funds to the Company. After October 25, 2019, Blue Capital Re may not pay any dividend to the Company without prior approval from the BMA. We cannot offer any assurance that we will receive such approval from the BMA. Absent receipt of dividends from Blue Capital Re, the Company’s ability to make distributions to the Company’s shareholders may be prevented or delayed.
CORPORATE RISKS
Sompo International has substantial control over us, which limits your ability to influence corporate matters and may result in conflicts of interest.
Sompo International currently has a 33.2% interest in the Company and therefore exerts considerable influence over matters presented to our shareholders for approval, including the election of directors and change of control transactions. Sompo International has the right to nominate two out of our five directors (or, if the Board consists of more than five directors, no less than 40% of the total Board seats at any given time), until the later of the date on which: (i) Sompo International sells any of its Common Shares; and (ii) Sompo International owns less than 5% of our Common Shares. This control may delay, deter or prevent acts that would be favored by our other shareholders, as the interests of Sompo International may not always coincide with the interests of our other shareholders. In particular, Sompo International has interests in us by virtue of our contracts with the Manager (see "Conflicts of Interest" contained in Item 1 herein for a description of these contracts). Sompo International may seek to cause us to take courses of action that, in its judgment, could enhance its interests or its investment in us, but which might involve risks to our other shareholders or adversely affect us or our other shareholders. In addition, this concentration of share ownership may adversely affect the trading price of our Common Shares because investors may perceive disadvantages in owning shares in a company with a significant shareholder.
Future sales or the possibility of future sales of a substantial amount of our Common Shares may depress the price of our shares.
Sompo International currently owns 2,917,032 Common Shares, representing 33.2% of our total outstanding Common Shares. These Common Shares may be sold into the market in accordance with Rule 144 under the Securities Act. In addition, Sompo International has the ability to require us to register the Common Shares it holds pursuant to a shareholder and registration rights agreement.
Our bye-laws and provisions of Bermuda law may impede or discourage a change of control transaction, which could deprive our investors of the opportunity to receive a premium for their Common Shares.
Our bye-laws and provisions of Bermuda law to which we are subject contain provisions that could discourage, delay or prevent "change of control" transactions or changes in the Board and management that certain shareholders may view as beneficial or advantageous. These provisions include, among others:
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the Board is divided into three classes, with each class serving for a staggered three-year term, which prevents shareholders from electing an entirely new board of directors at an annual meeting;
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the Board has the authority to issue preferred shares without shareholder approval, which could be used to dilute the ownership of a potential hostile acquirer;
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the Board may decline to record the transfer of any Common Shares on our share register if they believe that: (i) registration of the transfer is required under any federal or state securities law or under the laws of any other jurisdiction and the registration has not yet been effected; or (ii) such transfer is likely to expose us to adverse tax consequences or materially adverse legal or regulatory treatment in any jurisdiction;
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our shareholders may only remove directors for cause, or for other reasons set out in our bye-laws (e.g., unsound mind);
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there are advance notice requirements for shareholders with respect to director nominations and actions to be taken at annual meetings; and
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under Bermuda law, for so long as Blue Capital Re is registered under the Insurance Act, the BMA may object to a person holding more than 10% of our Common Shares if it appears to the BMA that the person is not or is no longer fit and proper to be such a holder.
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The foregoing factors, as well as the significant share ownership by Sompo International, could impede a merger, takeover or other business combination, which could reduce the market value of our Common Shares.
A shareholder may be required to sell its shares of Blue Capital.
Under our bye-laws and subject to Bermuda law, we have the option, but not the obligation, to require a shareholder to sell some or all of its Common Shares to us at fair market value (with fair market value determined in accordance with our bye-
laws) if the Board reasonably determines, in good faith based on an opinion of counsel, that share ownership, directly, indirectly or constructively, by such shareholder is likely to result in adverse tax, regulatory or legal consequences to us, certain of our other shareholders or our subsidiaries.
There are regulatory limitations on the ownership and transfer of our Common Shares.
