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The determinants of corporate financial performance
in the Bermuda insurance market
M. Adams
a
& M. Buckle
a
a
European Business Management School, University of Wales, Swansea, Singleton Park,
Swansea, SA2 8PP, UK, E-mail: m.b.adams@swansea.ac.uk, m.j.buckle@swansea.ac.uk
Published online: 07 Oct 2010.
To cite this article: M. Adams & M. Buckle (2003) The determinants of corporate financial performance in the Bermuda
insurance market, Applied Financial Economics, 13:2, 133-143, DOI: 10.1080/09603100210105030
To link to this article: http://dx.doi.org/10.1080/09603100210105030
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The determinants of corporate nancial
performance in the Bermuda insurance
market
M. ADAMS* and M. BUCKLE
European Business Management School, University of Wales, Swansea, Singleton
Park, Swansea, SA2 8PP, UK,
E-mail: m.b.adams@swansea.ac.uk, m.j.buckle@swansea.ac.uk
Drawing a framework from the organizational economics literature this study exam-
ines the determinants of corporate (i.e. underwriting and investment related) nan-
cial performance in the Bermuda insurance market. Using panel data for 19931997,
it was found that, as expected, highly leveraged, lowly liquid companies and rein-
surers have better operational performance than lowly leveraged, highly liquid com-
panies and direct insurers. Contrary to what was hypothesized, performance was
positively related to underwriting risk. However, the size of companies and the scope
of their activities were not found to be important explanatory factors.
I. INTRODUCTION
The last 30 years or so have witnessed the rapid growth and
development of oshore nancial centres. Prominent
amongst those oshore nancial centres is Bermuda,
which is currently ranked as amongst the most important
international markets for insurance, reinsurance and
insurance-based securities (Bawcutt, 1997; Wyn, 1998;
Dowding, 1999). Indeed, Dowding (1999) reported that
at the end of 1997, the Bermuda insurance market
generated annual premiums of US$20.4 billion, retained
capital and reserves valued at US$48.5 billion and held
assets with a total market value of approximately
US$112 billion. Premiums are generated not only by
subsidiaries of major global insurers/reinsurers (like
Scandinavian Re), but also by Bermudan headquartered
companies (such as XL) that have specialized in liability
and nancial lines insurance. Bermudas economic import-
ance as an insurance market is further underpinned by the
fact that by the mid-1990s Bermudan-based companies
accounted for approximately 10% of the worlds reinsur-
ance business and 20% of its property catastrophe capacity
(A. M. Best, 1999). These features thus contribute to make
Bermuda an important oshore centre within which to
focus research.
Industry commentators, such as Bannister (1999), con-
tend that this rapid market growth and development, has
largely been facilitated by two main factors. First, favour-
able company taxation rules that promote the rapid build-
up of reserves; and second, a exible regulatory structure
that encourages innovation and the free movement of for-
eign exchange. However, it is not clear from the practi-
tioner literature as to whether all Bermuda-based insurers
benet equally from the espoused institutional advantages.
For example, organizational characteristics, such as com-
pany size, could explain observed variations in corporate
nancial performance. Drawing a framework from the
organizational economics literature, this study thus uses
19931997 panel data to examine empirically the determi-
nants of corporate (i.e. underwriting and investment
related) nancial performance among non-captive
insurers/reinsurers operating in Bermuda.
1
Applied Financial Economics ISSN 09603107 print/ISSN 14664305 online # 2003 Taylor & Francis Ltd
http://www.tandf.co.uk/journals
DOI: 10.1080/09603100210105030
Applied Financial Economics, 2003, 13, 133143
133
* Corresponding author.
1
Bermuda is also home to about 1200 captive insurance companies (i.e. the insurance operations of non-insurance organizations).
However, insurance captives are excluded from our study as nancial data on their activities are not available from public sources.
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Four further motives underpin the research. First, prior
empirical research into oshore nancial markets has been
inhibited by a lack of published data (see Section IV). To
the authors knowledge, therefore, this is the rst study to
use what public data that are currently available to ex-
amine empirically the determinants of nancial perform-
ance of companies in an important oshore nancial
market. Second, the results could have important policy-
making implications. For example, insights into the rela-
tion between performance and organizational-specic fac-
tors (e.g. capital structure and liquidity) could help
industry regulators and policy-makers to frame licensing
regulations that discriminate in favour of certain types of
new entrant to the market such as those with adequate
nancial liquidity. Third, the study is likely to be of interest
to brokers, policyholders, investors and others concerned
with corporate nancial strength. For example, empirical
evidence suggesting a linkage between capital structure and
nancial performance could inuence the business deci-
sions of prospective customers and investors. Fourth, by
focusing on a single oshore market this study avoids the
potentially confounding eects that dierent regulations
could have in cross-jurisdictional studies of corporate per-
formance. For instance, compared with companies operat-
ing in more tightly regulated onshore markets such as the
USA, Bermudan-based insurance and reinsurance com-
panies are not overly constrained by external nancial
rules (e.g. that place limits on premium rates) and a dis-
criminatory scal code (e.g. that discriminates between dif-
ferent organizational types). As a consequence, it is
considered that a more robust test of the hypotheses can
be performed.
The rest of the article is organized as follows. Section II
provides background information on Bermudas relatively
unregulated insurance market, while Section III puts for-
ward six hypotheses drawn from the organizational eco-
nomics literature. Section IV describes the research
design, including the source of data, the model used and
denition of the variables. Section V presents and discusses
the results, while Section VI concludes the article.
II. INSTITUTIONAL BACKGROUND
Bermuda is a self-governing dependency of the British
Crown covering 20 inhabited islands located some 700 miles
o the eastern seaboard of the USA (A.M. Best, 1999).
The life and non-life insurance sectors are largely self-
regulated within the context of the islands Insurance Act
(1978) and supporting solvency and investment regula-
tions. The islands legislative framework prescribes,
amongst other things, the registration, accounting and sol-
vency reporting rules for companies transacting insurance
and reinsurance business. The majority of Bermudan
insurers/reinsurers (e.g. those holding discounted loss
reserves) must also have their statutory reports externally
audited (Bawcutt, 1997). The 1978 Act additionally denes
dierent classes of insurance and reinsurance companies.
These range from: single parent captives of non-insurance
parent corporations (class 1); multi-owner captives (class
2); third party insurers/reinsurers (class 3); excess liability
and catastrophe insurers/reinsurers (class 4); and other
classes such as long-term life and health insurers/reinsurers
and composites writing a combination of insurance busi-
ness. Subject to meeting minimum licensing and solvency
requirements, Bermuda is an open market and comprises
insurers/reinsurers that write both domestic and inter-
national business. Bawcutt (1997) also reports that in
Bermuda there are few statutory restrictions on managerial
underwriting and investment decisions. This means that
observed variations in corporate operational performance
will not be overly inuenced by external regulations. As
noted earlier in Section I, the absence of stringent regula-
tion is advantageous as it permits us to conduct a more
rened test of the company-specic hypotheses. In addi-
tion, this institutional attribute enables the results of this
