Attractive tax rates have lured many insurance companies offshore. However, as Ronald Gift Mullins discovers, there is an expensive flip-side to every penny
If the strategic objective of an insurance or reinsurance company is to reduce its corporate taxes, it could relocate to a country that has low or no corporate taxes. A number of countries meet this criterion - Honduras, Botswana, Bolivia, Montenegro and Serbia. Yet there has been no rush by management of insurance or reinsurance companies to set up shop in these countries. Quite clearly, other decisive and economic factors enter into the complex, financially-viable formula that determines when or where a company will move to.
Businesses driven solely by tax considerations are not likely to be successful, according to Brad Kading, president and executive director of the Association of Bermuda Insurers and Reinsurers. "Operational and underwriting success is the key to operating any insurance business," he says. "Managements must be measured by performance. Tax efficiency does not guarantee successful performance."
"A country's tax structure is certainly important," says David Flandro, who is on Benfield's industry analysis and research team, "but lack of infrastructure and/or political instability tend to act as offsetting factors. It is no surprise that many new insurance entities are formed in relatively stable regions with relatively good infrastructures like Luxembourg, Ireland, Switzerland and Bermuda."
There are several countries that meet the low corporate tax requirement - Ireland, the Cayman Islands and Bermuda for example - and which have other essential attributes that entice foreign investment. These include a stable government, streamlined regulatory systems, convenient geographic placement and an infrastructure of experienced personnel. Harmonising these pleasing notes with its sweet siren song of no corporate tax is Bermuda. A tiny island in the Atlantic, Bermuda has overwhelmingly lured investors with billions of capital during the past three decades to establish new insurers and reinsurers, in addition to other exotic capital platforms, to underwrite risks.
Lloyd's insurers Hiscox, Omega and Kiln have recently redomiciled to Bermuda, although they are all keen to point out that they retain a strong Lloyd's market presence. Hiscox noted in its announcement to relocate to Bermuda that "many of the group's principal competitors already enjoy the substantial potential tax benefits... [which] should improve the prospects for the group's share price."
Bermuda is expensive
So what does Bermuda have that the other similar-asset domiciles don't have? No corporate taxes are one factor, says Kading, "but it is over emphasised by outsiders." He notes that US insurance and reinsurance placed in Bermuda is subject to an excise tax. The excise tax on US to Bermuda business is 4% on commercial lines and 1% on reinsurance and it is not waived by the US/Bermuda treaty. "It's a cost of doing business to the Bermuda enterprise," Kading explains. Also, profits earned by Bermuda company subsidiaries outside of Bermuda are taxed in those jurisdictions. Business in Bermuda is subject to an employee payroll tax and tariffs on all imports. "Bermuda is an expensive place to conduct business," he adds.
Bermuda's cost of living is one of the highest in the world, nearly three times more than in the UK and nearly four times more than in the US. The downside to doing business in Bermuda is that the available workforce is becoming strained and enticing offshore employees to live on the island requires offering substantial salaries . Also, for non-native Bermudians, means to get off the island from time-to-time have to be provided to shake off cabin fever.
“Harmonising these pleasing notes with its sweet siren song of no corporate tax is Bermuda
But Bermuda's success is a result of its evolution into an underwriting centre of excellence with a focus on certain excess liability and property catastrophe lines of business, Kading insists. "It's got a critical mass of market expertise that attracts those seeking specific insurance coverage." A further powerful advantage for the success of Bermuda is its regulatory system that focuses on speedy approvals for qualified, highly capitalised companies.
No new US reinsurers
"I don't want to get into a debate on the offshore tax issue," says Joe Sieverling, senior vice president, Reinsurance Association of America. "Yes, it is always a concern, but I really think the reason reinsurance companies are being formed offshore has more to do with regulatory issues." In the past decades, catastrophes such as Hurricane Andrew, 9/11 and Hurricane Katrina have created a demand for capital to form new offshore insurance and reinsurance companies. Capacity needs to get to market quickly to meet current demands. A reinsurer can be formed in Bermuda and several other offshore areas much quicker and with less expense than in the US.
Proof of the reluctance of investors to employ capital in the US to establish new entities lies in the fact that there have been no new reinsurers formed in the US for more than a decade. Sieverling believes if the US had an optional federal insurance charter, additional companies could be formed quickly to react to emerging capacity to meet immediate market demands.
