Protectionism poses threat to reinsurers
The US tax overhaul is symptomatic of growing protectionism around the world threatening the global business model of Bermudian reinsurers.
That is the view of Bradley Kading, outgoing president of the Association of Bermuda Insurers and Reinsurers, who added that provisions in new tax laws that discriminate against foreign reinsurers could spark a trade war between the US and the European Union.
The US reforms, which will slash the US corporate tax rate to 21 per cent from 35 per cent, and which will levy a base erosion anti-abuse tax on affiliated reinsurance business, will have an “individualised” impact among Abir members, Mr Kading said.
Meanwhile analysts at US investment bank Keefe Bruyette & Woods said they expected such intra-company cessions to “largely disappear” under the impact of Beat.
While US domestic insurers would be the winners under tax reform, consumers would be the losers, Mr Kading argued.
He said that according to economic reports partly funded by Abir, affiliated reinsurance represents about $18 billion of supply to the US market, or about one eighth of the total reinsurance market — and the loss of it could lead to US consumers paying more than $5 billion a year extra for insurance.
It would also require insurers to hold tens of billions of dollars more in capacity simply to cover today’s probable maximum losses.
“The bigger picture is that this US tax law is an example of growing protectionism around the world,” Mr Kading said.
“We estimate that there are 24 jurisdictions with restrictions on cross-border reinsurance. If you are a global reinsurer and your business model is to pool global risk on one balance sheet to get the benefits of diversification, then protectionism, in the form of regulation or tax provisions, is dangerous.”
Before the US Congress passed the Tax Cuts and Jobs Act, finance ministers from the largest EU economies, as well as the Swiss Government and the European Commission, all wrote to the US Treasury stating that new legislation would be in breach of international trade rules.
The possibility of retaliation by the EU and a potential consequent trade war could spark further protectionism and greater difficulties for global businesses like Bermuda reinsurers, Mr Kading added.
The outgoing Abir president, who retires at the end of this year to be replaced by John Huff, added that it was impossible to gauge the impact on the Bermuda market as a whole.
“There are four separate and distinct parts of the market: captives, property and casualty, life and the alternative capital sector — and the tax legislation will affect these different sectors very differently,” Mr Kading said.
Company impact will depend partly on the concentration of US business, particularly that written by a US subsidiary which then cedes premiums back to the Bermudian reinsurer. This affiliated business is targeted by Beat, which effectively imposes a gross tax of 5 per cent on these transactions next year, rising to 10 per cent from 2019 and 12.5 per cent from 2026. Beat was “designed to be punitive”, Mr Kading said.
According to Meyer Shields, an analyst with Keefe Bruyette and Woods, the new tax will not only virtually end the practice of cross-border affiliated reinsurance, but will also make third-party business — not impacted by Beat — less attractive.
“From a financial perspective, we think lower domestic US tax rates will roughly offset taxes associated with intra-company cessions (particularly excise taxes and taxes applied to presumably profitable ceding commissions) that we think will largely disappear under the new tax regime, which is why our Bermudian earnings per share estimates aren’t changing much.
“On the other hand, we think there’s something of a strategic downside to the Bermudians, for two reasons. First, they are losing the pricing advantage embedded in tax rates that had been lower than those anticipated for domestic carriers.
“Second, and probably less significant, the shrinking difference between US and Bermudian tax rates means an incrementally smaller opportunity for tax arbitrage that should incrementally reduce demand for reinsurance.
“This is not to suggest that tax arbitrage outranks capital needs and earnings and/or balance sheet protection as a motivation for buying reinsurance. But it seems important to recognise that on the margins, one of the benefits of buying reinsurance from unaffiliated third parties is declining.”
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