No rating impact from offshore reinsurance tax changes: A.M. Best

Insurance and reinsurance rating agency A.M. Best said that it does not expect any impact to any reinsurance firm’s it provides ratings for as a result of the recently introduced offshore, or hedge fund targeting, reinsurance tax legislation.

The legislation was introduced last week (full details here) by Oregon Senator Ron Wyden and stipulate rules which would force a hedge fund or hybrid investment / underwriting reinsurance firm to ensure a certain proportion of its assets were allocated to underwriting at all times.

A.M. Best explains that the Offshore Reinsurance Tax Fairness Act, as it is named, seeks to close “a tax loophole that allows offshore reinsurers to take advantage of an exception to the passive foreign investment company (PFIC) rules of the U.S. Tax Code.”

A.M. Best said that while this rule would require ongoing surveillance, it “does not believe the proposed legislation will lead to rating revisions over the near term.”

The rating agency believes that reinsurance companies will “seek operating alternatives” in order to ensure compliance but while maintaining capital efficiency, if or when the tax benefits for offshore reinsurers are eliminated.

Flexibility in the legislation, to be able to determine whether a reinsurance company is breaching the rules through “facts and circumstances” will provide sufficient flexibility seems to be aimed at “those (re)insurance companies that at times may not hold a large base of (re)insurance liabilities due to the absence of large loss events, but nonetheless do take significant (re)insured risk.”

Best also notes that other companies at risk of falling foul of the legislation include startups which have not built up any reserve base yet, as they may tend to start slowly deploying growing proportions of their assets into underwriting over time. This flexibility provides some leeway for such reinsurers.

A.M. Best continues:

“The current administration and legislatures have tried unsuccessfully to eliminate tax loopholes that benefit offshore (re)insurance operations. It should be noted that hedge fund affiliated (re)insurers are not the only offshore reinsurers that at times may not meet the liability test threshold proposed by this legislation. Opposition on this issue comes from many members of Congress, particularly for states that have considerable exposure to natural catastrophes. Their concern is that a tax increase could lead to increased costs for (re)insurance coverage or possibly a decrease in allocated (re)insurance capacity for less profitable risks. Accordingly, any resolution of this issue still could be years away.”

The rating agency notes that this legislation could harm the build up of valuable risk transfer capacity offshore, which benefits citizens of catastrophe prone U.S. states such as Florida. Hence the legislation could see significant opposition from within the U.S.

Further, A.M. Best comments:

The subject of taxation of offshore (re)insurers has been argued for at least a decade, with very intense positions on both sides. The Coalition for a Domestic Insurance Industry, championed by William R. Berkley, argues that foreign companies that are allowed to reinsure their risk back to a tax-exempt country enjoy an advantage in terms of pricing and profits over U.S. insurers. On the other hand, the Coalition for Competitive Insurance Rates argues that an increase in tax to companies insuring large risks in the United States would hurt homeowners and states exposed to wind and earthquake cat events, since it could lead to higher pricing and lower capacity. Other strong opponents of offshore taxation include insurance regulators in the most hurricane-exposed states such as Florida, Mississippi, Louisiana and the Carolinas.

So the rating agency seems of the opinion that existing hedge fund backed reinsurers, or investment-oriented reinsurance start-ups, will be able to adjust their business strategies or navigate around this ruling successfully at this time.

It remains to be seen whether it actually comes into force in the form Wyden has proposed anyway.