Bermuda will continue to thrive in the global insurance market but it will face significant challenges in the years ahead, according to credit rating agency Fitch Ratings.

In its first commentary specifically on the state of the Bermuda market, Fitch said the Island's tax and regulatory environments, assembled underwriting talent and innovative risk management practices are the key factors to the Island's success and will continue for the foreseeable future.

However, Fitch added that efforts to eliminate the Island's tax advantage and coping with its high cost structure would be challenges for the industry to face.

And the agency said outsourcing of "back-office" jobs to overseas locations by Bermuda insurers was likely to continue in the future.

Fitch also estimated that Bermuda-based insurance and reinsurance companies had an effective tax rate advantage of their US-based rivals of 15 percent. It added that changes in US tax law to remove that advantage was unlikely to happen in the near term, despite vigorous private-sector lobbying.

"For the third time in the past 20 years, a group of large US-based property/casualty insurers have challenged the current tax system," Fitch said. "These mostly older, well-established US insurance companies, include Berkshire Hathaway, Liberty Mutual, W.R. Berkley Corp. and Chubb, among others, and they view the current system as unfair.

"From a practical perspective these companies are unable to relocate to Bermuda because doing so would require them to revalue assets, and in most cases, recognise large capital gains.

"Fitch believes that the political manoeuvring required to pass legislation altering the current tax system is extensive, and unlikely to occur in the near term."

The report adds that insurance capacity and the cost of insurance remain a sensitive issue in politically important coastal areas, such as Florida, New York and Texas. And that is another factor in Bermuda's favour.

"Fitch believes that opponents of legislation to effectively increase taxes on Bermuda (re)insurers could convincingly argue that doing so would reduce (re)insurance capacity and thus increase the cost of insurance," the report states. "Additionally, Fitch believes that Washington's reluctance to give up tax revenue makes legislation that would reduce taxes on US (re)insurers, to level the playing field between them and their Bermuda-domiciled competitors is even more unlikely."

The 15-percentage-point tax advantage that Fitch says Bermuda companies have over their US insurance rivals, a calculation based on data from the past four years, is "the single most important factor in Bermuda's emergence as an important (re)insurance market", the report deduces. "Bermuda-domiciled (re)insurers' ability to access the US market while retaining their low effective tax rates attracts capital and management talent, and provides pricing advantage in the marketplace," Fitch adds.

The agency stressed that the Bermuda market achieved a median net return on average equity 3.3 percentage points better than the US market — 1.8 percentage points better pre-tax — indicates Bermuda's profitability advantages are "not derived solely from its tax status".

Fitch's outlook for the Bermuda market is stable. Factors that could lead the agency to change its outlook to negative include a further deterioration in soft-market conditions, especially if that is accompanied by "shock" catastrophe- or investment-related losses.

Challenges faced by the Bermuda market included finding housing for staff, attracting talent to a tiny and geographically isolated location, and obtaining work permits, which Fitch says "can be a difficult and lengthy process".

While companies will likely continue to overcome these obstacles for senior management and underwriting staff, Fitch adds: "In response, several (re)insurers have decided to conduct such functions in locations other than Bermuda, and Fitch expects this trend to continue for the foreseeable future."