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Tax reform may lead to compliance, organizational changes for insurers

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As insurers assess how they will be affected by changes to U.S. tax laws passed late last year, some may consider structural changes to their operations or take other steps to comply with changes, experts say.

Lowering the corporate tax rate while raising the excise tax related to ceding certain business offshore may force insurers to re-evaluate some business and incur higher costs.

For insurers that cede business to offshore affiliates, such as those in Bermuda, changes in the law could make those transactions less attractive, said Baltimore-based Keefe Bruyette & Woods Inc. analyst Meyer Shields, and could lead companies to structure business differently.

“So, that’s going to require some significant changes in how business is done for companies with significant offshore entities that have up until this point reinsured their business, and will require some operational restructuring,” Mr. Shields said.

Such changes, Mr. Shields said, could potentially lead to higher costs involved in doing business and could conceivably affect a company’s competitive position.

“From a policyholder perspective, we would hope that doesn’t translate into higher premiums because of the claimed higher cost of doing business,” said Daniel J. Healy, a partner with Anderson Kill P.C. in Washington.

The change in the excise tax could also affect the way claims litigation is handled, Mr. Healy said.

If as a result of the change in tax treatment more business remains onshore, “should it become necessary for a policyholder to litigate for its insurance recovery, this type of overall dynamic could make it more likely that U.S. courts would be deciding claims brought by U.S policyholders,” Mr. Healy said.

Companies with significant deferred tax assets, such as losses to be applied against future earnings, will have to make a balance sheet adjustment to reflect the lower rate of taxation on those deferred assets, said Mr. Shields.

Similarly, those with deferred tax liabilities will have to make a similar such adjustment, as was the case with Chubb Ltd. recently, Mr. Shields said.

The change in the taxation of investment income earned by reserves raises questions of how reserves may be treated, Mr. Healy said.

“It may affect how insurance companies would like to book money into reserves and how they would like to release it,” he said.

The changes may also affect how foreign insurers treat reserves.

The new law tightened the exclusion applicable to foreign insurance companies with respect to avoiding classification as a passive foreign investment company, or PFIC, according to Jason Diener, an attorney with Wilson Elser Moskowitz Edelman & Dicker L.L.P. in Florham Park, New Jersey.

In order for a foreign insurance company to qualify for the active business exception to PFIC status, it must now maintain insurance reserves, excluding unearned premiums, of more than 25 % of total assets, Mr. Denier said.

Despite elements of the tax changes which may hit insurers specifically, the most significant change remains the lowering of the corporate tax rate, Mr. Diener said.

“Whereas property/casualty insurers looked at a 34% or 35% rate, it’s now 21%. That’s a significant decline, and that affects domestic insurance companies,” Mr. Diener said. “I think the perception now, in the industry, may be that they feel they are more competitive with their foreign rivals.”

“In terms of the earnings companies generate, they will be paying less in the way of taxes and will be able to keep more of their pretax profit. That is a good thing for the company and their shareholders,” Mr. Shields said, adding this applies mainly to domestic companies that don’t utilize offshore affiliates.

“For U.S. domestic insurance companies, I think it will have a dramatic effect on the industry,” Mr. Diener said.