study to be generalized to other relatively unregulated o-
shore centres such as the Cayman Islands and Channel
Islands. What is more, companies registered in Bermuda
benet from the absence of severe taxation burdens, such
as high corporation taxes and withholding taxes. Therefore
unlike more highly taxed regimes (e.g. the USA), the opera-
tional performance of Bermudan insurers/reinsurers will
not be obfuscated by dierences in their relative taxation
positions. It is thus contended that these important institu-
tional characteristics make Bermuda an interesting envir-
onment within which to focus research and help to
counteract the inherent limitations of the study such as
the small data set used.
III. FRAMEWORK
Berger et al. (1997) contend that the factors underpinning
the nancial performance of nancial services rms are
often dicult to discern because of the intangible nature
of outputs and the lack of transparency over resource allo-
cation decisions. Nonetheless, insights from the organiza-
tional economics literature, such as those provided by
agency theory, can contribute important insights into the
determinants of nancial performance in nancial services
rms (e.g. see Boose, 1993; Adams, 1996). For instance,
agency theory articulates that relationships between own-
ers of rms (principals) and managers (agents) are main-
tained by contracts (Jensen and Meckling, 1976). As the
separation between ownership and control diverges due to
corporate growth, contracts (e.g. compensation schemes)
have to be introduced to ensure the alignment of owners
and managers economic interests. As a result, nancial
performance is predicted to be a function, for instance, of
134 M. Adams and M. Buckle
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the eectiveness of organizational-specic contractual
mechanisms for attracting, retaining and controlling man-
agerial talent in ways that maximise owners wealth.
It is believed that an organizational economics perspec-
tive could help to explain variations in reported nancial
performance in the Bermuda insurance market given the
variety of entities (e.g. in terms of size and capital
structure) that operate from there (e.g. see Dowding,
1999). As noted earlier in Section I, such an approach
could help industry regulators and policymakers to assess
the economic eectiveness of current licensing policy
(e.g. in encouraging new entrants irrespective of size). It
could also help them to benchmark domestic corporate
nancial performance against standards in other major
(onshore) insurance markets such as those of the USA
and Lloyds of London (e.g. see Cummins et al., 1999).
These attributes can help to ensure the future competitive-
ness of Bermuda as an international centre of nancial
services business. The remainder of this section therefore
utilizes the organizational economics literature to derive six
test hypotheses.
Company size
There are several organizational economics-based argu-
ments supporting a positive linkage between nancial per-
formance and insurance company size. For example,
Hardwick (1997) suggested that large insurers are likely
to perform better than small insurers because they can
achieve operating cost eciencies through increasing out-
put and economizing on the unit cost of innovations in
products and process development. Such economies are
important for oshore nancial centres, such as
Bermuda, as prices and outputs in international insurance
business are widely acknowledged to be volatile (e.g. see
Winter, 1994). Large corporate size also enables insurers to
eectively diversify their assumed risks and respond more
quickly to changes in market conditions. For instance,
Wyn (1998) noted that increased competitive pressure
and a fall in international rates of premium have led
many of Bermudas catastrophe insurers to diversify their
investment in both non-catastrophe lines (e.g. health and
life insurance) and through the Lloyds of London market.
These developments have led to increased merger and
acquisition activity, particularly among the large
Bermudan reinsurance companies such as ACE and XL.
However, there is a contra-argument, predicated on
agency theory, which suggests that nancial performance
could be inversely related to company size (e.g. see Pi and
Timme, 1993). The reasoning here is that as organizations
grow it often becomes more dicult for owners to e-
ciently and eectively monitor and control aberrant behav-
iour by managers. For example, as job security and salary
levels are often positively related to company size (Jensen
and Murphy, 1990), managers have incentives to pursue
corporate size-related objectives, such as increasing market
share, rather than maximizing shareholders wealth.
Moreover, nancial performance could be adversely
aected in large organizations because of diseconomies of
scale, X-ineciency (i.e. resource misallocation), and the
failure of managers to fully exploit output eciencies.
Gardner and Grace (1993) and Cummins et al. (1999)
further assert that in oligopoly nancial services markets,
large companies may attempt to increase their output
through merger and acquisition activities rather than by
improving nancial performance. Nevertheless, despite
the apparent ambiguity in the academic literature, most
of the recent empirical evidence from international insur-
ance markets (e.g. Grace and Timme, 1992; Hardwick,
1997) suggested that large companies generally out-
perform smaller ones because they realize economies of
scale and have the resources to attract and retain manage-
rial talent. Indeed, much of the practitioner literature (e.g.
Dowding, 1999) emphasizes the considerable innovative
ability of large Bermuda-based insurance and reinsurance
companies compared with smaller entities. Accordingly:
H1: Other things being equal, large companies will have
better nancial performance than small companies.
Underwriting risk
Organizations that engage in risky activities are likely to
have more volatile cash ows than entities whose manage-
ment is more averse to risk-taking (Fama and Jensen, 1983;
Lamm-Tennant and Starks, 1993). As a consequence,
insurers that underwrite risky business (e.g. catastrophe
coverage) will need to ensure that good standards of man-
agement are applied to mitigate their exposure to under-
writing losses ex-ante and maximize returns on invested
assets ex-post. For this reason, it is likely that managers
in insurance and reinsurance companies that are engaged in
risky lines of insurance will be given more discretion to
respond to market events than their counterparts in com-
panies that are engaged in less risky business activities
(Oppenheimer and Schlarbaum, 1983). Such decision-
making discretion could improve annual nancial perform-
ance by encouraging managers to increase cash ows
through risk-taking. On the other hand, excessive risk-
taking could adversely aect the annual performance of
insurers and reinsurance companies. For example, unanti-
cipated market forces, such as enhanced competition and a
sharp fall in share prices, could limit managements ability
to increase annual premiums and investment income to
compensate for losses arising as a result of poorly priced
risks. Furthermore, high annual insurance losses will tend
to increase the level of corporate management expenses ex-
post (e.g. claims investigation and loss adjustment costs)
that could further exacerbate a decline in reported nancial
performance. In contrast, insurers and reinsurance com-
Determinants of Bermudan corporate nancial performance 135
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panies with lower than expected annual losses are likely to
exhibit better nancial performance because, for example,
they do not incur such high monitoring and claims hand-
ling costs. Therefore:
H2: Other things being equal, companies with low
underwriting risk will have better nancial per-
formance than companies with high underwriting
risk.
Leverage
The degree of nancial leverage reects insurance and rein-
surance companies ability to manage their economic expo-
sure to unexpected losses. Therefore, low leverage provides
a measure of corporate nancial strength and ostensibly,
reduces the need for managers to increase investment earn-
ings, for example, to build-up reserves. According to
