Reinsurers mull options as US tax hike looms
Bermudian reinsurers are weighing restructuring options in response to US tax reform legislation that could be signed by President Donald Trump as early as this week and come into effect by the start of next year.
Tax expert Will McCallum said that the island’s major industry will see its cost of doing business going up when the reform takes effect and some companies will likely have to relocate hundreds of millions of dollars of capital to the US. However, judging from conversations with clients, he views a mass exodus of jobs from the island as unlikely.
Mr McCallum, managing director and head of tax for KPMG in Bermuda, was speaking at a US tax reform update session hosted by the Bermuda Chamber of Commerce on Friday morning.
“I don’t see how anybody can say this a good thing for Bermuda, but it doesn’t feel apocalyptic,” Mr McCallum said.
Late on Friday, US Republicans put forward the latest version of the Tax Cuts and Jobs Act fashioned from the different Bills passed by the House of Representatives and by the Senate.
Members of the House and Senate are expected to vote on it this week, with Republicans hoping to get it to President Trump’s desk before Christmas.
The US corporate tax rate will be slashed from 35 per cent to 21 per cent, reducing Bermuda’s tax advantage over US rivals.
But perhaps the biggest direct impact for the island will come from the Base Erosion and Anti-Abuse Tax, known as Beat. It will hit Bermudian insurance groups with US subsidiaries, which cede premiums to their affiliated reinsurers in Bermuda, by effectively levying a 10 per cent tax on the transaction, rising to 12.5 per cent from 2026.
This will impact several major groups including XL Catlin, Arch Capital and Axis Capital.
Mr McCallum told a business audience, which included John Rankin, the Governor, and Wayne Furbert, the Junior Minister of Finance, that his impacted clients in the insurance industry had been working on their restructuring options.
He said Beat would effectively be a gross tax with no apparent deductibles. The Bill includes an option to be taxed as a US entity — with regard to affiliated US business — instead of paying Beat, an option that Mr McCallum believes most impacted groups will take.
If the Bill becomes law before the end of the year, Beat will come into effect on January 1, 2018, meaning insurance companies face a “busy couple of weeks” preparing. For the first taxable year, the rate will be a reduced 5 per cent.
Mr McCallum explained that many US subsidiaries of Bermudian insurance groups used quota-share reinsurance contracts with their parent companies, to transfer substantial amounts of risk from the US to the Bermuda balance sheet. He argued that this was “a standard way of managing risk, not a tax play”.
Much of the premium goes back to the US in the form of ceding commissions and claims, Mr McCallum said. And he added that the diversification of global risk and scale of the Bermuda balance sheet was what allowed Bermudian insurance groups to take on so much American risk.
He said the 10 per cent Beat tax was “not a gross tax, but it works that way” and would be so punitive to affiliated quota-share deals that most groups would take the option to file as a US taxpayer for this particular part of their business.
They would effectively “draw a box around their US earnings” and pay US corporate tax on those profits.
“Why would a Bermuda company opt to be a US company for tax purposes?” Mr McCallum said. “Because it’s a better outcome.
“The bad thing is that they will have to restructure their businesses in a way that they don’t want to, not for good business reasons. It will mean that some capital will have to be relocated to the US to satisfy the regulators. But the bottom line is that there may not be much change in Bermuda.”
Bermuda reinsurers write business from all over the world that will be unaffected by the US tax changes, he said. Also, Beat would not apply to third-party business from the US.
He did not expect to see mass relocation of underwriting teams to the US, but he said this would depend on each group’s circumstances and its concentration of US business.
The Association of Bermuda Insurers and Reinsurers is a member of the US-based Coalition for Competitive Insurance Rates, which expressed “disappointment” over the latest version of the Tax Cuts and Jobs Act and urged a rethink.
The effect of Beat would be to “unfairly slap US consumers and small businesses with higher insurance premiums — undoing potential tax relief they had hoped to get from this bill”, the CCIR stated.
“The global insurance and reinsurance industry is concerned that Congress would include a provision in the Tax Cuts and Jobs Act that will serve only to ‘Americanise’ risk by decreasing capacity benefits to insurance markets globally, thus increasing US prices.
“This is truly a blow to consumers and business, particularly those in Florida, Texas, California, South Carolina, Louisiana and other disaster-prone states who rely on this capacity in times of catastrophe.
“The only winner under the double-taxation that will result from Beat is a group of highly successful domestic insurance companies who stand to benefit greatly from the market distortion this provision will trigger. CCIR welcomes continued dialogue on this issue.”
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