The Offshore Tax Debate – Déjà vu – All over Again

By | September 28, 2007

At least that’s how Yogi Berra might describe it. On Sept. 25 William R. Berkley, chairman and CEO of the company of the same name, gave a detailed indictment before the Senate Finance Committee of the iniquities visited upon U.S. taxpayers by “Foreign-Owned Insurers” (See IJ web site Sept. 26).

The last time this question surfaced 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 Hartford, which are also members of the current “Coalition for A Domestic Insurance Industry,” on whose behalf Berkley testified. The Bill was reintroduced in 2001, but failed to get approval.

It should perhaps also be noted – not coincidentally – that in 2000 the industry was entering one of its “soft market” cycles, just as it seems to be doing now. The complaint was pretty much the same as well. Congresswoman Nancy Johnson, R-Conn., said that the current tax law “not only deprives our country of tax revenues, but it gives foreign companies an unfair advantage over U.S. owned companies and their workers.”

The phrase “foreign-owned insurers” conjures up visions of stealthy Swiss bankers and bowler hatted Englishmen poaching America’s righteous worth. One blogger on the IJ web site accused them of “eating our lunch.”

A closer examination of Bermuda-based companies, however, reveals that most of them aren’t so foreign after all. ACE Limited and XL have strong ties to and a large presence in the U.S. market.

The newer Bermuda specialty companies, mainly formed after the Sept. 11 attacks, do, too: A partial list of the founders and original investors of those companies includes the following:
— Endurance Specialty Insurance Limited – Aon and Zurich.
— Allied World Assurance Co. (AWAC) – AIG, Chubb, Goldman Sachs
— Axis Capital Holdings Ltd. (AXIS) -Marsh’s Trident II Investment Trust, CSFB, The Blackstone Group, J.P. Morgan and Thomas Lee
— Arch Capital – Warburg Pincus and Hellman & Friedman private investment funds
— Montpelier Re – White Mountains Insurance Group and Benfield
— Platinum Underwriters – spun off from The St. Paul

The list should also contain Harbor Point Limited, a Bermuda-based reinsurance company established in 2005 by Trident III, L.P., a private equity fund [set up by MMC Capital], which is now managed by Stone Point Capital. Harbor Point acquired the ongoing business of Chubb Re, Inc., a Chubb subsidiary, including the renewal rights to Chubb Re’s in-force book of business. Stone Point and Chubb were the principal investors. Commenting on the transaction, Chubb’s Chairman, President and CEO John D. Finnegan indicated: “It’s clear there are dislocations in the reinsurance marketplace as a result of recent catastrophe experience, among other issues. This transaction offers Chubb an outstanding opportunity to leverage its position in that marketplace in a way that should achieve the greatest opportunity for significant upside capital appreciation.”

With the exception of Benfield and Zurich, all of the above companies and investment partnerships are solidly American, which would seem to indicate that “foreign-owned” in this context should be understood to mean simply “offshore.”

Nonetheless Berkley and the coalition do raise a valid point, as do those who oppose amending the current laws. 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. The report can be downloaded at: http://www.house.gov/jct/x-85-07.pdf.

Bradley Kading, president and executive director of the Association of Bermuda Insurers and Reinsurers (www.ABIR.bm) 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 US 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.”

Donald Kramer, chairman and CEO of Bermuda-based Ariel Reinsurance Co., provided the official response. He expanded on Kading’s summary, in a written statement presented to the Senate Finance Committee. Kramer 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 added.

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.” He’s right on that score. Most of the companies named above were formed within four months of the Sept. 11 attacks, which would not have been possible in the U.S.

Kramer also 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; “therefore these transactions must be respected for tax purposes.”

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 US insurers seeking to grab more business for themselves by increasing the taxes on their non-US competitors – taxes ultimately paid by Florida consumers.”

The debate will no doubt continue, as it should. That after all is what democracy’s all about. Ultimately, however, Nelson’s observation carries the ring of ultimate truth. If additional taxes are imposed, in the end it will be the consumers who foot the bill – déjà vu, anybody?

Sources: ABIR (as above); Senate Finance Committee hearing testimony- http://www.senate.gov/~finance/sitepages/hearing092607.htm; Senate Staff report, as above.

Was this article valuable?

Here are more articles you may enjoy.