The Insurance Act requires that, in respect of a company whose shares are listed on a stock exchange recognized by the BMA, any person who becomes (or ceases to be) a holder of at least 10%, 20%, 33% or 50% of the shares of an insurance or reinsurance company or its parent must notify the BMA in writing within 45 days of becoming such a holder or 30 days from the date they have knowledge of having such a holding, whichever is later. This requirement will apply to us as long as our shares are listed on the New York Stock Exchange or the Bermuda Stock Exchange. If our Common Shares are no longer listed on the New York Stock Exchange or the Bermuda Stock Exchange or another exchange recognized by the BMA, the BMA may, by written notice, object to a person holding 10%, 20%, 33% or 50% of our Common Shares if it appears to the BMA that the person is not fit and proper to be such a holder. The BMA may require the holder to reduce its shareholding in us and may direct, among other things, that the voting rights attaching to its shares shall not be exercisable. A person that does not comply with such a notice or direction from the BMA will be guilty of an offense.
In addition, pursuant to the Exchange Control Act 1972 and related regulations of Bermuda, specific permission is required from the BMA for all issuances and transfers of securities of Bermuda companies, other than in cases where the BMA has granted a general permission. The BMA, in its policy dated June 1, 2005, provides that where any equity securities of a Bermuda company, which would include the Common Shares, are listed on an appointed stock exchange (which includes the New York Stock Exchange and the Bermuda Stock Exchange), general permission is given for the issue and subsequent transfer of any securities of the company from and to non-residents, for as long as any equity securities of the company remain so listed. Once the Common Shares are delisted from the New York Stock Exchange and the Bermuda Stock Exchange the general permission will no longer apply. The Company has applied to the BMA for an additional permission to permit the free transferability of Common Shares once they are delisted from the New York Stock Exchange and the Bermuda Stock Exchange. However, absent receipt of such permission from the BMA, advance approval will need to be obtained, or notification will need to be made, to the BMA for transfers of Common Shares.
Blue Capital Re is also required to notify the BMA in writing in the event any person has become or has ceased to be a Controller or an officer of it, an officer being a director, chief executive or senior executive performing duties of underwriting, actuarial, risk management, compliance, internal audit, finance or investment matters.
Except in connection with the settlement of trades or transactions entered into through the facilities of the New York Stock Exchange and the Bermuda Stock Exchange, the Board may generally require any shareholder or any person proposing to acquire our Common Shares to provide the information required under our bye-laws. If any such shareholder or proposed acquirer does not provide such information, or if the Board has reason to believe that any certification or other information provided pursuant to any such request is inaccurate or incomplete, the Board may decline to register any transfer or to effect any issuance or purchase of Common Shares to which such request is related.
U.S. persons who own our Common Shares may have more difficulty in protecting their interests than U.S. persons who are shareholders of a U.S. corporation.
The Companies Act, which applies to Blue Capital, differs in certain material respects from laws generally applicable to U.S. corporations and their shareholders. These differences include the manner in which directors must disclose transactions in which they have an interest, the rights of shareholders to bring class action and derivative lawsuits and the scope of indemnification available to directors and officers.
Bermuda law differs from the laws in effect in the U.S. and may afford less protection to holders of our shares.
We are organized under the laws of Bermuda. As a result, our corporate affairs are governed by the Companies Act, which differs in some material respects from laws typically applicable to U.S. corporations and shareholders, including the provisions relating to interested directors, amalgamations, mergers and acquisitions, takeovers, shareholder lawsuits and indemnification of directors. Generally, the duties of directors and officers of a Bermuda company are owed to the company only. Shareholders of Bermuda companies typically do not have rights to take action against directors or officers of the company and may only do so in limited circumstances. Class actions are not available under Bermuda law. The
circumstances in which derivative actions may be available under Bermuda law are substantially more proscribed and less clear than they would be to shareholders of U.S. corporations. The Bermuda courts, however, would ordinarily be expected to permit a shareholder to commence an action in the name of a company to remedy a wrong to the company where the act complained of is alleged to be beyond the corporate power of the company or illegal, or would result in the violation of the company’s memorandum of association or bye-laws. Furthermore, consideration would be given by a Bermuda court to acts that are alleged to constitute a fraud against the minority shareholders or, for instance, where an act requires the approval of a greater percentage of the company’s shareholders than that which actually approved it.