Jensen and Meckling (1976), high leverage also engenders
agency and other costs of contracting (e.g. bankruptcy
costs) as it provides incentives for owners to increase the
value of their residual claims (e.g. through greater risk-
taking) while simultaneously reducing the xed claims of
debtholders (or their policyholder equivalent). However,
Jensens (1986) free cash ow hypothesis holds that high
nancial leverage can increase a companys nancial per-
formance because it obliges managers to generate cash
ows in order to meet their obligations to xed claimants.
This view is supported by Berger et al. (1995: 399) who
report that increased debt liabilities put . . . pressure on
managers to generate cash ows and avoid their loss of
human capital from bankruptcy . . . and may give (them)
incentives to work harder . . . and make better investment
decisions. Therefore, managers of highly leveraged insur-
ance and reinsurance companies could also be motivated to
use cash ows to full their investment and underwriting
obligations, thereby enhancing their promotional prospects
in the internal and external job markets (e.g. see Fama,
1980). Indeed, empirical evidence from international insur-
ance markets testies to the predictive power of the free
cash ow hypothesis (e.g. see Wells et al., 1995; Adams,
1996). Thus:
H3: Other things being equal, companies with high
leverage will have better nancial performance
than companies with low leverage.
Liquidity
Liquidity measures the ability of managers in insurance
and reinsurance companies to full their immediate com-
mitments to policyholders and other creditors without hav-
ing to increase prots on underwriting and investment
activities and/or liquidate nancial assets. This reasoning
therefore implies that high liquidity obviates the need for
management to improve annual nancial performance.
Furthermore, high liquidity could increase agency costs
for owners by providing managers with incentives to
misuse excess cash ows by investing in projects with
negative net present value and engaging on excessive
perquisite consumption (e.g. luxurious oces) (e.g. see
Pottier, 1998). Managers are expected to act in such an
aberrant manner in order to enhance their job security
and compensation packages through corporate growth at
the expense of shareholders value. Indeed, empirical
evidence supporting the predictions of this agency theory-
based notion in insurance companies is reported elsewhere
in the literature (e.g. see Boose, 1993; Adams, 1996). As a
consequence:
H4: Other things being equal, companies with low
liquidity will have better nancial performance
than companies with high liquidity.
Type of company
The ecient and eective management of insurable risk,
such as underwriting assessment and pricing, is likely to
impact nancially on companies whether they are direct
writers or reinsurance companies. Nonetheless, there are
circumstances where annual nancial performance could
vary depending upon whether companies are engaged in
direct insurance or reinsurance business. For example,
Kiln (1991) observes that compared with direct insurance
business, the reinsurance industry is subject to less regula-
tory control and monitoring in respect of risk coverage,
indemnity terms, contract-types permitted and so forth.
This gives reinsurance companies considerably more free-
dom than direct writers to realize economies from diversi-
ed portfolios of business and to enhance nancial
performance. Additionally, their ability to transfer risks
across insurance pools and capital markets means that
reinsurance companies are generally less exposed to cata-
strophe risks than direct insurers. As a result, reinsurance
companies can avoid much of the compliance and solvency
monitoring costs associated with the licensing and regula-
tion of retail insurers. Furthermore, reinsurance companies
do not bear the same non-trivial costs that direct writers
incur in screening the insurable risk of each prospective
policyholder ex-ante (e.g. underwriting checks) and servi-
cing policies ex-post (e.g. claims handling). These attributes
can help to reduce reinsurance companies total annual
expenses and thus increase their nancial performance rela-
tive to that of direct insurers. Therefore:
H5: Other things being equal, reinsurance companies
will have better nancial performance than direct
insurance companies.
Scope of operations
As noted earlier in Section II, insurance and reinsurance
companies registered in Bermuda may be licensed either to
136 M. Adams and M. Buckle
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conduct domestic business or overseas business. To carry
out domestic insurance business at least 60% of the
issued equity must be owned by Bermuda residents, whilst
international business can be transacted by entities that are
wholly owned by overseas investors (Bawcutt, 1997). The
ability of insurance and reinsurance companies to spread
assumed risks optimally across jurisdictions could be,
however, an important determinant of their annual
nancial performance. For instance, Berger et al. (1992:
257) state that trans-national companies . . . can be
expected to experience higher protability and to gain
market share at the expense of rms that do not engage
in optimal risk diversication. Moreover, managers of
multinational insurers are likely to have considerable dis-
cretion to invest their portfolio of assets across inter-
national boundaries in order to minimize risks and
maximize returns for shareholders (Joseph and Hewins,
1997). Multinational companies are also likely to have
internationally recognized brand names that enable them
to generate higher levels of new business compared with
companies that operate solely from a single market. In
addition, greater brand awareness at the customer and
distribution network level is likely to help managers of
multinational insurers and reinsurance companies to
more easily dierentiate their products, realize the benets
of innovation and better manage their business risks
compared with their counterparts in companies that focus
on a single market. Accordingly:
H6: Other things being equal, multinational companies
will have better nancial performance than
companies that transact business from a single
location.
IV. RESEARCH DESIGN
Data
Minimal public disclosure requirements and condentiality
rules have inhibited the performance of empirical research
in oshore nancial centres such as Bermuda.
2
However,
panel-based public (and audited) accounting data for 1993
1997 (denominated in US$) were obtained for up to 47 of
the major non-captive Bermuda registered insurance/rein-
surance companies selected from the A.M. Best Insurance
Reports (1999).
3
This time series/cross-sectional data set
represents approximately 17% of those open market
equity-funded insurance and reinsurance companies under-
writing risks in lines such as liability, catastrophe and life
insurance for which data were complete. One important
advantage of using a panel data design is that it enables
estimates to be derived that are robust to short-term uc-
tuations in the annual nancial performance of rms (e.g.
due to international underwriting cycles).
Model
This article used a common-eects model. This is a
standard panel data design model that enables tests of
statistical dierences between years to be derived from a
single test of signicance rather than a series of individual
tests of inter-year model stability (e.g. by means of the
Chow test). A xed-eects model was tried in this study,
but it could not be estimated because of multicollinearity
between the binary variables TYPE and SCOPE and the
xed-eects parameters. The xed-eects model eectively
partitions the data set into a panel of company-year
observations with each entity having its own intercept.
This level of separation could not coexist with the parti-
tioning that is a consequence of the two binary variables.
It would have been possible to estimate the model as a
xed-eects model by omitting the two binary variables,
but this was felt to be inappropriate as their inclusion
was required to test hypotheses H5 and H6 set out earlier
in this paper. Additionally, a random-eects model was
also deemed to be inappropriate in this study as the
data were not a random sample drawn from a larger
population. The common-eects model employed is thus
expressed as:
PERF
it

