ABIR Statement on Ways & Means Hearing on "Increasing US Competitiveness and Preventing American Jobs from Moving Overseas
Statement for the Record
Submitted by the Association of Bermuda Insurers and Reinsurers
U.S. Committee on Ways & Means
“Increasing U.S. Competitiveness and Preventing American Jobs from Moving Overseas”
May 23, 2017
The membership of the Association of Bermuda Insurers and Reinsurers (“ABIR”), which consists of 22 global insurers and reinsurers that have insurance underwriting legal entities domiciled in Bermuda, fully supports the efforts by the President and Congress to enact reforms to the U.S. tax system that will lower tax rates and produce a more competitive and rational international tax regime. ABIR appreciates the opportunity to submit this statement for the record in support of maintaining full deductibility of all insurance and reinsurance premiums paid by U.S. companies to foreign insurers or reinsurers; in conjunction with the U.S. Committee on Ways and Means’ hearing on “Increasing U.S. Competitiveness and Preventing American Jobs from Moving Overseas.”
Insurance is the backbone of the safety net that U.S. businesses and consumers depend on to help rebuild when disaster strikes. U.S. insurers, in turn, rely on an efficient and stable global reinsurance market that provides access to affordable reinsurance.
ABIR has serious concerns about the impact that any proposal to disallow deductions for reinsurance premiums that property and casualty (P&C) insurance companies pay to foreign reinsurers or to their foreign affiliates. Specifically we believe that potential application to insurance and reinsurance transactions of the Border Adjustment proposal (i.e. border adjustment tax or BAT) that is a feature of the House Republican Blueprint for Comprehensive Tax Reform would have serious negative consequences for the market for reinsurance of United States risks. Similarly, we believe other more targeted proposals aimed specifically at so-called related party reinsurance would also cause significant disruptions in reinsurance coverage and lead to dramatically higher costs for consumers. We urge the Ways & Means Committee to take the information set forth below into account if it considers any proposals that would limit the deductibility of reinsurance premiums paid to foreign affiliates or any BAT-style proposals that would treat commercial insurance and reinsurance transactions as an import of a service that would result in the denial of the deduction for premiums paid for insurance or reinsurance acquired from non-U.S. insurance and reinsurance companies.
Proposals to limit the deductibility of P&C reinsurance premiums paid to foreign affiliates.
The Obama Administration’s FY2017 Budget, along with prior budget plans, proposed to disallow deductions for property and casualty (P&C) reinsurance premiums paid to foreign affiliates that are not subject to U.S. federal income tax. A substantially identical proposal was included in both (1) the Tax Reform Act of 2014 introduced by former Chairman Camp of the Ways and Means Committee and (2) former Chairman Baucus’s staff discussion draft on international tax reform, published in November 2013. These are similar to the legislative proposal that has been introduced over the years by Rep. Richard Neal (D-MA) (and by Sen. Mark Warner (D-VA) in the Senate in 2016).
The Obama Administration offered the following “reasons for change” in their Budget proposal: “Reinsurance transactions with affiliates that are not subject to U.S. federal income tax on insurance income can result in substantial U.S. tax advantages over similar transactions with entities that are subject to tax in the United States.….These tax advantages create an inappropriate incentive for foreign-owned domestic insurance companies to reinsure U.S. risks with foreign affiliates.1” ABIR respectfully submits that the Obama Administration failed to offer credible evidence in support of these assertions; in contrast, the information, facts, and data discussed below flatly contradict the notion that U.S. subsidiaries of foreign reinsurers enjoy a substantial competitive advantage.
A group of large and profitable U.S. insurance companies have waged a decade-long campaign to obtain a competitive advantage by pushing for the enactment of the type of discriminatory rule exemplified by the Obama Administration’s proposal.2
All insurance companies, foreign and domestic, use reinsurance as a way of spreading risk, so when they have to pay out claims, they have an adequate pool of capital to make payments. Many foreign-based insurance companies have U.S. subsidiaries that provide insurance to customers in the United States. A subsidiary that reinsures a policy with its foreign affiliate takes a deduction for the reinsurance premium payment, as an ordinary and necessary business expense—the same as if a U.S. subsidiary engaged in manufacturing were to buy raw materials from its foreign affiliate and take a deduction for that cost.