When the affairs of a company are being conducted in a manner that is oppressive or prejudicial to the interests of some shareholders, one or more shareholders may apply to the Supreme Court of Bermuda, which may make such order as it sees fit, including an order regulating the conduct of the company’s affairs in the future or ordering the purchase of the shares of any shareholders by other shareholders or by the company. Additionally, under our bye-laws and as permitted by Bermuda law, each shareholder has waived any claim or right of action against our directors or officers for any action taken by directors or officers in the performance of their duties, except for actions involving fraud or dishonesty. In addition, the rights of holders of our Common Shares and the fiduciary responsibilities of our directors under Bermuda law are not as clearly established as under statutes or judicial precedent in existence in jurisdictions in the U.S., particularly the State of Delaware. Therefore, holders of our Common Shares may have more difficulty protecting their interests than would shareholders of a corporation incorporated in a jurisdiction within the U.S.
Anti-takeover provisions in our bye-laws could impede an attempt to replace or remove our directors, which could diminish the value of our Common Shares.
Blue Capital’s bye-laws contain provisions that may make it more difficult for shareholders to replace directors even if the shareholders consider it beneficial to do so. In addition, these provisions could delay or prevent a change of control that a shareholder might consider favorable. Even in the absence of an attempt to effect a change in management or a takeover attempt, these provisions may adversely affect the prevailing market price of our Common Shares if they are viewed as discouraging changes in management and takeover attempts in the future.
The price of our Common Shares may fluctuate significantly and you could lose all or part of your investment.
Volatility in the market price of our Common Shares may prevent you from being able to sell your Common Shares at or above the price you paid for your Common Shares. The market price for our Common Shares can fluctuate significantly for various reasons, including:
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catastrophes that may specifically impact us or are perceived by investors as impacting the reinsurance market in general;
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the financial condition, financial performance and prospects of the Company, the Manager or Sompo International;
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our quarterly or annual change in value of net assets or earnings of other companies in our industry;
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exposure to capital market risks related to the performance of insurance-linked investments;
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our capital management policy and whether special distributions on our Common Shares have been, and are likely to be, declared and paid from time to time;
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speculation by the investment community regarding our business;
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future announcements concerning our business or our competitors’ businesses;
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the public’s reaction to our press releases, other public announcements and filings with the SEC;
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market and industry perception of our success, or lack thereof, in pursuing our strategy;
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strategic actions by us or our competitors, such as acquisitions, restructurings, significant contracts or joint ventures;
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changes in government regulation;
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potential characterization of us as an investment company, a controlled foreign corporation or a passive foreign investment company;
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general market, economic and political conditions;
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changes in conditions or trends in our industry, geographies or customers;
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arrival and departure of key personnel of the Company, the Manager or Sompo International;
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sales of our Common Shares by us, Sompo International, our directors or members of our management team; and
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adverse resolution of litigation against us.
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In addition, stock markets, including the New York Stock Exchange and the Bermuda Stock Exchange, have experienced price and volume fluctuations that have affected and continue to affect the market prices of equity securities issued by many companies, including companies in our industry. In the past, some companies that have had volatile market prices for their securities have been subject to class action or derivative lawsuits. The filing of a lawsuit against us, regardless of the outcome, could have a negative effect on our business, as it could result in substantial legal costs and a diversion of management’s attention and resources.
As a result of the factors described above, investors in our Common Shares may not be able to resell their Common Shares at or above the price they paid or may not be able to resell them at all. These market and industry factors may materially reduce the market price of our Common Shares, regardless of our operating performance. In addition, price volatility may be greater if the public float and the trading volume of our Common Shares are low.
It may be difficult to enforce service of process and enforcement of judgments against us and our officers and directors.
Blue Capital is a Bermuda company and certain of its officers and directors are residents of jurisdictions outside the United States. A substantial portion of its assets and its officers and directors, at any one time, are or may be located in jurisdictions outside the United States. It may be difficult for investors to effect service of process within the United States on our directors and officers who reside outside the United States or to enforce against us or our directors and officers judgments of U.S. courts predicated upon civil liability provisions of the U.S. federal securities laws.
There is no treaty in force between the United States and Bermuda providing for the reciprocal recognition and enforcement of judgments in civil and commercial matters. As a result, whether a United States judgment would be enforceable in Bermuda against us or our directors and officers depends on whether the U.S. court that entered the judgment is recognized by the Bermuda court as having jurisdiction over us or our directors and officers, as determined by reference to Bermuda conflict of law rules.
