Cat Risk at Center of Offshore Tax Debate
3 min read

Cat Risk at Center of Offshore Tax Debate

Legislation that would target the tax status of affiliated foreign reinsurers would likely have its most significant reverberations in the U.S. catastrophic risk market, according to industry professionals.

But how much — and how deeply — the cat market will change remains up for debate as both sides dig in for a protracted lobbying battle .

Last week Rep. Richard Neal (D-Mass.) sponsored legislation that would limit the deductibility of reinsurance paid by domestic insurers to affiliated foreign reinsurers.

Practically, U.S. subsidiaries would no longer be able to deduct the full reinsurance premiums ceded to foreign-domiciled affiliates. Instead, they would be required to pay taxes on premiums that exceed an “industry average” determined by the U.S. Treasury of reinsurance paid to unaffiliated reinsurers. 

A similar bill died in committee in the previous congressional session and lobbyists expected that it would reintroduced.

CAT MARKET FOCUS

While the legislation does not target specific business lines, foreign reinsurance makes up a significant portion of U.S. reinsurance capacity and, consequently, an important share of domestic catastrophic cover.

According to the Reinsurance Association of America [as cited by the Insurance Information Institute], the market share in 2008 of both unaffiliated and affiliated offshore reinsurers is 83.6 percent of U.S. reinsurance premiums. The RAA adds that more than $58 billion in U.S. insurance premiums were ceded to more than 2,600 offshore reinsurers during the same period.

The bill’s opponents argue that removing premium deductibility would specifically disrupt insurance markets in catastrophe prone regions in the U.S because foreign affiliated reinsurers would remove capacity to avoid the tax.

“These negative effects would be felt most significantly in disaster-prone states like Florida, Louisiana and California,” said a statement from the Coalition of for Competitive Insurance Rates, a Washington D.C.-based lobbying group backed by the Association of Bermuda Insurers and the Risk and Insurance Management Society.

The group cited a report issued by Boston-based consultant Brattle Group which argues that if the legislation is passed the net the supply of primary reinsurance in the U.S. would drop by approximately two percent with premium rising an average of two percent.

“We have a huge exposure to cat risk and those lines are particularly sensitive to the availability of foreign reinsurance from Bermuda and parts of Europe,” says J. David Cummins, professor of risk management, insurance and financial institutions at Temple University’s Fox School of Business and co-author of the Brattle Group report. “The states where you have the highest concentration of cat risk would have the biggest swings.”

Cummins adds that additional capital from non-affiliated reinsurance and capital markets solutions like catastrophe bonds would not make up the difference quickly enough to impact price or offer enough capacity.

“Yes, there will be similar capital formed. Yes, there will be unaffiliated reinsurance. But they are not a perfect replacement [for existing foreign affiliated cover],” Cummins added. “The net effect would be supply declines and price increases that would have the catastrophe lines and commercial liability lines taking the biggest hit.”

Proponents of the bill, however argue that the impact on catastrophe markets is overblown and that there is enough capacity from non affiliated reinsurers to absorb any shock.

“The bill specifically does not affect third party reinsurance. Thus, additional needed capacity for catastrophic coverage provided by policies that spread risks among unrelated parties is not affected by the legislation,” said an earlier statement from the Coalition for a Domestic Insurance Industry, a group of 14 U.S.-based insurers attempting to remove foreign affiliated reinsurance deductibility. “In fact, companies that regularly engage in related party reinsurance typically are not providers of direct homeowners coverage.”

While the legislation did not survive the last Congress, it may have a better chance in the current session since President Barack Obama was critical of offshore reinsurance arrangements in his 2008 campaign.

At that time candidate Obama criticized Republican candidate John McCain (R-AZ) over his support of offshore tax arrangements that “hide” profits.

The legislation is currently in the House Ways and Means Committee.

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