Congress has passed and President Donald Trump has signed the Tax Cuts and Jobs Act (HR1) into law. It is the biggest tax change in 30 years.
Under the legislation, insurers, agencies and other businesses organized as C corporations will see their statutory tax rate slashed from a top rate of 35 percent to 21 percent starting next month. That is considered a “huge win” for the property/casualty insurance industry, as one lobbyist worded it.
There is some good news for other insurance agencies, too. The legislation adjusts taxpayer income brackets and lowers individual tax rates; rates will range from 10 percent to 37 percent in 2018. The reform benefits so-called “pass-through” businesses including S corps, partnerships and sole proprietorships—which many insurance agencies are — and whose pass-through income will continue to be taxed at individual rates. Some smaller pass-through service business owners (including in insurance) will also be able to deduct 20 percent of business income if their annual taxable income does not exceed $157,500 (single) or $315,000 (joint).
At the same time, the law almost doubles the standard deduction.
The corporate tax cuts are permanent, while the 20 percent pass-through deduction and individual tax rate changes are scheduled to expire at the end of 2025 unless Congress acts.
The new law also closes the so-called “Bermuda insurance loophole” that has allowed non-U.S. insurers and reinsurers with U.S. subsidiaries to avoid paying U.S. taxes by ceding reinsurance to their non-U.S. affiliated reinsurers in Bermuda and the Cayman Islands. This change has been a goal of a coalition of 12 major U.S. insurers for years.
Most commenters from the property/casualty insurance industry are pleased with the outcome, even if they did not get everything they wanted. Here is some of what insurance trades and analysts are saying:
Keefe, Bruyette & Woods analysts including Managing Director Meyer Shields, who specializes in property/casualty insurance industry, updated EPS estimates and target prices in light of the tax bill. Following is an edited partial summary of KBW analyst updates for P/C insurers:
“The primary changes are 1) the lower corporate tax rate; 2) the likely near-total discontinuation of intra-company cessions to non-U.S. affiliates; 3) the elimination of tax-friendly intra-company debt, and 4) adjustments to deferred tax assets and liabilities. Along with this initial financial exercise, several secondary consequences should emerge over time, including the following:
4Q17 Could Contain “Kitchen Sink” Reserve Charges: Domestic 4Q17 reserve development will carry a 35 percent tax rate, which implies a smaller after-tax impact on earnings and capital than the same development would in 2018’s lower tax era. We think this will motivate some insurers to either report bigger reserve charges or smaller reserve releases than would happen without the tax bill backdrop. We obviously don’t expect this consideration to be made explicit, and we’re not suggesting explicitly fraudulent behavior, but at the very least, it seems reasonable to expect the timing of reserve development (and, for that matter, other potential charges) to reflect the economics of changing tax rates.
P&C Pricing Should (Eventually) Reflect Lower Taxes: The P&C insurance industry’s longstanding track record of price competitiveness (other than when underwriting and expected returns are obviously inadequate) strongly suggests that the bottom-line benefits of the tax bill will be competed away relatively quickly. The speed with which P&C rates will reflect lower tax rates should vary by line. On the other hand, we expect the brokers to broadly retain the bottom-line benefits of the domestic tax bill, especially since several brokers’ benefits should be offset by the elimination of current tax management strategies.
Bermudian Operating Structure Changes: From a financial perspective, we think lower domestic U.S. tax rates will roughly offset taxes associated with intracompany 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 EPS 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 U.S. and Bermudian tax rates means an incrementally smaller opportunity for tax arbitrage that should incrementally reduce demand for reinsurance.”
The National Association of Mutual Insurance Companies, which has 1,400 member companies, welcomed passage of the Tax Cuts and Jobs Act. The following are excerpts from a statement by Jimi Grande, senior vice president of government affairs for NAMIC:
“For property/casualty insurers, the legislation would slash the tax rate 14 percentage points and eliminate the corporate alternative minimum tax, while maintaining the current effective rate for municipal bond interest, the deductibility of advertising expenses, and current law regarding carrybacks and carryforwards of net operating losses. Also, critical to NAMIC’s smallest member companies, the bill maintains the investment income election for small property/casualty insurers that helps ensure consumers in underserved rural areas continue to have coverage options.
“Given that property/casualty insurance industry’s average effective tax rate has been in the low 30s, a 21 percent corporate rate is a huge win for us. Congress deserves high praise for its ability to balance the very real need to keep our corporate tax rate internationally competitive with the need to ensure that they did not create a fundamental mismatch between the federal tax code and our industry’s regulatory and accounting systems. We think they struck this balance nicely.”
The Independent Insurance Agents & Brokers of America (Big “I”), the largest organization for insurance agents, released a statement from Bob Rusbuldt, Big “I” president and CEO. The following are excerpts:
“This is the most significant tax reform in 30 years, and it will have a positive impact on the membership of the Big ‘I’. The new 21 percent corporate tax rate will provide significant relief to our member agencies classified as C Corps and allow them to grow their business and hire new employees. Furthermore, while no legislation is perfect, the Big ‘I’ would like to thank Republican leaders in the House and Senate for the improvements they made throughout the legislative process which allow a greater number of our small business members organized as ‘pass-throughs’ to obtain more tax relief.
