Insurers urge changes to US Treasury plans

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  • ABIR president Bradley Kading

    ABIR president Bradley Kading

A Bermuda insurance industry body has written to the US Treasury urging it not to penalise long-established reinsurers as part of its efforts to clamp down on what the US sees as hedge funds masquerading as reinsurance companies to lower their tax bills.

In a detailed 20-page document, The Association of Bermuda Insurers and Reinsurers (ABIR) proposes its own recommendations as to how the US Treasury should test what constitutes a real insurer.

“ABIR believes that the central element qualifying an entity as an active insurer is underwriting and holding insurance risk,” ABIR stated. “Regardless of a chosen business model, the primary purpose of an insurance legal entity is to issue contracts that assume risk that otherwise would be held by its customers.”

The statement, signed by ABIR president Bradley Kading, proposes that the focus of the US regulations should be on objective measures of assumed insurance risk.

ABIR’s submission is one of many sent to the US Treasury from various bodies concerned with the impact on the insurance industry of the proposed regulations on the ‘Exception from Passive Income for Certain Foreign Insurance Companies’. Most, including ABIR, have requested a public hearing at the US Treasury, to ensure their voices are heard. It is likely that this would take place in late August.

The Reinsurance Association of America questions the Treasury’s intention to focus on employee headcount as a means of testing the insurance credentials of a company, saying that it would impact “many entities long recognised as bona fide insurance companies, as well as jeopardising the insurance company treatment of alternate risk transfer mechanisms, such as catastrophe bonds and sidecars for US tax purposes”.

And professional services firm PwC argues that the proposal, in its existing form, would force the restructuring of many Bermuda insurers and reinsurers.

The Bermuda Insurance Managers Association (BIMA), whose interests are predominantly in the captive sector, has argued that there would be a “devastating” impact on the risk management planning of corporations that use Bermuda captive insurers.

The US Treasury’s aim is to target hedge fund managers who have pushed into the Bermuda reinsurance market to access additional capital for investing while gaining tax advantages.

The US authorities are weighing whether to impose minimum standards for reserves or premiums to distinguish the companies that rely most on underwriting from those that depend more on investing, or “passive foreign investment companies” (PFIC).

The methods of differentiation are key, given that many established insurers could be caught in the PFIC net although the US Treasury has indicated that this is not its intention.

The Treasury has invited comments from interested parties on the form the regulation should take. ABIR’s response, which is attached to the online version of this story under “Related Media”, argues for a “bright line safe harbour test” of a 15 per cent reserves to assets ratio. Reserves refer to the capital insurers set aside for estimated claims.

ABIR, which analysed the financial results of 40 Bermuda-based insurers to back up its submission, concedes that four of those companies would fall short of the 15 per cent line. They are PaCRe (0.4 per cent reserves to asset ratio), Hamilton Re (9 per cent), MS Frontier Re (11.9 per cent) and DaVinci Reinsurance (14.7 per cent), a subsidiary of RenaissanceRe Holdings.

Bermuda-based Third Point Re, whose investments are managed Dan Loeb’s hedge fund Third Point, scores 25.5 per cent.

While ABIR does not name the companies, the RAA submission does, showing the ABIR analysis in some detail.

PaCRe is a joint venture between US hedge fund Paulson & Co and Bermuda-based Validus Re. Hamilton Re is the successor to SAC Re, which was founded by hedge fund manager Steven Cohen. SAC Re was bought out by a group of investors headed by Brian Duperreault, and was renamed Hamilton Insurance Group.

ABIR goes on to argue that the bright line test is an imperfect measure of true insurance activity, as reserves do not necessarily reflect the risk exposure of a company, and calls for a “facts and circumstances test” for those who fall short of the bright line.

A property-catastrophe reinsurer’s reserves may fall below 15 per cent, for example, simply because of a lack of major events over a few years, or because it has been in business for a short time.

ABIR also points out that municipal bond or financial guaranty firms traditionally carry a low level of reserves, but a high degree of risk tied to infrequent events.

Bermuda is the world’s largest captive domicile and BIMA fears that this sector will be unfairly targeted by the PFIC regulations.

“Our membership, clients and the various tax experts we have consulted are concerned that the proposals in their current form reach beyond the hedge fund structures identified (on which we make no comment) and into the well-established captive arena,” the BIMA letter, signed by the organisation’s president Robert Paton, states.

“The effect of the unintended consequence of the proposed regulations as currently drafted would have a devastating effect on the risk management planning of our clients.”

PwC’s submission, which is signed by Richard Irvine, Bermuda-based managing director of PwC Tax Services Ltd, expressed particular concern about the regulation’s focus on employee activity, which would disadvantage those who outsource activities.

“We believe the appropriate definition of ‘active conduct’ would instead look to what a company actually does and not who does it on behalf of the company,” Mr Irvine stated.

The PFIC regulation, as proposed, would ignore established practices of the industry and “force the restructuring of business operations in Bermuda and other offshore domiciles, which in turn would increase the cost of operations and the cost of insurance and reinsurance to US policyholders”, he added.

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Published Jul 27, 2015 at 8:00 am (Updated Jul 26, 2015 at 8:55 pm)

Insurers urge changes to US Treasury plans

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