0it

1
lnSIZE
it

2
URISK
it

3
LEV
it

4
LIQ
it

5
TYPE
it

6
SCOPE
it

7
YR1
8
YR2
9
YR3
10
YR4

11
YR5 "
it
where the dependent variable PERF
it
, is measured by the
dierence between the ratio of net investment income to
net premiums earned and the ratio of annual operating
expenses (including commission) to net premiums written
for company
i
in time
t
. This denition of nancial per-
formance is often used by insurance industry analysts as it
succinctly summarizes, in a single measure, performance in
the two major economic activities of insurance/reinsurance
Determinants of Bermudan corporate nancial performance 137
2
For example, Bermudas Companies Act, 1981, allows companies to annually report summarized nancial information.
3
Complete data for each company/year were not available and as such, our panel is unbalanced. The number of company/year cases is as
follows: 1997 45 cases; 1996 47 cases; 1995 46 cases; 1994 39 cases; and 1993 31 cases. This gives a total of 208 company/year
observations. Dierences in the number of company/year observations are largely the result of new entrants rather than from merger and
acquisition activity. Therefore, one considers that survivorship bias is unlikely to be a major constraint in this present study. Addition-
ally, the sample comprises companies for which A.M. Best provides ratings and entities for which ratings are not given but nancial data
are nonetheless collected for the purposes of comparative analysis.
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rms, namely: investment management and the underwrit-
ing of business risks (e.g. see A.M. Best, 1999).
4;5;6

