The US re/insurance industry is split over a measure in President Obama’s budget proposal for 2016 which seeks to remove tax deductions for premiums paid to foreign reinsurance affiliates. The proposal, which is limited to property/casualty insurers, would mean that US-based insurers would no longer gain the price advantages that can occur when transferring premiums offshore.
“The new proposal is that, if a US property/casualty insurer reinsures with an affiliate that is not subject to US tax, either directly or through the existing controlled foreign corporation regime, then the ceding company would lose its deduction for the premiums that it pays to the reinsurer,” says Chris Flanagan, a tax partner at Locke Lord. “If they lose that deduction then that would increase the tax cost and hopefully level the playing field.”
If it passes through Congress, President Obama’s 2016 tax proposal would have significant ramifications for the re/insurance industry. The move is seen by its US supporters as a way to promote equality between US insurers that reinsure domestically and US-based insurers with a foreign affiliate which can charge lower premium rates because the reinsurer is domiciled in a more favourable tax regime.
“The concern is that US insurers that are insuring with affiliated offshore reinsurers may be gaining a competitive advantage because they don’t have to pay as much for the reinsurance, since the reinsurer is not subject to US tax,” says Flanagan.
“The resulting savings can potentially be passed along to the ultimate consumer via lower insurance premiums. Although there is an excise tax that can apply where a foreign insurer reinsures a US risk, there is a feeling that this may not be enough. Firstly because it’s a small tax and secondly because it is very often eliminated through available tax treaties.”
Some prominent industry figures have come out in favour of the proposal which they say corrects a situation which disadvantages US companies that seek to reinsure premium domestically. They add that the status quo is forcing capital out of the US, ultimately disadvantaging the US economy.
“I am very pleased that the Obama Administration, like the congressional tax reform discussion drafts, is taking aggressive steps to close this unintended loophole in our tax code that favours foreign-owned insurance companies over US competitors,” says Bill Berkley, chairman and chief executive of WR Berkley.
“This loophole is exactly the type of income-shifting behaviour that the G-20 countries are concerned about as part of the BEPS
The market though is split between those who perceive the current situation to be unfair for domestic US insurers that choose to keep reinsurance capital in the US and those who say that the proposal could hurt what is currently a healthy market.
“The people who want this are those who perceive that there is an inequity in the current situation, and want a more level playing field,” says Flanagan. “These are insurers that are not reinsuring with untaxed offshore affiliates, either because they are retaining the risk or because they are reinsuring with affiliates who are ultimately subject to US taxation. The people who are going to push for this are thus going to be the people who are not gaining a benefit from pushing the premiums into a non-US taxed situation.
“On the other side of the coin, insurers who are currently reinsuring with non-taxed affiliates will likely argue that this proposal will increase the cost of such insurance, which cost will ultimately be borne by the consumers through increased premiums.”
Those who Flanagan says are on the other side of that coin have claimed that the idea of taxing foreign affiliate premium could be seen as protectionism and have argued that proposition’s benefits could be outweighed by the negatives that could occur if it becomes law.
This is backed up by a report released in February by the Tax Foundation’s Center for Federal Tax Policy, which said that the measure could cost the US economy four dollars for every dollar raised and ultimately as much as $1.35bn.
“The proposal is well-thought-out and serious, but ultimately mistaken on the policy merits,” noted the report. “While the deduction eliminated is neatly matched with the income exclusion, there are substantial drawbacks to the proposal.”
Another drawback to the policy could be a sharp rise in catastrophe insurance premiums, particularly in the catastrophe-prone Gulf States. These states claim that they rely on a relatively robust reinsurance market and some say they would be disproportionately subjected to the adverse effects of the proposals. For example, with Hurricanes Katrina, Wilma and Rita in 2005, more than 60% of the $59bn in payments came from funds with foreign-domiciled insurers and reinsurers.
“The Tax Foundation study demonstrates that industry-specific changes to our current, poorly constructed tax code is the wrong approach to needed tax reform,” said Tom Feeney, president and chief executive of the Associated Industries of Florida. “In addition to being bad for individuals and businesses that purchase insurance, it would simply be bad public policy for America.”
While some companies have been outspoken about this issue, many are leaving the public comment to industry groups for the time being.
However, behind the scenes many insurers and their clients are already expressing concerns that the administration’s plan would lead to a rise in prices that would ultimately trickle down to policy holders.
Howard Mills, director and chief advisor for insurance industry group at Deloitte, told Reactions that the short- and medium-term effect of this policy could be a rise in insurance prices.
“We have been speaking to some of our clients and to a degree this tax on foreign affiliate reinsurers will make things more expensive for them,” says Mills. “There is a trickledown effect to US domestic insurance capacity and price to consumers which will impact overall insurance coverage around the country – particularly in states where they have a high degree of natural catastrophes.”
A further problem with the proposal could rest on how a foreign affiliate insurer is actually defined. As the measure is currently in the proposal stage and is not yet legislation, this still remains unclear. However, there are a fair few complexities revolving around the exact nature of foreign reinsurance affiliates.
Also, while the term foreign reinsurance affiliate makes it seem as if the measure is a tax on foreign companies – a point championed by its supporters – it ignores the fact that many of these affiliates are intrinsically linked to US-based companies and benefit the US market.
“A number of companies have affiliate reinsurers that might be based overseas and they point to the fact that it is a global risk spreading mechanism,” says Mills.
“I can see the politics here – it sounds to the novice that the government is taxing companies outside the US, so what’s wrong with that? But they really are affiliates of US-based companies and there is a direct discernible benefit to the US insurance consumer by having more affordable reinsurance available to primary writers. They can then spread that saving down to the consumer and better cover risk.”
This is not the first time that this proposal has come before Congress. A measure to end tax deductions for foreign affiliate reinsurance premiums has been present in every single Obama Administration budget proposal and can be traced back as far as 2000.
Whenever the issue has been put before Congress, it has always weighed in on the side of more competitive market conditions and for keeping