Bermuda Insurers, Reinsurers Take Steps to Avoid Base Erosion Tax

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By Allyson Versprille

Bermuda-based insurers and reinsurers are making moves to hold their own after the U.S. effectively smacked down a big tax advantage they used to have.

Mark D. Lyons, chief financial officer of Bermuda-based Arch Capital Group Ltd., said in a May 2 call with shareholders that effective Jan. 1 the company had canceled the internal reinsurance arrangement that, before this year, it had been able to use to cede business from the U.S. to Bermuda to take advantage of the island’s zero percent corporate tax rate.

The 2017 tax act (Pub. L. No. 115-97) subjects companies with such arrangements to the new base erosion and anti-abuse tax (BEAT), removing the economic incentive for using the reinsurance agreements and significantly reducing a long-standing tax advantage Bermuda companies have had over their U.S. competitors.

By ending its internal reinsurance arrangement and keeping more business in the U.S., Arch Capital can avoid the BEAT, Brian Schneider, an analyst at Fitch Ratings, told Bloomberg Tax.

Other Bermuda-based companies are finding other ways to plan around the BEAT, Meyer Shields, a managing director at Keefe, Bruyette & Woods Inc., told Bloomberg Tax.

James River Group Holdings Ltd., a Bermuda-based insurer, for example, announced in February that it had altered its corporate structure in response to the new U.S. tax law, and in doing so expected its tax rate to “remain consistent with our tax rates over the past five years.”

Before and After

Before 2018, Bermuda-based insurers and reinsurers that did business in the U.S. could sidestep most U.S. taxes by shifting the income they generated from writing U.S. policies to their Bermuda affiliates through intercompany reinsurance, which covers insurance companies’ risks. Traditionally, those companies had to pay a U.S. excise tax of 4 percent on direct premiums and 1 percent on reinsurance premiums, but they could avoid the U.S.'s 35 percent corporate tax rate, which the new tax law lowered to 21 percent.

Now, in addition to those excise taxes, companies engaging in such offshore reinsurance transactions face the BEAT, which applies at the rate of 5 percent in 2018, 10 percent starting in 2019, and 12.5 percent beginning in 2026.

Schneider said most Bermuda-based insurers and reinsurers with significant U.S. operations have reacted to the new U.S. tax law, though not all have provided details. The most common approach has been for them to go the Arch Capital route—eliminate their old intercompany reinsurance arrangements and retain more business and capital in their U.S. subsidiaries, he said.

Arch Capital has taken other steps to bolster this strategy. In January, the company announced it had transferred $1.35 billion of loss reserves from the U.S. to Bermuda effective Dec. 31, 2017. This move immediately reduced the capital required in the U.S. to support those reserves, Schneider said. The loss portfolio transfer “provides an element of U.S. capital relief while new business builds up in the U.S.,” he said.

James River’s response was entirely different from a strategic standpoint, Shields said.

The company restructured its existing internal reinsurance arrangement by forming a new Bermuda reinsurer, Carolina Re Ltd., that is owned by its U.S. affiliates and is electing to be taxed as a U.S. taxpayer, Sarah C. Doran, James River’s chief financial officer said Feb. 23 on a call with shareholders. Starting this year, James River is ceding the business that used to go to its Bermuda-based reinsurance company to the newly formed U.S.-taxpaying entity.

Doran also said Carolina Re would purchase a stop-loss policy—to protect itself against large claims—from that Bermuda-based affiliate.

Mergers and Acquisitions

The new BEAT, paired with the corporate tax rate cut to 21 percent, has had the desired effect of leveling the playing field between U.S.-based insurers and reinsurers and their foreign counterparts, Schneider and Shields said. This new dynamic is being factored into mergers and acquisitions.

Assurant Inc. in January modified its deal with the Warranty Group Inc., a global provider of protection plans and related programs, to remain domiciled in the U.S. The company cited the U.S. tax law as the impetus for the change.

Under the revised terms of the $2.5 billion transaction, Assurant was to acquire TWG Holdings Ltd. and its subsidiaries, and remain a Delaware corporation. Originally, the plan was for Assurant to acquire Warranty Group and then move its tax domicile to Bermuda.

There are two main reasons Bermuda-based companies may want to get more involved in M&A transactions, according to Shields. “Bermuda companies are worse off in the aggregate than they had been before, and therefore they’ll look for other strategies to enhance their returns, including acquisitions,” he said. “By the same token, they’re probably more willing to sell because their outlook is not as good as it has been.”

Shields said he expects to see more M&A activity and that the U.S. tax changes are “partly responsible for that.”

Another driver is 2017 catastrophe losses, stemming from natural disasters—hurricanes, earthquakes, and wildfires—that have strained many Bermuda-based entities, Schneider said.

There are already at least two examples in 2018 of non-Bermuda-based companies targeting businesses on the island. American International Group Inc. (AIG) has announced plans to purchase Bermuda reinsurance company Validus Holdings Ltd. for $5.6 billion in a deal set to close in mid-2018. French company AXA SA has agreed to buy Bermuda-based XL Group Ltd. for $15.3 billion.

Key Market

Schneider said in a Jan. 23 Fitch Ratings report that while the U.S. tax law would “significantly reduce the long-standing Bermuda tax advantage over the U.S.,” the “overall benefit of maintaining a Bermuda market domicile and operations will likely endure, albeit at a decreased level.”

He told Bloomberg Tax he still believes that to be the case. “Bermuda’s been a very nimble market for quite a long time, and I think they’re good at being able to adapt to these things and maintain some strength in their operations,” he said.

U.S.-based companies looking to grow their businesses may want to take advantage of the quality underwriting that takes place on the island, Schneider said. When discussing the Validus acquisition, AIG President Brian Duperreault has said the Bermuda-based company’s talent and diversification should help drive “profitable growth.”

“Bermuda remains well-positioned to add value to leading markets,” John Huff, president and CEO of the Association of Bermuda Insurers and Reinsurers, told Bloomberg Tax in an email.

“Thanks to Solvency II equivalence with the EU, mutual recognition in the U.S. and a worldwide reputation for blue-chip regulation and half-century of expertise, Bermuda is recognized as a key market,” he said. Under the 2016 Solvency II directive, the European Union recognized Bermuda as having insurance regulation standards for commercial insurers that are equivalent to its own. This formal recognition means that commercial insurers and reinsurers in Bermuda won’t be disadvantaged when competing for, and writing, business in the EU.

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