In addition to and irrespective of jurisdictional issues, the Bermuda courts will not enforce a United States federal securities law that is either penal or contrary to Bermuda public policy. An action brought pursuant to a public or penal law, the purpose of which is the enforcement of a sanction, power or right at the instance of the state in its sovereign capacity, will not be entertained by a Bermuda court. Consequently, certain remedies available under the laws of U.S. jurisdictions, including certain remedies under U.S. federal securities laws, may not be available under Bermuda law or enforceable in a Bermuda court, as they may be contrary to Bermuda public policy. Further, no claim may be brought in Bermuda against us or our directors and officers in the first instance for violation of U.S. federal securities laws because these laws have no extraterritorial jurisdiction under Bermuda law and do not have force of law in Bermuda. A Bermuda court may, however, impose civil liability on us or our directors and officers if the facts alleged in a complaint constitute or give rise to a cause of action under Bermuda law.
TAXATION RISKS
We and our subsidiaries may be subject to U.S. tax which may have a material adverse effect on our financial condition and run-off performance.
The Company and its subsidiaries are Bermuda companies. Each intends to operate in such a manner that none will be deemed to be engaged in the conduct of a trade or business within the United States. However, whether business is being conducted in the United States is an inherently factual determination. Because definitive identification of activities which constitute being engaged in a trade or business in the United States is not provided by the U.S. Internal Revenue Code of 1986, as amended (the "Code"), regulations or court decisions, the U.S. Internal Revenue Service (the "IRS") might successfully contend that any of the Company and/or its subsidiaries are/is engaged in a trade or business in the United States. A non-U.S. corporation deemed to be so engaged would be subject to U.S. income tax at regular corporate rates, as well as the branch profits tax, on its income that is treated as effectively connected with the conduct of that trade or business unless the corporation is entitled to relief under the permanent establishment provision of an applicable tax treaty, as discussed below. Such income tax, if imposed, would be based on effectively connected income computed in a manner generally analogous to
that applied to the income of a U.S. corporation, except that a non-U.S. corporation is generally entitled to deductions and credits only if it timely files a U.S. federal income tax return. Each of the Company and Blue Capital Re file protective U.S. federal income tax returns on a timely basis in order to preserve the right to claim income tax deductions and credits if it is ever determined that it is subject to U.S. federal income tax. The highest marginal federal income tax rates as of 2020 are 21% for a corporation's effectively connected income and 30% for the branch profits tax. If Blue Capital Re were to qualify for benefits under the tax treaty between the United States and Bermuda (the "Bermuda treaty"), Blue Capital Re would not be subject to U.S. income tax on any business profits of its insurance enterprise found to be effectively connected with a U.S. trade or business, unless that trade or business is conducted through a permanent establishment in the United States. Blue Capital Re does not have sufficient information about its ownership to determine whether it would be entitled to the benefits of the Bermuda Treaty. However, based on the information that it does possess, Blue Capital Re believes that it may not be entitled to the benefits of the Bermuda Treaty. If the Company and/or its subsidiaries were subject to U.S. federal income tax, our financial condition and run-off performance, as well as an investment in our Common Shares, could be materially adversely affected.
U.S persons who hold our Common Shares may be subject to U.S. income taxation at ordinary income tax rates on our undistributed earnings and profits under the controlled foreign corporation ("CFC") rules.
If the Company or any of its subsidiaries were considered a CFC, any "10% U.S. Shareholder" (as defined below) may be subject to current U.S. income taxation at ordinary income tax rates on all or a portion of the Company's or its subsidiaries' undistributed earnings and profits attributable to the Company's insurance and reinsurance income, including underwriting and investment income, other subpart F income and an additional category of income in excess of a prescribed return (global intangible low-taxed income). Any gain realized on a sale of our Common Shares by such shareholder may also be taxed as a dividend to the extent of the Company's earnings and profits attributed to such shares during the period that the shareholder held the shares and while the Company was a CFC (with certain adjustments). A foreign corporation is considered a CFC if 10% U.S. Shareholders own (directly, indirectly through foreign entities or constructively pursuant to the application of certain constructive ownership rules) more than 50% of the total combined voting power of all classes of voting stock of such foreign corporation, or the total value of all stock of such corporation. For purposes of taking into account insurance income, a CFC also includes a foreign corporation in which more than 25% of the total combined voting power or value of all classes of stock is owned (directly, indirectly through foreign entities or constructively pursuant to the application of certain constructive ownership rules) by 10% U.S. Shareholders, on any day during the taxable year of such corporation, if the gross amount of premiums or other consideration for the reinsurance or the issuing of insurance contracts exceeds 75% of the gross amount of all premiums or other consideration in respect of all risks.