0it
is
the constant, which is assumed to be identical for all panel
members;
1it
. . .
6it
are the parameter coecients to be
estimated; and YR1 . . . YR5 are the time eects. The nota-
tion "
it
represents an error term assumed to have a zero
mean and constant variance. The use of a price deator,
however, is precluded by the fact that our variables (as
dened below) are measured at the logarithmic, binary or
ratio scales.
Independent variables
The independent variables used in the study are dened as
follows.
Company size. This variable (lnSIZE) was measured as
the natural log of total net assets. The logarithmic trans-
formation helps to eliminate extreme values in the data.
Underwriting risk. Underwriting risk (URISK) was meas-
ured by the loss ratio i.e. annual losses incurred (net of
loss adjustment expenses) divided by annual premiums
earned. This ratio reects the adequacy, or otherwise, of
companies underwriting performance.
Leverage. Leverage (LEV) was measured as the ratio of
net technical reserves (after deducting any reinsurance
share) to capital/surplus. This ratio represents the poten-
tial impact on capital and surplus of deciencies in
reserves due to nancial claims.
Liquidity. This variable (LIQ) was dened as current
assets over current liabilities.
Company type. Company type (TYPE) was represented
by a dummy variable assigned a value of 0 for a direct
insurer and 1 for a reinsurance company.
Scope of operations. Scope of operations (SCOPE) was
measured by a dummy variable that took the form of 0
for a single country operative and 1 for a multinational
company.
V. RESULTS
Descriptive and univariate results
Table 1 provides the descriptive statistics for the dependent
and independent variables for the pooled rm/year obser-
vations for the sample of Bermudan insurance and reinsur-
ance companies for the period 19931997 N 208. They
show that the logarithmic transformation of the company
size variable reduces its variability leaving nancial lever-
age and liquidity as the variables that dier most among
companies in the sample. This suggests that some
Bermudan insurance and reinsurance companies are accu-
mulating more cash resources than others because of rela-
tively better control of expenses and/or the realization of
good investment returns. A KruskalWallis one-way
analysis of variance was also computed for each variable
(excluding the binary variables) across years with the null
hypothesis that the distribution of the variable is the same
for each year. In each case the computed
2
statistics were
less than the critical value of
2
9:488 at the 0.05 level of
statistical signicance (with ve degrees of freedom). This
indicates that there had not been a substantial change in
the characteristics of our sample of Bermuda-based
insurers and reinsurance companies over the ve years.
Table 2 presents the correlation coecients between the
dependent and independent variables for the pooled rm/
year observations for 19931997. The pair-wise correlation
coecients (Pearson and Spearman rank) reported indicate
statistically signicant positive associations between the
dependent variable, PERF, and the independent variables
URISK and LEV at the 0.01 level in a two tail test. The
positive association between PERF and LEV appears, on
rst sight, to support Jensens (1986) free cash ow hypoth-
esis (H3). Contrary to what was hypothesized, the positive
correlation between PERF and URISK further implies that
insurance and reinsurance companies engaged in high-risk
underwriting activities have better nancial performance
138 M. Adams and M. Buckle
4
Insurance claims are excluded from the measurement of operational performance because they are liabilities and not operating items
(Gardner and Grace, 1993). One acknowledges, however, that there may be some distortion in underwriting performance between
companies arising from the writing of long-tail (e.g. liability) risks. Nonetheless, an analysis of premiums by type of risk underwritten
could not be carried out from the available data. In addition, as most underwriting expenses will be managerial salaries the extent of
possible distortion arising from the writing of long-tail business in the sample is unlikely to be substantial.
5
It is acknowledged that studies from various international nancial services industries/markets (e.g. Grace and Timme, 1992; Gardner
and Grace, 1993; Hardwick, 1997) have used multi-product statistical models to examine the input and output eciencies of rms.
However, again data limitations precluded such tests from being carried out in this study. Furthermore, the absence of data, such as
stang levels, labour input prices and the types of policies underwritten prevented non-parametric estimates of eciency to be computed
through data envelopment analysis (DEA) (e.g. see Worthington, 2000).
6
In the insurance industry, prot-related indicators, such as the return on assets, are invariably subject to inter-period actuarial
smoothing (e.g. via the manipulation of loss reserves), thereby limiting their usefulness as clean measures of annual corporate perform-
ance (e.g. see Petroni, 1992).
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than those companies that are less inclined to take under-
writing risks. This implies that managerial innovation and
risk-taking behaviour could realize short-term cash ow
benets for companies. The statistically signicant inverse
correlation between PERF and LIQ (at the 0.01 level, two
tailed) suggests, as expected, that companies with low
liquidity have better nancial performance than companies
