US loses minimal tax through the Bermuda 'loophole' says analyst
Potential tax revenue that leaves the US as a result of the much-discussed Bermuda insurance "loophole" amounts to less than $200 million a year, according to a Citigroup analyst.
And in years when major catastrophes spark enormous insurance claims, the US actually makes a tax gain through the arrangement.
Joshua Shanker, who covers the Island's insurance sector for Citigroup, said Ace, Arch Capital and XL Capital were the Bermuda companies that stood to lose most from proposed legislation to close the loophole.
The analyst believes that such a decision might be more about generating political capital than financial capital.
Citigroup believes that if US tax legislation punitive to the Bermuda insurance sector is enacted, then Dublin would be the most likely alternative domicile for companies that decided to leave.
A group of major US insurers, the Coalition for a Domestic Insurance Industry, has lobbied Congress for two decades to clamp down on "related-party reinsurance", which enables Bermuda-based insurance groups to cut their tax bills.
The law allows premiums written by a US subsidiary to be ceded to its Bermuda parent in the form of a reinsurance contract, thereby slashing the tax bill on the primary insurance.
In a detailed report, Mr. Shanker showed the ways in which Bermuda insurers pay their US taxes. By law the US subsidiaries cannot cede all of their premiums back to the Bermuda parent, so this minority of premiums is taxed at the US corporate rate.
Ceding premiums outside the US attracts excise tax, levied at one percent, and cedants also pay a transfer pricing tax, usually between three and seven percent of premiums ceded in a profitable year.
Mr. Shanker estimates that around $10 billion in premiums per year is ceded from the US to a Bermuda parent company. This generates $100 million a year for the US Treasury in excise tax alone, whether or not the underwriting is profitable.
Had these premiums all been written by US companies, the tax paid would have depended largely on how much profit was generated. From 2005 to 2007, the US insurance industry achieved a combined ratio of 95 percent. That means that 95 percent of premium dollars were paid out in claims and expenses. On $10 billion in premiums, this would generate $500 million in profits and $175 million in US income tax at 35 percent.
This rough example suggests the US would lose out on about $75 million in tax.
Companies based in Bermuda pay no tax on their profits and no tax on the income they receive from investing premium dollars.
Factoring in all of this, Mr. Shanker calculates, in what he admits is an over-simplified example, that the US would lose $55 million in taxes through the Bermuda loophole.
However, following a scenario like the 9/11 terrorist attacks in 2001, or Hurricane Katrina in 2005, US-based companies that made a loss would be entitled to a tax rebate from the US Government, while Bermuda companies would not.
Based on companies having to pay out ten percent more in claims and expenses than they took in premiums, the US would actually receive $170 million more in tax revenue than it would without it.
The benefits of a tax code change would be "de minimus from an economic standpoint", Mr. Shanker added, but "it might make sense from a political standpoint".
"Such a legal change could be viewed as low-hanging fruit in the form of a political win for the Democratic Congress and new President, even if it doesn't produce much in the way of tax dollars," he added. "However, it does give the impression of protecting US jobs and closing tax loopholes."
Legislation targeting Bermuda could backfire on the US, Mr. Shanker suggests. "While the intention is to protect taxable US revenue and US jobs, the tax code change might have the opposite effect," Mr. Shanker said. He noted that Tyco International planned to follow Ace Ltd.'s change of domicile to Switzerland. "This represents jobs leaving for Europe," the analyst added.
Most of the companies that would be affected by a change in the tax code would be prepared to move to Dublin, he said, adding: "The companies have located their alternative headquarters in Ireland, presumably due to the 12.5 percent flat corporate tax that prevails there. We believe that, if there is a tax impact, the companies would relocate there."
Bermuda had some allies in Congress who argued that a change of tax code could lead to an increase in insurance premiums, Mr. Shanker said. "Moreover there are some in Congress who see tax haven status for Bermuda, Cayman, Barbados, etc. as a benefit to island nations that are forced otherwise to subsist on agriculture and tourism, keeping friendly neighbours just off our shores as poor," he added.
Despite this view, Mr. Shanker said the size of the Democratic majority made it likely any such bill would pass.
Congressman Richard Neal has tabled a bill in the House of Representatives aiming to close the "loophole", and earlier this month the US Senate Finance Committee proposed similar legislation.