U.S. tax reform could be a positive for European reinsurers’ June and July renewals, as it carries the potential to level the taxation playing field with Bermudians who have traditionally had the upper hand on U.S. natural catastrophe business, according to Deutsche Bank.
The July renewals, which focus on U.S. reinsurance business and a significant part of natural catastrophe coverage, have typically favoured Bermudian reinsurers who benefited from a favourable tax advantage which enabled them to offer more competitive prices.
However, Deutsche Bank analysts believe the lower U.S. tax rates and the burden of the Base Erosion and Anti Abuse Tax (BEAT) will level out the playing field as “Bermudian players will likely lose their traditional tax advantage.”
The U.S. tax reform lowers the corporate tax rate from 35% to 21%.
In addition, firms could have to pay a positive or negative one-off fee depending on the DTA/DTL overhang, as well as the BEAT on premiums ceded to non-U.S. affiliates; this tax is set at 5% for 2018, 10% from 2019 and 12.5% by 2026.
Deutsche Bank analysts explained; “while we see U.S. tax cuts in general as a positive for our European reinsurers, we believe that the BEAT puts a short-term burden on all of European reinsurers.
“The rising BEAT rate will force all non-U.S. reinsurers to rethink their internal retrocession structures. Effectively, the BEAT will likely push non-U.S. reinsurers to write more business directly from their U.S. base and bring down internal retrocessions.”
In addition, the tax reform could force Bermudian players to write more business directly from the U.S. “this should lead to a level playing field, at least among non-US players, while US players (esp. Berkshire) are straight beneficiaries.”
These factors mean European reinsurers will no longer be operating at a pricing disadvantage compared to the Bermudians while, “offering a superior security/rating,” the Deutsche Bank stated.
Morgan Stanley and Keefe, Bruyette & Woods analysts predict that offshore reinsurers and higher-margin U.S. lines of business that are ceded to foreign affiliates such as P&C could be the most negatively impacted.
However, Morgan Stanley analysts said firms in Bermuda plan to adapt to changes to tax law to mitigate the impact of the reforms through strategies such as retaining more business in the U.S. – where tax rate goes lower.
With the reforms likely to encourage firms to concentrate risks within the U.S. to prevent paying higher rates on premiums ceded to foreign affiliates, some industry experts say the new legislation could act as a mini border adjustment tax but with limited overall industry impact particularly for big players who already operate through U.S. entities.
Now it seems European reinsurers stand to benefit from the tax reform creating a more equal playing field with Bermudian players who will see some of their traditional tax advantages eroded and these changes to the market environment could surface in July 2018 renewals which typically focus on U.S. natural catastrophe business.