with high liquidity. Although correctly signed, the corre-
lation coecients in Table 2 indicate no statistically signif-
icant association between PERF and lnSIZE and PERF
and TYPE. A MannWhitney U test (one-tailed) was
also conducted to determine whether there was any statis-
tical dierence between the medians for PERF sub-groups
where the sub-groups are classied by the binary indepen-
dent variables TYPE and SCOPE. Consistent with the
results of correlation analysis, no statistical signicance
between the median performance of direct insurers and
reinsurance companies was found for each of the ve
Determinants of Bermudan corporate nancial performance 139
Table 2. Bermudan insurance and reinsurance companies, 19931997 correlation coecients (panel data
208 company/year observations)
Variable PERF lnSIZE URISK LEV LIQ TYPE
PERF
LnSIZE 0.043
URISK 0.550* 0.084
LEV 0.423* 0.044 0.175*
LIQ 70.485* 70.133 70.167* 70.485*
TYPE 70.106 0.382* 70.146* 70.257* 0.203*
SCOPE 0.098 0.486* 0.090 0.181* 70.140* 0.386*
Notes:
1. PERFoperational performance the percentage dierence between the ratio of annual operating
expenses (including commission) plus net premiums written, and the ratio of net investment income to
net premiums earned; lnSIZErm size the natural log of total assets; URISKunderwriting risk
annual losses incurred (net of loss adjustment expenses) divided by annual premiums earned; LEVLever-
age ratio of net technical reserves (after deducting any reinsurance share) to capital/surplus; LIQliquid-
ity cash and cash equivalent current assets over current liabilities; TYPEcompany type dummy
variable, direct insurer 0, reinsurance company 1; SCOPEscope of operations dummy variable,
single country operative 0, multinational insurer 1.
2. Correlations involving the non-metric variables TYPE and SCOPE were computed using the Spearman
rank test. The remaining correlation coecients were computed using the Pearson product-moment test.
3. * Statistically signicant at 0.01 (two-tailed).
Table 1. Bermudan insurance and reinsurance companies, 19931997 descriptive statistics (panel data 208
company/year observations)
Standard
Variable Mean Median deviation Minimum Maximum
PERF 0.454 0.587 0.592 70.999 3.320
lnSIZE 0.498 0.412 0.674 72.045 0.889
URISK 0.665 0.643 0.495 0.000 4.999
LEV 1.450 1.100 1.503 0.000 7.300
LIQ 2.642 1.460 2.879 0.005 10.000
TYPE 0.327 0.000 0.470 0.000 1.000
SCOPE 0.596 1.000 0.492 0.000 1.000
Notes:
1. PERFoperational performance the percentage dierence between the ratio of annual operating
expenses (including commission) plus net premiums written, and the ratio of net investment income to
net premiums earned; lnSIZErm size the natural log of total assets; URISKunderwriting risk
annual losses incurred (net of loss adjustment expenses) divided by annual premiums earned; LEVLever-
age ratio of net technical reserves (after deducting any reinsurance share) to capital/surplus; LIQliquid-
ity cash and cash equivalent current assets over current liabilities; TYPEcompany type dummy
variable, direct insurer 0, reinsurance company 1; SCOPEscope of operations dummy variable,
single country operative 0, multinational insurer 1.
2. Non-parametric KruskalWallis tests on the annual variation of variable means indicated no major
changes in the nature of the Bermudan insurance/reinsurance industry over the ve years (19931997).
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years. In addition, the median performance of single coun-
try insurers was found not to be signicantly dierent from
the median performance of multinational insurers for each
of the ve years in the sample. These results suggest that
the type of company and the scope of its operations may
not be important inuences on corporate nancial per-
formance in the Bermuda insurance market.
Multivariate results
To supplement the univariate results and allow for poten-
tial interactions among the variables, a multivariate panel
data analysis was also carried out. Table 3 thus presents the
common-eects results for the pooled rm/year observa-
tions for the sample of Bermudan insurance/reinsurance
companies for the ve-year period 19931997 N 208.
They indicate that with the exception of lnSIZE and
SCOPE the independent variables are statistically signi-
cant at the 0.01 level in a one tail test. However, of the
statistically signicant independent variables, URISK does
not have the predicted sign. The main dierence between
the univariate and multivariate results is that the coecient
for TYPE is now both statistically signicant and has the
expected sign.
Consistent with the hypothesis (H3) set out in Section
III, LEV was found to have the correct (positive) sign and
was statistically signicant at the 0.01 level (one tailed),
indicating that companies with high nancial leverage
have better performance than companies with low nancial
leverage. This result is consistent with the univariate analy-
sis and supports Jensens (1986) free cash ow hypothesis
that predicts that high leverage tends to commit managers
140 M. Adams and M. Buckle
Table 3. Bermudan insurance and reinsurance companies, 19931997 multivariate results
(panel data 208 company/year observations)
Predicted signs Coecient Standard t-statistics
Variable = estimates errors (one-tailed)
LnSIZE 70.043 0.122 70.355
URISK 0.574 0.105 5.459*
LEV 0.099 0.017 5.782*
LIQ 70.055 0.017 73.139*
TYPE 0.163 0.058 2.816*
SCOPE 70.046 0.074 70.627
INTERCEPT? ? 70.043 0.122 70.355
F
11;197
= 18.522 (probability 0.000, two tailed); adjusted R
2
0.458
Notes:
1. The common-eects model estimated in this study is:
PERF
it