The U.S. subsidiaries of foreign-based insurance companies are U.S. taxpayers and their transactions are highly scrutinized on a regular basis by state insurance regulators and the Internal Revenue Service. Under transfer pricing rules set forth in Internal Revenue Code Sections 482 and 845 and the underlying regulations, the IRS has authority to make any allocation, re-characterization, or adjustment deemed necessary to reflect the proper amount, source or character of the taxable income, deductions, or any other item related to a reinsurance agreement. Further, Bermuda-based insurance companies are required to pay a 1% Federal Excise Tax (“FET”) on gross reinsurance premiums received with respect to U.S. risks. In our economic analysis, U.S. insurance companies’ income tax payments, on average, are equal to 2.3% of premiums, while FET on premiums ceded to a Bermuda affiliate (plus the income tax paid by the U.S. affiliate) equate to 2.0% of premiums. This is equivalent to the difference between an income tax rate of 35% and 30.4%. Thus any statements in support of this proposal often exaggerate the tax benefits of deductible reinsurance premiums paid to a Bermuda affiliate. Moreover, many ignore the fact that when reinsured losses occur, the ceding U.S. subsidiaries do not receive the benefit of business expense deductions for paying the relevant claims.
Furthermore, there is no evidence that foreign based insurance groups use affiliate reinsurance to any greater degree than wholly US owned insurance groups. The Brattle Group study found that “US P&C companies rely heavily on other companies in the same insurance group (i.e., affiliates) for reinsurance…half of the US-owned insurers ceded at least 60 percent of their premiums to an affiliate, and close to 40 percent of them ceded at least 90 percent.” Brattle further noted:3
“It is not hard to understand why affiliate reinsurance would play a central role in the insurance market. Absent reinsurance, regulators would require each company within an insurance group to have enough capital on a standalone basis to support the business it writes. With offshore affiliate reinsurance, US subsidiaries can reduce the total amount of capital needed to support their business. Reinsurance becomes an integral part of an insurer’s capital structure as recognized in regulatory and accounting rules.”
Foreign-based reinsurers play an important role in the U.S economy by helping U.S. property owners recover and rebuild when catastrophe strikes. Foreign insurers have provided substantial support following recent disasters: foreign reinsurers paid nearly 50 percent of the estimated $19 billion in losses incurred from Hurricane Sandy; an estimated 85 percent of privately insured crop losses resulting from the 2012 drought (approximately $1.2 billion) were paid by international reinsurers; and, in the aftermath of the 2001 terrorist attacks on New York, international insurance and reinsurance firms paid 64 percent of the estimated $27 billion in US payouts for the claims.
Proposals to deny a tax deduction for certain premium payments paid to foreign-based affiliates are widely opposed by consumer advocates, insurance regulators and other stakeholders.4 There is no basis for singling out the global reinsurance industry by enactment of tax legislation that would penalize the U.S. operations of foreign insurance and reinsurance companies, including those based in Bermuda. Particularly in view of continuing uncertainty in the global capital markets, it seems counter-intuitive to advance a legislative proposal that would limit the availability of foreign sources of insurance capital, which would occur under any new rule disallowing deductions for reinsurance premiums in whole or in part. Increasing the taxes on international insurance carriers will result in reduced insurance capacity and increased costs for U.S. consumers.
A recent study by the Brattle Group reported “U.S. homeowners and businesses would feel the effect of the denial of a deduction in the form of reduced availability of, and higher prices for, P&C insurance….finding that the net supply of reinsurance (non-affiliate and affiliate combined) would drop by one-eighth or $18.3 billion as a result of the proposed tax increase…[and] that U.S. consumers would have to pay $5 billion more per year to obtain the same coverage.5”
“The numbers really do speak for themselves,” said Lars Powell, one of the study’s authors and director of the Alabama Center for Insurance Information and Research. “This study reaffirms prior Brattle studies on the issue: if the US subsidiaries of foreign-based reinsurers are subject to the tax outlined in Sen. Warner’s and Rep. Neal’s legislation, then there will be a marked decrease in the domestic supply of insurance. This will increase costs, and homeowners and businesses throughout the country, especially those in areas that are vulnerable to catastrophes, will end up paying the price.”
Areas prone to hurricanes and other natural disasters, like earthquakes, will see the highest increases in costs to consumers. According to the Brattle report, the following chart shows the “The hardest-hit states (California, Florida, New York, Texas, New Jersey, Illinois and Pennsylvania) have large, diverse economies with huge exposure to property and liability losses.” Based on the amount of premiums written, the following chart shows the states that will have the highest increase in costs from the reinsurance tax.
In identifying the importance of showing the impact by state, it is noted that the Brattle report “…comes at a critical time,” said Louisiana Insurance Commissioner James Donelon. “As lawmakers begin to consider reforming the tax code, they must be mindful of the sweeping effects that the proposed Neal-Warner legislation will have on homeowners, consumers and businesses if enacted. Louisiana alone will see insurance prices skyrocket more than $30 million, and I am sure that my fellow insurance commissioners throughout the country, many of whom also oppose this measure, would strongly agree that this will hit nearly all Americans in the pocketbook. That isn’t something to take lightly.”
