President Obama’s recently announced intention to crack down on corporations that use foreign subsidiaries as tax shelters was foreshadowed by a long-running battle within the insurance industry.
U.S. domiciled reinsurers have long contended that they are at a competitive disadvantage to reinsurers based offshore in low-tax countries such as Bermuda. Foreign companies, they charge, dodge U.S. taxes by shifting premium from the U.S. subsidiary’s books to the foreign parent’s books, while the risk remains in the same corporate group.
The Coalition For a Domestic Insurance Industry, a group of 14 major U.S.-based insurance groups, was formed to lobby for a revision to the U.S. tax code that they say would put foreign and domestic reinsurers on equal footing.
In the previous congress, Rep. Richard Neal (D-Mass.) introduced a bill, H.R. 6969, intended “to amend the Internal Revenue Code of 1986 to disallow the deduction for excess non-taxed reinsurance premiums with respect to United States risks paid to affiliates.” A similar bill is widely expected to be introduced in the present legislative session.
In a pre-emptive strike against the legislation, the Coalition for Competitive Insurance Rates, which represents the foreign reinsurers, commissioned a study from the Brattle Group, to gauge the economic impact of such legislation. Titled “The Impact on the U.S. Insurance Market of a Tax on Offshore Affiliate Reinsurance: An Economic Analysis” the study predicts dire implications for the U.S. reinsurance market if such a tax were enacted.
“The legislation defines a benchmark above which offshore affiliate reinsurance is “excess” and thus subject to the tax,” the report, authored by Michael Cragg, J. David Cummins and Bin Zhou, states. “But the benchmark is both illogical and perverse, penalizing U.S. subsidiaries for their use of non-affiliate (as well as affiliate) reinsurance. Fully 87% of offshore affiliate reinsurance ($23.9 billion of $27.4 billion) would be classified as “excess.”
The upshot, the authors contend, is that U.S. homeowners and businesses would bear the brunt of the tax in the form of reduced availability of, and higher prices for, P&C insurance. “Our key finding is that the net supply of reinsurance (non-affiliate and affiliate combined) would drop by 20% as a result of the proposed tax.”
The Coalition for Competitive Insurance Rates study drew an immediate riposte from proponents of the legislation, who charged that study’s conclusions were flawed. “When prices are rising, additional capital flows into the market, attracted by the prospects of good returns,” William Berkley, a spokesman for the Coalition For a Domestic Insurance Industry said in a statement. “The combination of higher prices and additional capacity eventually turns the market soft and prices decline to a level where losses cause a reduction in capital, and then prices rise again. Even major catastrophes like Hurricanes Katrina, Rita and Wilma didn’t deflect the market from its natural cycle. It’s irrational to think a marginal cost increase to a small number of market players could materially change prices.”
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