0it

1
lnSIZE
it

2
URISK
it

3
LEV
it

4
LIQ
it

5
TYPE
it

6
SCOPE
it

7
YR1
8
YR2
9
YR3
10
YR4
11
YR5 "
it
where PERF
it
operational performance the percentage dierence between the ratio of
annual operating expenses (including commission) plus net premiums written, and the
ratio of net investment income to net premiums earned; lnSIZE
it
rm size the natural
log of total assets; URISK
it
underwriting risk annual losses incurred (net of loss
adjustment expenses) divided by annual premiums earned; LEV
it
Leverage ratio of
net technical reserves (after deducting any reinsurance share) to capital/surplus;
LIQ
it
liquidity cash and cash equivalent current assets over current liabilities;
TYPE
it
company type dummy variable, direct insurer 0, reinsurance company 1;
SCOPE
it
scope of operations dummy variable, single country operative 0, multi-
national insurer 1.
0it
is the constant, which is assumed to be identical for all panel
members; YR1 . . . YR5 are time eects; "
it
represents an error term assumed to have a
zero mean and constant variance.
2. * Statistically signicant at 0.01 (one tailed)
3. The computed Whites statistic (
2
37:24 with 10 degrees of freedom) rejects the
hypothesis of homoscedastic errors at the 5% signicance level. The reported standard
errors are therefore the White heteroscedasticity-consistent standard errors. The Jarque
Bera statistic was 79.02 and therefore the hypothesis of normally distributed residuals is
rejected. Variance ination factors are all less than two, suggesting that the coecient
estimates are not rendered inecient by the eects of multicollinearity. Correlation
between adjacent years residuals is 0.208 and is signicant at the 5% level (two tail).
4. The year dummies (not reported in Table 3) are all insignicant. In addition, an F-test
(F-statistic 1.150 which is insignicant at the 0.05 level in a one-tail test) indicates that
the year dummies together are not signicantly related to the dependent variable.
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to generating cash ows in order to full their obligations
under debt (insurance) contracts. Again, consistent with
the univariate results and prior expectations, LIQ was sta-
tistically signicant at the 0.01 level in a one tail test. This
nding supports the hypothesis that companies with low
liquidity will have better nancial performance as low
liquidity can lower agency costs and provide an incentive
for managers to improve performance (H4). Also, con-
sistent with our expectation (H5), the binary variable
TYPE was found to be positively related to nancial per-
formance and statistically signicant at the 0.01 level (one
tailed). This conrms the prediction that reinsurance com-
panies, with their ability to realize economies from diversi-
cation and bear lower costs of regulatory compliance, are
likely to have better nancial performance than direct
insurers.
Contrary to the hypothesis (H2), URISK was inversely
related to nancial performance at the 0.01 level (one
tailed). This observation appears to support the view that
nancial intermediaries that give their managers underwrit-
ing discretion to evaluate the risk-return potential on a
case-by-case basis could realize economic benets from
increased levels of new business premiums and/or reduced
ex-ante screening costs. Consistent with the univariate
results, no statistically signicant relation could be found
for lnSIZE and SCOPE. This suggests that company size is
not a determinant of nancial performance in Bermudas
insurance market (contrary to H1), and as such, manage-
rial innovation and competitive capabilities are likely to be
evenly distributed across the entire size range of companies.
It also implies that the espoused benets of being a multi-
national company do not lead to better nancial perform-
ance (contrary to H6), suggesting that the risk management
benets of international diversication may be overstated.
The fairly high degree of association between lnSIZE
and SCOPE indicated in Table 2 indicates that the largest
Bermudan insurance and reinsurance companies are likely
to be multinational organizations. There is therefore a
potential for multicollinearity in the estimation (discussed
below). However, dropping one of the two variables and
keeping the other in the estimation did not lead to either of
the two variables becoming statistically signicant.
Interaction terms between lnSIZE and TYPE and lnSIZE
and SCOPE were also not statistically signicant suggest-
ing that in the sample the nature and extent of business
activities are not inuenced by company size. Additionally,
dummy variables for each of the ve years were included in
the estimation to test for year-eects but none of these were
found to be signicant using a t-test at the 0.01 level (two
tailed). This result suggests that there was no statistically
signicant dierence in the annual nancial performance of
the companies in our data set. The model was re-estimated
without the year dummy variables giving an adjusted R
2
of
0.457 indicating that the time-eects do not contribute sub-
stantially to the models explanatory power. To conrm
this, the YR variables were tested jointly using an F-test.
The computed F-statistic of 1.156 was not signicant at the
0.05 level (one tailed).
Diagnostics and sensitivity tests
Formal diagnostic tests on the estimated model were also
carried out. First, homoscedasticity of the residuals was
tested for using Whites test. The computed statistic
(
2
37:24;
2
crit
18:31, with 10 degrees of freedom)
means the hypothesis of homoscedastic errors could not
be supported at the 5% level of signicance. As a conse-
quence the reported standard errors in Table 3 are White
heteroscedastic-consistent standard errors. Normality of
the residuals was tested using the Jarque-Bera statistic
and the null hypothesis of normally distributed errors
was rejected at the 0.05 level (
2
79:02,
2
crit
5:99,
two degrees of freedom). However, econometric sources,
such as Kmenta (1971: 2478), suggested that non-normal
disturbances are common in small data sets and so this
limitation is an unavoidable constraint of the research
design.
The statistically signicant correlations between some of
the independent variables reported in Table 2, raises the
possibility that interpretation of the coecients may be
inecient due to multicollinearity. However, it was felt