U.S. consumers who depend on access to affordable insurance and reinsurance to protect their most valuable assets, can’t afford new reinsurance taxes.
A reinsurance tax increase could negatively impact the economy.
A recent economic study by the Tax Foundation6 found that the Obama Administration’s proposal would cost the U.S. economy more than four dollars for every dollar raised. In addition, the study also projects that over the long term, the United States’ GDP would experience $1.35 billion in losses. The report states, “over the long term, the tax provision reduces GDP by about twice the revenue it collects directly. As a result, about 40 percent of the intended revenue from the provision ends up being lost through lower collections of other taxes.” The Tax Foundation concludes its report with the following commentary on tax reform:
“Eliminating the deduction for foreign reinsurance premiums ultimately creates more problems than it solves. It redefines the corporate tax base to effectively ignore legitimate business transactions. It is poor for growth because it increases the cost of capital. And it doubles down on a dubious corporate tax system in need of broader reforms.
“Congress should not go through the tax code industry-by-industry, legislatively redesigning the definition of corporate income on an ad-hoc basis in an attempt to find more corporate revenue from overseas firms. Instead, it should look to larger reforms that make the U.S. more attractive as a domicile for corporations.”
The House Republican Blueprint and the BAT
The Blueprint released in June 2016 does not provide sufficient details to determine the tax treatment of cross border insurance and reinsurance under the BAT proposal that would tax imports and provide for tax-free exports. It is our understanding that the authors of the Blueprint intended that the BAT apply to services as well as goods, but we also understand that the application of the BAT to financial services is a design issue — the final details of which are still being developed. If policy makers were to follow the design of most other border adjustable tax systems imposed globally, generally through value added taxes, they would exempt such services from the BAT as most countries that impose VAT or GST taxes do not apply those taxes to insurance or reinsurance.
However, should legislation implementing the Blueprint impose a new tax on all cross-border reinsurance transactions, the distortions to the U.S. insurance markets could be devastating to U.S. consumers—according to the Brattle report7:
- “At the low end, for example, a 20 percent reduction in reinsurance would lead to a $15.6 billion drop in the supply of U.S. insurance, which is 67 percent greater than the impact we calculated under the Warner/Neal Bill, and U.S. consumers would pay $8.4 billion more to obtain the same coverage.
- “At the high end, an 80 percent reduction in reinsurance would lead to a $69.3 billion drop in the supply of U.S. insurance, which is 7.5 times the impact we calculated under the Warner/Neal Bill, and U.S. consumers would pay $37.4 billion more to obtain the same coverage.
- “If we apply our analysis of the Warner/Neal Bill and assume the 39 percent reduction in reinsurance ceded by foreign firms in long-return lines similarly applied to all firms and all lines, the impact would be a $31.2 billion drop in the supply of U.S. insurance, and U.S. consumers would pay $16.9 billion more to obtain the same coverage.”
KPMG in a paper providing an analysis of a theoretical application of the BAT to various reinsurance transactions found:
“The result of disallowing a deduction for the net ceded premium … is distortionary compared with the result under a wholly domestic reinsurance transaction … and could be seen as creating a strong disincentive for cross-border risk pooling and spreading.” The report noted this would be particularly troubling for long tailed risk and infrequent but severe catastrophe risks.8
Further to the consumer impact potential, the R Street Institute and Florida Tax Watch scholars analyzed the impact a decrease in the supply of international reinsurance would have on the property insurance premiums paid by consumers in states prone to natural catastrophe, including Florida, Louisiana, North Carolina, and Texas. The results have been sobering.
These studies found that, a BAT set at 20 percent would increase the cost of property-casualty insurance in Texas by $3.39 billion over the next ten years. In Louisiana, it would result in an increase of $1.1 billion over the next ten years. And, in North Carolina, it would result in an increase of $800 million over the next ten years. Yet, most striking is the impact a BAT would have on Florida. Research indicates premiums would need to increase between $1.4 and $2.6 billion annually simply to maintain coverage as it exists today.
R Street noted: “Deep and liquid global reinsurance markets are a vital component of the nation’s approach to risk transfer. Having access to international reinsurance capital keeps insurance rates affordable and allows consumers to protect themselves without burdening fellow taxpayers. Our research indicates that virtually any scenario in which a BAT set at a rate of 20 percent were levied on the import of insurance or reinsurance would have significant negative effects for policyholders. Insurance, and the financial services sector as a whole, benefit from the ready availability of international capital. Policy developments limiting the availability of such capital produce a cascade of negative effects for Americans across the country and from all walks of life.”9
Senator Lindsey Graham (R-SC) said it best, “Simply put, any policy proposal which drives up costs of Corona, tequila, or margaritas is a big-time bad idea,” Mr. Graham wrote in a post on Twitter. 10 The same can be said for the reinsurance that protects the U.S. and its consumers.
