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The offshore reinsurance tax debate resurfaces in Congress again

Domestic-owned insurers claim Bermuda-based companies hold an unfair tax advantage

An industry executive, representing a coalition of 14 large U.S.-based insurance groups, told the U.S. Senate Finance Committee late last month that a major tax advantage for certain foreign insurance groups could threaten the future of the domestic insurance industry.

The tax advantage allows foreign insurance groups based in places such as Bermuda or the Cayman Islands to legally avoid paying billions of dollars in taxes on much of their U.S. underwriting and investment income, said William R. Berkley, chairman and CEO of W. R. Berkley Corporation and spokesman for the Coalition for a Domestic Insurance Industry.

Berkley and the Coalition say the tax advantage, which originated in practice around 20 years ago, has already caused significant migration of insurance capital abroad. Berkley said the tax advantage permits foreign-based insurers with U.S. affiliates to move much of their taxable underwriting and investment income from their U.S.-based businesses out of the country merely by reinsuring the business with a foreign affiliate in a low-tax or no-tax jurisdiction. This type of reinsurance transaction generally requires a mere bookkeeping entry to shift revenue from one pocket to another and out of the reach of U.S. taxing authorities, Berkley noted.

“By contrast, U.S.-based insurers must pay current U.S. tax on all of their income from these policies,” he told the committee. “Thus, even though the U.S. income-generating activities are the same, these foreign-domiciled insurers can avoid U.S. tax on much if not all of their underwriting and investment income.”

A report for the hearings, prepared by the Senate Staff — “Present Law and Analysis Relating to Selected International Tax Issues” — describes the opposing points of view. “Insurance company reinsurance transactions with offshore reinsurers, particularly affiliated reinsurers, have been characterized as creating the potential for tax avoidance and as causing a competitive disadvantage for U.S. insurance businesses. At the same time, reinsurance is a fundamental component of global risk management techniques.”

Recurring concern

The last time Bermuda-based insurers were called into question in Congress was in 2000, when supporters of HR 4192, or the Johnson/Neal bill, proposed legislation aimed at ending “favorable tax treatment” for foreign based insurers, principally those located in Bermuda. The main backers then were Chubb and The Hartford, which are also members of the current coalition. The bill was reintroduced in 2001, but failed to get approval.

While Bermuda-based insurance companies are considered foreign-owned, many such as ACE Limited and XL have strong ties to and a large presence in the U.S. market, and insist they are not trying to avoid taxation.

Bradley Kading, president and executive director of the Association of Bermuda Insurers and Reinsurers, summarized the points his organization focuses on. “1) Bermuda’s substantial economic contribution to the United States; 2) Bermuda’s insurers’ role in filling U.S. insurance market needs; 3) Explaining that U.S. insurers do substantial affiliated reinsurance transactions for the same business reasons (risk transfer, avoiding trapped capital, diversification) that Bermuda reinsurers do them; 4) Bermuda insurers are primarily in Bermuda for ease of entry into insurance markets and that Bermuda regulation affords insurers an opportunity to quickly form an insurer and start writing business in time to take advantage of new market opportunities.”

In a written statement presented to the Senate Finance Committee, Donald Kramer, chairman and CEO of Bermuda-based Ariel Reinsurance Co., pointed out that “a substantial percentage of U.S. insurance companies cede more that half of the gross premiums they write to reinsurers. Affiliate reinsurance is used routinely with the U.S.-based insurance company groups, for valid non-tax reasons.” The practice enables related groups of companies to “pool risks and mange them more efficiently.”

He joined company past and present Bermuda leaders — notably Brian Duperreault, former CEO and chairman of ACE Limited, and Brian O’Hara, who founded and still leads XL — in observing: “First and foremost we are in Bermuda because we can quickly deploy our capital, form a company, get licensed and write insurance.”

Kramer said it is “simply incorrect” that Bermuda companies are located on the island “to avoid U.S. taxation.” He pointed out that a reinsurance transaction, even among affiliates, “involves the true transfer of risk.” In addition “regulation requires the price in a reinsurance transaction to be an arm’s length price,” he continued.

Kramer isn’t alone, nor is he supported solely by ABIR members. Attached to his statement were letters from Risk and Insurance Management Society President Michael Liebowitz and Bill Newton, executive director of the Florida Consumer Action Network.

“RIMS has a history of opposing any legislation that encumbers free market movement and the transfer of risk that is vital to a sound global insurance and reinsurance community,” wrote Liebowitz. “We strongly urge you to oppose any legislation that would result in negative implications for the global reinsurance marketplace and more importantly, those U.S. businesses who rely on this market to manage their risk exposure.”

Nelson was even more specific. “We urge you [the Senate Finance Committee] to be on the lookout for amendments proposed this summer and fall that offer hundreds of millions in additional revenue that in the end will be paid for by Florida consumers!” Nelson wrote. “It’s not a good deal and these amendments should be exposed as protectionist measures by U.S. insurers seeking to grab more business for themselves by increasing the taxes on their non-U.S. competitors.”