On December 22, 2017, the United States enacted a budget reconciliation act amending the Internal Revenue Code of 1986 (the "TCJA"). Prior to the enactment of the TCJA, a "10% U.S. Shareholder" was defined as any shareholder that is a U.S. person that owns directly, indirectly or by attribution, 10% or more of the total voting power of the Company. However, for taxable years beginning after December 31, 2017, the TCJA expands the definition of a "10 % U.S. Shareholder" to include U.S. persons that own directly, indirectly or by attribution, 10% or more of either the total voting power of the Company or total value of the stock of the Company. TCJA also expands the application of the constructive ownership rules that are applied for determining whether a U.S. person is a 10% U.S. Shareholder of a foreign corporation. Under prior law, certain ownership attribution rules did not apply so as to treat a U.S. person as owning stock that is owned by a non-U.S. person. TCJA has repealed this limitation. Consequently, under the new attribution rules, Common Shares owned by Endurance Bermuda would be treated as owned by Endurance U.S. Holdings Corp. Accordingly, Endurance U.S. Holdings Corp. would be treated as a 10% U.S. Shareholder for purposes of determining whether Blue Capital Re is a CFC. The Senate Finance Committee suggested, however, that the repeal of the limitation to the ownership attribution rules is not intended to cause a foreign corporation to be treated as a CFC with respect to an unrelated U.S. person, such as an investor for example. Although the U.S. Treasury Department issued proposed regulations in October 2019 addressing some of the concerns raised by the repeal of the ownership attribution rule described above, they do not address the impact such repeal has on us or otherwise confirm this intent. Until further guidance is issued by the U.S. Treasury Department or the IRS confirms or otherwise codifies this intent, based on the technical application of the TCJA, we would be treated as a CFC for purposes of taking into account our insurance income. By expanding the constructive ownership rules and the definition of 10% U.S. Shareholder, the TCJA will increase the likelihood that an investor could be treated as a 10% U.S. Shareholder in 2018 and in any subsequent taxable years. Investors should consult their tax advisors regarding the application of the CFC rules to an investment in our Common Shares.
U.S. persons who hold our Common Shares may be subject to U.S. income taxation on their pro rata share of our related party insurance income ("RPII").
The CFC rules apply to certain insurance and reinsurance companies that earn RPII. If the RPII rules were to apply to Blue Capital Re, a U.S. person who owns our Common Shares directly, or indirectly through foreign entities, on the last day of the
taxable year would be required to include in its income for U.S. federal income tax purposes the shareholder's pro rata share of Blue Capital Re's RPII for the entire taxable year, determined as if such RPII were distributed proportionately to such U.S. shareholders at that date regardless of whether such income is distributed. In addition, any RPII that is to be included in the income of a U.S. tax-exempt organization would be treated as unrelated business taxable income. Although Blue Capital Re intends to generally operate in a manner so as to qualify for certain exceptions to the RPII rules, there can be no assurance that these exceptions will be available. Accordingly, there can be no assurance that U.S. persons who own our Common Shares will not be required to recognize gross income inclusions attributable to RPII.
U.S. persons who dispose of our Common Shares may be subject to U.S. federal income taxation at the rates applicable to ordinary income.