Reinsurance plays a vital role in spreading risk in the global marketplace. All insurance companies, U.S.-based and foreign-based, utilize reinsurance in order to most efficiently and safely pool catastrophic and other risks and to match capital to support those risks. Such pooling diversifies risk into a global portfolio providing substantial price and capacity benefits to insurance markets globally. A reinsurance tax proposal would unfairly penalize foreign-based insurers, raise costs for domestic insurers and consumers, and would arguably violate U.S. obligations under the World Trade Organization’s (WTO) “National Treatment” principle, which ensures equal access to the U.S. market11. In addition, the BAT is designed to put the United States on a level footing with much of the rest of the world that imposes border adjustable consumption taxes. However, since most of the world excludes cross-border insurance and reinsurances from their VAT systems, application of the BAT to reinsurance would seem to be unnecessary and counterproductive. It would not follow the global best practices for a VAT/GST and could cause major disruptions in the U.S. reinsurance markets impacting the amount of affordable reinsurance available.
Foreign-based reinsurers play an important role in the U.S. insurance marketplace— they help the U.S. recover and rebuild when catastrophe strikes. There is no reason why a policy maker would choose to compel New York policyholders and U.S. investors to shoulder the entire costs of the 9/11 terrorism attack or Gulf Coast policyholders and US investors to shoulder the entire costs of Hurricane Katrina – when the alternative of sharing these losses with global shareholders is available and affords identifiably better benefits in lower prices and more competitive insurance markets to US consumers.
We urge you to maintain the current law treatment of deductions for reinsurance premiums paid by U.S. companies to foreign insurers, reinsurers or their affiliates.
President and Executive Director
Association of Bermuda Insurers and Reinsurers
1 General Explanations of the Administration’s Fiscal Year 2017 Revenue Proposals, Department of the Treasury (February 2016) page 15.
2 This contingent of U.S. P&C companies call themselves “The Coalition for a Domestic Insurance Industry,” but they do not speak for the majority of the U.S. P&C industry: The major insurance trade associations are neutral on the Obama Administration’s proposal. The 12 members of the coalition are: W.R. Berkley Corporation, AMBAC Financial Group Inc.; American Financial Group; Berkshire Hathaway Inc.; EMC Insurance Companies; The Hartford Financial Services Group, Inc.; Liberty Mutual Group, Inc. (which recently purchased Bermuda’s Ironshore Insurance Group); Markel Corporation (which recently purchased Bermuda’s Alterra Capital); MBIA Inc. ; Scottsdale Insurance Company; The Travelers Companies, Inc.; and Zenith Insurance Company (now owned by Canada’s Fairfax Financial).
3 The Impact of Offshore Affiliate Reinsurance Tax Proposals on the U.S. Insurance Market, An Updated Economic Analysis, the Brattle Group, Jan. 23, 2017, pages 23-24
4 For example, public opposition to reinsurance tax proposals is evidenced by letters from past or current insurance commissioners of the following states: Florida, Georgia, Louisiana, Mississippi, Nevada, North Carolina, Pennsylvania, South Carolina and Utah; copies of which are available at www.keepinsurancecompetitive.com Consumer groups which have written in opposition include: the Florida Consumer Action Network, the Consumer Federation of the Southeast, the Risk and Insurance Management Society and the American Consumer Institute.
5 The Impact of Offshore Affiliate Reinsurance Tax Proposals on the U.S. Insurance Market: An Updated Economic Analysis. January 23, 2017. (Executive Summary)
6 Incorrectly Defining Business Income: The Proposal to Eliminate the Deductibility of Foreign Reinsurance Premiums, by Alan Cole, Economist, Tax Foundation. February 18, 2015. Report number 452.
7 The Brattle report provides annual economic impact costs.
8 KPMG report: Questions for insurers and reinsurers raised by proposed Border Adjustment Tax. April 2017.
9 R Street Institute. www.Rstreet.org. Impact of a border adjustment tax on the North Carolina Insurance Market, May 17, 2017; Impact of a border adjustment tax on the Louisiana Insurance Market, May 4, 2017; Impact of a border adjustment tax on the Texas insurance market, April 27, 2017; Policy studies by Dr. Lars Powell.
11 April 15, 2013 Letter from former U.S. Trade Representatives Mickey Kantor and Susan Schwab.