"You need a market to sell to if you form a reinsurer," says John Andre, vice president at AM Best. "Setting up a company for tax reasons is not very sound. There are other factors that are more important in a locality such as the depth of the infrastructure, proximity to the US and the UK, a compatible, unstructured regulatory system."
Peter Dickey, senior financial analyst at AM Best, mentions Ireland as an up and coming domicile for insurance. "It does have income taxes, but they are lower than the UK," he says. "Several insurers and reinsurers have established subsidiaries there which enables them to access EU markets and EU countries. The vibrant workforce in the country is very beneficial as well."
Ireland may well be a harbinger of future insurance centres. Benfield's Flandro believes that a country's lower taxes may be an incentive for companies to move their headquarters and/or domicile, but more importantly, "as the density of (re)insurers in a region increases, it will create a cluster effect (as in the City of London and Bermuda), which will increase a region's attractiveness and accelerate the pull away from traditional centres."
Ronald Gift Mullins is an insurance journalist based in New York City.
Reinsurance markets | Corporate versus indirect tax
In KPMG's "Corporate and Indirect Tax Rate Survey 2007", the lowest corporate taxes among the developed economies were in the countries of the European Union. At the beginning of 2007 of 92 countries in the survey, the average rate in the EU was 24.2%, compared with 27.8% in the Organization for Economic Co-operation and Development (OECD) countries, 28% in Latin America and 30.1% in Asia-Pacific. Worldwide, there has been only a small decrease in corporate tax rates from 27.1% in 2006 to 26.9% in 2007, compared to the plunge from 37.7% in 1996 to 33.2% in 1997.
But as corporate taxes have declined, countries have quietly, often surreptitiously enacted indirect taxes to make up for the loss of funds flowing from corporate taxes. Evidence of this trend came from the KPMG survey which revealed that indirect taxes rise as corporate taxes fall.
The survey found that indirect taxes in Europe are the highest in the world. Value added tax (VAT) or goods and services tax (GST) rates in the EU countries average 19.5%, compared with 17.7% in the OECD, 14.2% in Latin America and only 10.8% in Asia Pacific. In fact, every country in the survey imposed some indirect tax, as compared to seven that had no corporate taxes.
Indirect versus corporate
"This is the first year that we have added indirect taxes to our survey of international corporate tax rates," says KPMG's global head of tax, Loughlin Hickey, "and the figures seem to confirm a trend that indirect taxes rise to compensate for lower corporate tax rates."
The highest indirect taxes in the world, over 25%, are found in Denmark, Norway and Sweden. Each of these countries has a corporate tax rate of 28%, which combined with indirect taxes puts them at the upper end of the total tax rate scale. However, the US and Japan, whose corporate tax rates of 40% and 40.7% respectively, are not far behind. They are the most expensive of the developed economies for corporate taxpayers. Japan's main indirect tax rate is 5%. The US does not have a federal GST, but states impose their own sales taxes at various rates.
While indirect taxes play an increasingly important role in most countries' revenue streams, raising them too rapidly or expanding them into new areas, can produce negative reactions. Higher indirect taxes bring higher prices for unhappy citizens who buy goods and services.
Explaining the relationship between lowering corporate tax rates to encourage increased offshore investment is not an easy sell to a populous paying more for essential goods than they once did. This remains a task even if you emphasise that increased investment will bring increased employment and infrastructure development.
"It might be tempting to say that international tax competition has forced corporate taxes, in Europe particularly, close to their lowest point," says Hickey. But he noted that while other indirect sources of revenue remain available, the corporate tax rate "will continue to matter for countries wanting to attract inward investment".
The importance of low taxation may be making a dent on some well-established governments. The UK has lowered its corporate tax rate from 30% to 28%. In fact, the KPMG survey suggests a definite trend for lower corporate tax rates from 1993 to 2007.
There are certain attractions for any international insurance company headquartered in a major centre to relocate to an amenable offshore site. One advantage surely is the lower corporate tax rate, and having to pay taxes only on income earned in the new home country, and not on the profits made in the rest of the world.
But there are hurdles that must be considered before an insurer or reinsurer packs up and moves to a far-away country. Will the executive officers willingly relocate themselves and families? Or will the company just rent an office and mailbox and have board meetings in the new locale to satisfy legal requirements? Such sham arrangements can create problems elsewhere and may bring damaging restrictions on the company's operations in some countries.