Section 1248 of the Code, in conjunction with the RPII rules, provides that if a shareholder who is a U.S. person disposes of shares in a foreign insurance corporation that has RPII and in which U.S. persons collectively own 25% or more of the shares, by vote or value, at any time during the five-year period ending on the date of the disposition any gain from the disposition will generally be treated as ordinary income to the extent of the shareholder's share of the corporation's undistributed earnings and profits that were accumulated during the period that the shareholder owned the shares (possibly whether or not such earnings and profits are attributable to RPII). In addition, such a shareholder will be required to comply with certain reporting requirements, regardless of the amount of shares owned by the shareholder. The Company believes that these rules should not apply to dispositions of our Common Shares because the Company is not itself directly engaged in the insurance business. The RPII provisions, however, have not been interpreted by the courts or the U.S. Treasury Department, and regulations interpreting the RPII provisions of the Code exist only in proposed form. Accordingly, the IRS might interpret the proposed regulations in a different manner and the applicable proposed regulations may be promulgated in final form in a manner that would cause these rules to apply to dispositions of our Common Shares.
U.S. persons who hold our Common Shares will be subject to adverse tax consequences if we are considered a passive foreign investment company ("PFIC") for U.S. federal income tax purposes.
For U.S. federal income tax purposes, a foreign corporation will generally be considered a PFIC during a given year if (i) 75% or more of its gross income constitutes "passive income" or (ii) 50% or more of its assets produce passive income. For purposes of the PFIC determination, passive income generally includes interest, dividends, capital gains, annuities and other investment income. The PFIC statutory provisions contain an express exception for income derived in the active conduct of an insurance business. The PFIC statutory provisions also contain a look-through rule stating that, for purposes of determining whether a foreign corporation is a PFIC, such foreign corporation shall be treated as if it received directly its proportionate share of the income and as if it held its proportionate share of the assets of any other corporation in which it owns at least 25% by value of the shares. While no explicit guidance is provided by the statutory language, under this look-through rule the Company should be deemed to own the assets and to have received the income of Blue Capital Re directly for purposes of determining whether it qualifies for the insurance business exception.
To qualify for the exception applicable to corporations engaged in the active conduct of an insurance business, the applicable insurance liabilities of such corporation must exceed 25 percent of its total assets. It is unclear how liability reserves are measured and taken into account for purposes of determining the applicable insurance liabilities. Based on our insurance liability reserves as at December 31, 2019, we believe we satisfied the 25% test and that we should not be considered a PFIC for U.S. federal income tax purposes for the year then ended. Due to the uncertainties and ambiguities in the application of the PFIC provisions, however, there can be no assurance that the IRS will agree with our belief regarding PFIC status. Moreover, in the future if we experience a period with a lower incidence of loss events impacting our portfolio of business and in which our current estimates for insurance liabilities are settled, it is possible that we will no longer meet the 25% test. If a corporation fails the 25% test, U.S. tax law provides an alternative test which permits a U.S. person that owns stock in such corporation to elect to treat such stock as stock of a qualifying insurance corporation if (A) the corporation's applicable insurance liabilities are at least equal to 10% of its total assets and (B) under U.S. Treasury Regulations to be issued, based on the applicable facts and circumstances, (i) the corporation is predominantly engaged in an insurance business and (ii) the failure to satisfy the 25% test is due solely to runoff-related or rating-related circumstances involving such insurance business. Proposed U.S. Treasury Regulations have recently been issued that are intended to provide additional guidance regarding the determination of whether a foreign corporation will constitute a "qualifying insurance corporation" and clarify the circumstances under which investment income earned by a qualifying insurance corporation is derived in the active conduct of an insurance business. It is uncertain if, when and in what form the proposed
regulations will be finalized and if, when or in what form any additional guidance will be provided by the IRS regarding the application of the PFIC provisions to foreign insurance companies, or if enacted, whether such guidance would have retroactive effect. Under certain circumstances, however, U.S. persons that are shareholders in certain foreign corporations may rely upon the proposed regulations. Due to the ambiguities in the application of the TCJA and the PFIC provisions in general and because we cannot determine whether we would be a PFIC for the current taxable year until the end of the year, it is possible that we could be considered a PFIC for the current and any future taxable years.