“The Big ‘I’ was also pleased that a provision that would have subjected name and logo royalties to the unrelated business income tax (UBIT) was kept out of the final legislation after being included in earlier versions of the Senate bill. This provision would have left the Big ‘I’ and its state associations with significant new tax liability. Excluding this provision from the final bill will enable the Big ‘I’ and its state associations to continue to provide our small business members with the services they expect and deserve.”
S&P Global Ratings highlighted the potential impact of this legislation on rated U.S. insurers in this release, credit analyst Deep Banerjee:
“U.S. insurers will need to be quite nimble in adapting to the new regime. Although we don’t expect immediate rating changes, the manner in which U.S. insurers adjust to the tax code revisions will determine the longer-term impact on individual company ratings. Additionally, we don’t expect to revise our ratings methodology or ratings expectations for rated insurers as a result of the new tax code.
“At the heart of this tax proposal is the lower corporate tax rate. A 21 percent corporate tax rate is attractive for most corporates, including most insurers, and will result in higher after-tax income in the longer term. Also, there would likely be competitive benefits, especially for U.S. insurers looking to compete in international jurisdictions. But before they can enjoy the benefits of the lower tax rates, some insurers will see a decline in their capitalization due to the write-down of their deferred tax assets (DTA) in line with the new tax regime. We expect this to have a meaningful near-term impact especially for U.S. life insurers and multiline insurers that currently have sizeable DTAs on their balance sheets.
“Another major change being introduced by the tax bill relates to multinational entity taxation rules. Shift to a territorial tax system and the base erosion tax provisions will affect U.S. insurers with international operations as well as foreign reinsurers with admitted U.S. subsidiaries. We expect some degree of repatriation of offshore retained profits to bring cash into the U.S. (from foreign subsidiaries). Conversely, the increased excise tax may result in reinsurers and certain insurers that use offshore reinsurance captives adjusting their capital optimization strategies or product pricing due to the higher taxes.
“Other key aspects of the tax bill include deferred acquisition cost amortization changes and loss-reserve updates that will increase taxable income for life and property/casualty insurers respectively, though it will be offset by the lower effective tax rate. The repeal of the tax penalty associated with the health insurance mandate will worsen the morbidity profile of the individual market, hurting health insurers with meaningful presence in that segment. But overall we don’t expect these changes to have a ratings impact in the near term.
“Overall, 2018 will be a rather active year for insurers as they adapt to the new tax regime. Insurers that are negatively affected in the near term may need to update their strategies for funding any capital deficiencies. Insurers that are positively affected may want to plan to be more opportunistic with the lower tax rate. We will continue to engage with our rated insurers to better understand their near-term and longer-term strategies around the new tax law.”
Excerpts from a statement from the National Association of Professional Insurance Agents (PIA):
“The passage of H.R. 1, the tax reform bill, will benefit owners of small businesses. Many PIA members own independent insurance agencies that are organized as sole proprietorships, partnerships or subchapter S corporations. Such small businesses do not pay corporate income tax. Instead, their income “passes through” the firm and appears directly on their owners’ individual tax returns, where it is taxed as normal income.
“While the bill provides provisions that will result in savings for some pass-through entities, the benefit is limited by an income threshold that will prevent some PIA members from benefitting from the maximum new deduction available to certain pass-throughs. As such, many may opt to reorganize as C corporations, a process that costs money and presents logistical and compliance issues that could be overly burdensome to small businesses. Furthermore, the benefit for pass-throughs, even at its most generous, is not permanent, which leaves small business owners at a disadvantage compared to large corporations. Still, overall this legislation will be a net positive for most PIA members.”
The Coalition for American Insurance represents major U.S.-based insurance groups (Alleghany, Allstate, American Family, American Financial, Berkshire Hathaway, Cincinnati Insurance, CAN, EMC Insurance, Liberty Mutual, The Hartford, Travelers and W.R. Berkley.
“The Coalition strongly supports the final version of the Tax Cuts and Jobs Act. The historic legislation includes a significant reform that will ensure more equal tax treatment for U.S. based insurers and consumers by addressing a longstanding loophole that allowed foreign insurance companies to move their U.S.-generated insurance profits abroad to avoid tax.
“With this agreement, Congress has made good on its promise to create U.S. jobs and to keep American companies competitive in the global marketplace. Importantly, the Tax Cuts and Jobs Act helps to close the tax haven loophole in the current tax code that unfairly rewarded the transfer of profits and jobs overseas. Now, with the inclusion of the Base Erosion and Anti-Abuse Tax (BEAT) to impede the offshoring of profits by foreign companies to tax havens, all insurers operating in the U.S. market will do so on the most level playing field in decades. The BEAT is not discriminatory. Instead, it ensures that all companies doing business in the United States will pay U.S. taxes on that business. This is an important reform that will help maintain a thriving American-based insurance industry and enhance choices for all consumers.
