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New York Times: New Taxes on Global Reinsurers Would Hurt Response to Natural Disasters

Friday, October 26, 2012

J. David Cummins is a Professor at Temple University’s Fox School of Business. Bradley Kading is the President of the Association of Bermuda Insurers and Reinsurers.

After disasters like earthquakes in California and hurricanes along the coast of the Gulf of Mexico, the public face of recovery often is the insurance companies. Just as important to ensuring this sector’s survival are the reinsurers that provide backup insurance coverage, particularly in high-risk areas.

But legislation proposed by Representative Richard Neal, Democrat of Massachusetts, and Senator Robert Menendez, Democrat of New Jersey, would impose punitive taxes that will drive up the costs for consumers and businesses. A similar proposal is also included in President Obama’s budget for the 2013 fiscal year.

The Neal-Menendez bill, H.R. 3157 and S. 1693, is intended to reverse current policies that allow insurance companies based in the United States to claim a deduction as an ordinary business expense on their corporate tax return for the amount of reinsurance premiums paid to a foreign affiliate. The net effect of this legislation, however, would impose a costly tariff on international reinsurance firms.

Aiming at global insurance companies with these taxes would be disastrous for areas vulnerable to natural calamities. An economic impact study prepared on behalf of an insurance industry coalition by the Brattle Group, a leading economic consulting firm based in Boston, found that the proposed tax would reduce the net supply of reinsurance in the United States by 20 percent. American insurers depend heavily on international reinsurers for nearly two-thirds of their backup catastrophe coverage, with insurers based in Bermuda providing 40 percent.

A new tax that restricts the supply of reinsurance is bad for consumers. For example, in 2005, Hurricane Katrina caused total losses of $125 billion. Insured losses amounted to $62.2 billion, with foreign insurers and reinsurers paying more than 60 percent. Similarly, 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 United States payouts for the claims.

As we learn in Economics 101, reducing the supply of something raises its price. The Brattle Group study estimates that the proposed tax would increase the price of insurance in the United States by 2.1 to 2.4 percent and up to 9 percent in some industries. To maintain their level of coverage, consumers across the county would have to pay a total of $11 billion to $13 billion more annually. Furthermore, because of the design of the proposed tax, it would significantly disrupt insurance markets, yet fail to raise much revenue.

With the potential losses from extreme weather on the rise, the need for global reinsurance will continue to expand. A recent report by the catastrophe risk management firm Karen Clark & Company, based on an analysis of more than a century of hurricanes, warns that the United States can expect insured losses of at least an average of $10 billion from a hurricane every four years.

Though reorganizing United States business to avoid the proposed tax may seem like the simple solution, many sound business policies have led several global reinsurers to be started in Bermuda. The regulatory environment there provides a speedy license process, which is supervised by a respected independent regulator, the Bermuda Monetary Authority.

Even risk-averse capital providers are comfortable with Bermuda’s government and its economic environment.

And Bermuda’s low-tax environment allows reserves to be built up to cover the huge disasters. Low taxes for reinsurers doesn’t mean “no tax” — all United States-to-Bermuda transactions are subject to a special federal excise tax, which goes into the Treasury’s coffers.

Far from being a “tax haven,” Bermuda has helped the reinsurance industry develop excellent best practices, innovate to better serve customers and establish highly regarded enterprise risk management programs. This attention to detail helps the major reinsurers retain their important credit ratings, better meet shareholder expectations and demonstrate resilience to global customers. During the worst days of the financial crisis, the Bermuda Monetary Authority tested its reinsurers to determine whether they could still meet their promises if large catastrophic losses occurred. The reinsurers passed these tests, with flying colors.

Bermuda’s insurance regulation meets or exceeds standards used by state insurance regulators in the United States. Bermuda’s insurance regulator meets international regulatory standards and is regularly measured against the standards by the International Monetary Fund. Bermuda’s financial regulators have cooperation agreements in place with many American and international agencies, with more negotiated every day. In addition, European regulators have assessed Bermuda for equivalency with its own new solvency regulation regime.

Moreover, the Departments of Justice, State and Treasury have all cited Bermuda’s government as a cooperative partner and the United States has two tax law enforcement treaties with Bermuda. Many federal and state agencies in the United States have said that Bermuda’s government is a cooperative partner in many areas, including financial regulation, protection of sensitive marine environments, anti-money-laundering measures and tax law enforcement.

With the increased threat of natural disasters, the United States needs a robust insurance market that is open to as many competitors as possible and encourages direct foreign investment — including Bermuda. Establishing a punitive tax that restricts global risk-spreading will increase consumer costs and take away from the pool of money needed for the unforeseen hurricanes, earthquakes and other catastrophes that cannot be handled with traditional insurance alone.

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