If we are classified as a PFIC, a U.S. holder of our Common Shares that does not make any of the elections described below would be required to report any gain on the disposition of our Common Shares as ordinary income, rather than as capital gain, and to compute the tax liability on the gain and any "Excess Distribution" (as defined below) received in respect of our Common Shares as if such items had been earned ratably over each day in such holder’s holding period (or a portion thereof) for the Common Shares. The amounts allocated to the taxable year during which the gain is realized or distribution is made, and to any taxable years in such U.S. holder’s holding period that are before the first taxable year in which we are treated as a PFIC with respect to the U.S. holder, would be included in the U.S. holder’s gross income as ordinary income for the taxable year of the gain or distribution. The amount allocated to each other taxable year would be taxed as ordinary income in the taxable year during which the gain is realized or distribution is made at the highest tax rate in effect for the U.S. holder in that other taxable year and would be subject to an interest charge as if the income tax liabilities had been due with respect to each such prior year. For purposes of these rules, exchanges pursuant to corporate liquidations, gifts, and use of Common Shares as security for a loan may be treated as a taxable disposition of the Common Shares. An "Excess Distribution" is the amount by which distributions during a taxable year in respect of a Common Share exceed 125% of the average amount of distributions in respect thereof during the three preceding taxable years (or, if shorter, the U.S. holder’s holding period for the Common Shares). In addition, if we were considered a PFIC, dividends paid in respect of our Common Shares would not be eligible for the preferential tax rate applied to "qualified dividend income" received by certain non-corporate U.S. holders.
Certain additional adverse U.S. federal tax rules will apply to a U.S. holder of our Common Shares for any taxable year in which the Company is treated as a PFIC with respect to such U.S. holder and any of our subsidiaries is also treated as a PFIC (a "Subsidiary PFIC"). In such a case, such U.S. holder will generally be deemed to own its proportionate interest (by value) in any Subsidiary PFIC and be subject to the PFIC rules described above with respect to the Subsidiary PFIC regardless of such U.S. holder’s percentage ownership in the Company.
The adverse tax consequences described above may be mitigated if a U.S. holder of our Common Shares is able to make a timely qualified electing fund election (a "QEF election") or a mark-to-market election with respect to our Common Shares. A QEF election made with respect to the Company, however, will not apply to any Subsidiary PFIC; a QEF election must be made separately for each Subsidiary PFIC. A QEF election may only be made by a holder of our Common Shares if, among other things, the Company provides such holder with certain information. It is uncertain whether the Company would be able to provide investors with the information necessary to make a QEF election. A mark-to-market election (instead of a QEF election) will only be available if our Common Shares are treated as regularly traded on a qualified exchange or other market within the meaning of the applicable U.S. Treasury Regulations. Since we intend to delist our Common Shares prior to March 31, 2020, we expect that our Common Shares will not be treated as regularly traded on a qualified exchange or other market during 2020 and therefore, a mark-to-market election generally would not be available in 2020. In addition, a U.S. holder of our Common Shares will technically not be permitted to make a mark-to-market election with respect to a Subsidiary PFIC.
During any taxable year in which the Company or any Subsidiary PFIC is treated as a PFIC with respect to a U.S. holder of our Common Shares, that holder generally must file IRS Form 8621.
The rules regarding PFICs, including the QEF election and mark-to-market election, are complex. Holders of our Common Shares should consult their tax advisors regarding the application of the PFIC rules to their particular circumstances.
Legislative and regulatory action by the U.S. Congress could materially and adversely affect the Company.
The Company's tax position could be adversely impacted by changes in tax laws, tax treaties or tax regulations or the interpretation or enforcement thereof. Legislative action may be taken by the U.S. Congress which, if ultimately enacted, could, adversely affect the results of our operations and financial condition and could have a material adverse effect on our business, financial condition or run-off performance.
Dividends paid in respect of our Common Shares will no longer be eligible for the preferential tax rate applicable to "qualified dividend income" received by certain non-corporate U.S. shareholders after we delist our Common Shares from the New York Stock Exchange.
Generally, dividends paid in respect of stock of a foreign corporation that is not classified as a PFIC for the taxable year in which the dividend is paid, or the preceding taxable year, are eligible for the preferential tax rate applicable to "qualified dividend income" received by certain non-corporate U.S. shareholders if such stock is readily tradable on an established securities market in the United States. After we delist our Common Shares, such shares will no longer be readily tradable on the New York Stock Exchange, and any dividends paid in respect thereof will no longer be eligible for such preferential tax rate.
U.S. holders of our Common Shares may not be able to recognize a loss for U.S. federal income tax purposes until they receive a final distribution from us.