that omitting the oending variables could lead to model
misspecication. Moreover, Judge et al. (1982: 620) con-
sider that correlation coecients are only indicative of ser-
ious collinearity if they exceed 0.80 and if the regression
model employed is associated with a high R
2
and statisti-
cally insignicant t-statistics among all the coecients. As
Table 3 makes clear, these conditions do not exist in this
study. However, as multicollinearity can exist between
more than two independent variables at the same time,
variance ination factors (VIFs) were calculated for the
independent variables to ascertain the magnitude of hidden
collinearity.
7
Since none of the computed VIFs were more
than two, we conclude that multicollinearity is unlikely to
be a problem in this model (e.g. see Gujarati, 1995: 3389).
Finally, the correlation between adjacent years residuals
was found to be 0.208 and statistically signicant at the
0.05 level (two tailed). This suggests that a degree of non-
randomness might be present in the residual errors.
Nonetheless, the low correlation coecient of 0.208 indi-
cates that the eciency of the parameter estimates is un-
likely to adversely aected.
Determinants of Bermudan corporate nancial performance 141
7
The variance ination factor is calculated as 1=1 R
2
where R
2
is derived from regressing each independent variable on all other
independent variables.
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Additionally, as recommended by Kennedy (1995: 95), a
regression specication error test (RESET) was conducted
to examine whether the functional form of our model suf-
fered from misspecication error and/or omitted variable
bias. The computed F-statistic of 1.893 indicated that the
null hypothesis of no functional misspecication could not
be rejected at the 0.05 level (one tailed). Kennedy (1995)
also reported that the RESET test is useful for detecting
non-linearity in the data. The lack of signicance of the
RESET statistic, however, suggests that the linear speci-
cation we used in this study is well specied.
Finally, a Hausman specication test was performed to
examine whether lnSIZE might be endogenous with PERF.
If this were the case, then the OLS estimates would be
biased and inconsistent. The Davidson and Mackinnon
(1989) version of the Hausman specication test was there-
fore conducted by running an auxiliary regression of
lnSIZE on all the exogenous variables and an instrument
variable. The chosen instrument was a categorical meas-
ured variable for nancial size reported in A.M. Best
(1999). This variable is measured on a 15-point scale
from 15 (large) to 1 (small) and is designed to provide a
composite indicator of company size derived from the
aggregate assessment of a companys equity capital, accu-
mulated surplus and reserves. As such, it is an ordinal
measure of the degree of a companys nancial strength
and its capacity to write insurable risks. The residuals
from the auxiliary regression were then included as a vari-
able in the estimation of the main equation. The coecient
of this variable was found to be not signicantly dierent
from zero in a one-tailed test indicating that an endogene-
ity problem does not exist. Consequently, the regression
estimates presented in Table 3 are judged to be unbiased
and consistent.
VI. CONCLUSION
This study performed an empirical test of the determinants
of nancial performance among companies in Bermudas
insurance market using a framework derived from the
organizational economics literature. It was found that, as
expected, highly leveraged, lowly liquid companies and
reinsurers have better nancial performance than lowly
leveraged, highly liquid companies and direct insurers.
Contrary to what was hypothesized, nancial performance
was positively related to underwriting risk. However, the
size of companies and the scope of their activities were not
found to be important explanatory factors. The results,
particularly in respect of underwriting risk, are generally
supportive of the view widely reported in the practitioner
literature (e.g. see Wyn, 1998) that the recent success of
Bermuda-based nancial services rms is founded on
underwriting innovations and the design of new risk-
based products (e.g. nite insurance). The results for the
nancial leverage and liquidity variables also support the
notion that economic advantages can be realized from the
ecient management of capital and cash resources. In par-
ticular, high nancial leverage can provide an important
incentive for managers to generate free cash ows in
order to meet the future xed claims of policyholders.
The absence of a discernable size and multinational busi-
ness eects in our results further suggests that Bermudan
licensing authorities are correct to encourage an open mar-
ket to new entrants. Therefore, a key implication arising
from this research is that the evidence appears to vindicate
the current licensing policy of the Bermudan authorities
and supports the case for a continuation of this strategy.
The results could also be informative to other oshore
nancial centres such as those in the Caribbean and the
British Channel Islands, and could support the case for a
non-discriminatory inward investment strategy in those
jurisdictions. It was acknowledged that interpretation of
the results should be tempered by recognition of the limita-
tions in the study such as the small sample of companies
used. However, where possible, one has attempted to con-
trol for these limitations by employing a panel data design
and testing the model against a battery of diagnostic tests.
The authors thus feel that the results are generally applic-
able to other oshore centres and as such, the study could
encourage others to investigate ways of overcoming the
data availability problem and carry out further research
in these important international nancial markets.
ACKNOWLEDGEMENTS
The assistance of Philip Hardwick and Alan Watkins dur-
ing the course of this study is gratefully acknowledged. The
article also beneted from the comments of participants at
a seminar hosted by the School of Finance and Law,
University of Bournemouth. However, the normal disclai-
mer applies.
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Determinants of Bermudan corporate nancial performance 143
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