The Coalition for Competitive Insurance Rates (CCIR), representing insurers that fought the closing of the Bermuda reinsurance loophole and imposition of the BEAT, issued a statement, excerpted below:
“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 ‘Americanize’ risk by decreasing capacity benefits to insurance markets globally, thus increasing U.S. 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 what 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.”
Rating agency A.M. Best offered this mixed assessment:
“The insurance industry will see overall benefits from the reduced corporate tax rate as a result of The Tax Cuts and Jobs Act, once it is signed into law; however, partially offsetting the benefits are certain revenue enhancements that will impact life and property/casualty insurers. In particular, a repeal of all net operating loss carrybacks could reduce total adjusted and risk-based capital for life insurers. For life insurers, the repeal of the loss carryback period has the potential to reduce the amount of gross deferred tax assets that can be admitted, thereby reducing capital and surplus. Higher after-tax earnings may offset the surplus declines, but this may take time to emerge. A.M. Best will view companies on a case-by-case basis to determine future surplus expectations as the new law takes effect.
Reserve changes will impact life and P/C companies; however, changes applicable to business in effect as of Dec. 31, 2017 will be spread over the next eight years. While life insurance risk-based capital ratios could be significantly impacted, the required capital in Best’s Capital Adequacy Ratio may not change significantly.
It still remains to be seen how companies’ capital management, product pricing and risk management will be impacted as management of these companies and investors re-evaluate risk and return measures such as effective cost of debt, cost of capital or return on equity.”
Excerpts from a report from Moody’s Investors Service:
“While the Tax Cuts and Jobs Act is broadly credit positive for U.S. companies, the sweeping legislation makes many changes to the tax code, some of which will suppress house prices and are credit negative for other sectors, including the U.S. sovereign. Overall, the tax cuts’ stimulative impact on the economy from increased consumption and investment spending from the private sector is likely to be modest. Ultimately, Moody’s estimates that the tax legislation will spur economic growth in the range of one-tenth to two-tenths of one percent of GDP, due mostly to increased household consumption.
“In the corporate sector, the lower rate and full deductibility of capital spending are credit positive, and largely outweigh the cost of the limitation on interest deductibility for all but a handful of investment grade U.S. companies. Limits on interest deductibility will leave highly leveraged companies worse off.
The banking sector will benefit from the net reduction in lenders’ tax liabilities and an associated improvement in profitability, which will mostly benefit shareholders.
“The bill is also net positive for asset managers and for insurers.
“The legislation is credit negative to the U.S. sovereign, owing to the reality that the cuts do not pay for themselves, and Moody’s estimates the cuts will add $1.5 trillion to the national deficit over 10 years. Higher deficits will put further pressure on the federal government’s finances, which are already facing prospects of increased costs of entitlements. Unless fiscal policy reverses course, Moody’s estimates that the federal government’s debt-to-GDP ratio will rise by over 25 percentage points over the next decade, to above 100 percent. Combined with rising interest rates, debt affordability for the U.S. will weaken significantly.
“The net impact to state and local governments is negative. While the new $10,000 limit on state and local tax (SALT) deductions does not directly impact state or local tax receipts, it will blunt the effect of lower federal rates for many taxpayers. Because the state and local provisions raise the effective tax cost for many taxpayers, public resistance to tax increases will likely rise, and that in turn will constrain local governments’ future revenue flexibility. In addition, if larger federal deficits caused by the tax cuts result in attempts to cut entitlement spending, states will be pressured to backfill cuts to federal funds from their own budgets.
“The SALT change, combined with the higher standard deduction and tighter limit on the mortgage interest deduction, also reduces the tax incentive for home ownership, which is likely to slow home construction and sales, and moderately suppress home values and property tax growth in higher-price markets.”
The American Insurance Association, representing P/C insurers, issued the following statement from David Pearce, vice president and director of tax policy:
“Today, the House and Senate took an important step in reforming our tax code. In addition to a more competitive corporate rate, AIA supports this simpler, fairer approach, especially as it relates to our industry’s unique business model. We look forward to continuing to work with Congress on our remaining priorities.”
The Financial Services Roundtable (FSR) released the following statement from CEO Tim Pawlenty:
“The tax bill will help make American businesses of all sizes more competitive, add more jobs, and increase wages. With a near 35 percent rate, the U.S. has one of the highest corporate tax rates in the industrialized world. This bill includes meaningful tax reforms that will help make America more economically competitive and increase opportunity for individuals and families.”
On Dec. 26, Chubb released this announcement:
Chubb Limited expects to record a one-time benefit from the new U.S. tax law in excess of $250 million in the fourth quarter of 2017. Chubb’s preliminary estimate reflects the one-time impact of the reduced U.S. corporate income tax rate and the deemed repatriation of foreign subsidiary earnings on the company’s net deferred tax liability position.