Subject to the PFIC rules discussed above, as a result of our winding-up and liquidation, for U.S. federal income tax purposes, U.S. holders of our Common Shares generally will recognize gain or loss equal to the difference between (i) the sum of the amount of cash and the fair market value (determined at the time of the distribution) of property, if any, distributed to them and (ii) their adjusted tax basis in our Common Shares. Such gain or loss generally will be computed on a per-share basis. If a U.S. holder acquired our Common Shares at different prices or at different times, the amount that such shareholder receives on each liquidating distribution will be allocated to each different block of our Common Shares based on the number of shares in each block. Within each block, a cost recovery approach will generally be applied, and a U.S. holder’s full tax basis of a block will generally be recovered before any gain is recognized with respect to it. Liquidating distributions pursuant to the winding-up may occur at various times and in more than one tax year. Any loss generally will be recognized by a U.S. holder only in the tax year in which such shareholder receives our final liquidating distribution, and then only if the aggregate value of all liquidating distributions with respect to each block of our Common Shares held by such shareholder is less than the shareholder’s adjusted tax basis for such block of our Common Shares. Holders of our Common Shares are urged to consult with their own tax advisors as to the specific tax consequences to them of our winding-up and liquidation.
The tax treatment of any liquidating distribution may vary from shareholder to shareholder.
You should consult your own tax advisor for tax advice in connection with the winding-up and liquidation. We have not requested a ruling from the U.S. Internal Revenue Service or any other tax authority with respect to the anticipated tax consequences of our winding-up and liquidation, and we will not seek an opinion of counsel with respect to the anticipated tax consequences of any liquidating distributions. Tax considerations applicable to particular shareholders may vary with and be contingent on the shareholder’s individual circumstances.
The Organisation for Economic Co-operation and Development ("OECD") and the European Union ("EU") are considering measures that might increase our taxes and reduce our net income.
The OECD has published reports and launched a global dialogue among member and non-member countries on measures to limit harmful tax practices. In particular, as a result of the Base Erosion and Profit Shifting ("BEPS") project, the OECD and the G20 delivered a package of policies that will allow governments to address the gaps in the international tax system. The BEPS package included four new minimum standards which included the commitment to (i) address harmful tax practices; (ii) to prevent tax treaty shopping; (iii) to ensure country-by-country reporting; and (iv) to improve the effectiveness of cross-border tax dispute resolution.
Bermuda has not been listed in the OECD's periodic progression reports as an uncooperative tax haven jurisdiction because it had previously committed to eliminate harmful tax practices and to embrace international tax standards for transparency, exchange of information and the elimination of any aspects of the regimes for financial and other services that attract business with no substantial domestic activity. Bermuda was reported as being largely compliant with the OECD's international tax standards on transparency and exchange of information in the OECD's 2016 Tax Transparency Report on Progress. Bermuda set up its Tax Information Reporting Portal in June 2017. Other "largely compliant" jurisdictions include Germany, the United Kingdom and the United States. In 2017 Bermuda issued its common reporting standard regulations and country-by-country reporting regulations. Further, in February 2020, Bermuda was returned to EU's 'white list' of fully cooperative tax jurisdictions. Although Bermuda is now on the list of fully cooperative tax jurisdictions, further measures are being considered by the OECD. These include establishing a global minimum rate of taxation for multinational companies, which proposal is at the end of its consultation phase. We will need to monitor and assess these proposals.
In addition, on July 12, 2016 Council Directive 2016/1164/EU ("ATAD") was adopted which laid down rules against tax avoidance practices that directly affect the functions of the internal market. Member States were required to implement ATAD into domestic law by January 1, 2019 (except in relation to the exit tax rule and the interest restriction rules which in certain circumstances need not be implemented until January 1, 2020 and 2024 respectively). In October 2016 the EU Commission presented its corporate tax reform package in which the Commission proposed that the provisions of the ATAD dealing with hybrid mismatches should be extended to hybrid mismatches with third countries and on May 29, 2017 Council Directive 2017/952/EU ("ATAD II") was adopted. Member States were required to implement ATAD II into domestic law by December 31, 2019.
We are currently not able to provide a definitive view on whether any changes arising from any proposals introduced in connection with the possible new OECD and EU measures will subject us to additional taxes or otherwise affect our operations.