Bermuda: Industry insiders see holes in ‘tax loophole’ story

By added on 21/02/2013

Three of Bermuda’s newest hedge-fund backed reinsurers came under scrutiny yesterday after an international article published by Bloomberg called into question whether the companies’ billionaire backers are exploiting a loophole for US tax avoidance, reports the Royal Gazette.

But industry insiders, regulatory authorities and the Government responded yesterday stating that while tax neutral jurisdictions like Bermuda offer advantages, the hedge fund-backed reinsurers face the same scrutiny, oversight and reporting as any other Class 4 reinsurer on the Island.

The in-depth article calls into question why PAC Re, SAC Re and Third Point Re have deployed a fraction of their capital to underwrite risk as compared to traditional reinsurers, claiming they are sitting on a large pool of tax-free capital. The article claims that this pool accumulates money to pump back to the investment managers at a lower US tax rate than a hedge fund would normally pay.

But that doesn’t tell the complete story says Don Kramer, an industry veteran and founder of ILS Capital Management. The hedge-fund backed reinsurance business model is inherently different from the traditional reinsurance model so to compare them is a flawed theory.

“Hedge fund reinsurance companies really cannot take big insurance risk because they are taking investment risk,” said Mr Kramer. “Rating agencies would eat them alive if they were really writing heavy cat risk where you can make some real money but also could lose some.”

Traditional reinsurers’ investment portfolio is very conservative — which differs from the investment risks these firms take.

“Hedge fund companies try to break even on their underwriting,” he said, then using that capital to take risks on the investment side.

Additionally, each of these three companies were start-ups in 2012 and aside from Third Point Re, SAC Re and PAC Re, which all have staff in Bermuda, did not have the full year to capitalise on the June Florida wind renewals and the January multi-peril renewals. A lopsided deployment-to-capital-pool ratio is to be expected, said Mr Kramer.

“It takes a year or more to get fully invested,” said Mr Kramer.

Another piece of the story that was missing from the article, say industry insiders, is that while hedge-fund backed reinsurers may not write as much business as a traditional reinsurer, the risks they do underwrite have very large pay outs when catastrophe events do happen.

Bermuda’s reinsurance industry — which has paid more than $35 billion in US catastrophe claims over the last 12 years — has to report directly to the Bermuda Monetary Authority and the Bermuda Government, which has multiple tax treaties with the US.

“The process involves rigorous due diligence on shareholders, capital and business plans, with particular attention paid to a firm’s asset and investment strategy, as well as the underwriting platform that will support its business,” the BMA said in a response to the article. “The Authority also sets stringent solvency requirements for the companies based on a detailed risk assessment. We also require the companies to submit to detailed prudential filings, in addition to conducting periodic on-site examinations.”

The Ministry of Finance also responded saying it has worked with the US Treasury for more than 20 years in the area of tax cooperation, pursuant to the USA — Bermuda Tax Convention 1988. In 2009, Bermuda signed the Mutual Legal Assistance Treaty (MLAT) with the US.

“Every aspect of our financial services policy objectives is designed to emphasise that a competitive, efficient, and stable financial centre operating with integrity is in Bermuda’s best interests,” the Ministry said in a statement. “Bermuda can demonstrate — not just by words, but by our track record — that we are committed to exchange of information and transparency.”

The benefits to US customers for Bermuda’s reinsurance industry are unparalleled, said the Association of Bermuda Insurers and Reinsurers (ABIR). Just from October’s Hurricane Sandy, Bermuda’s reinsurers are reporting an estimated US$3 billion in loss estimates.

“Reinsurers provide real economic value to the US,” said Brad Kading, president of ABIR. “The BMA has intense regulation that applies to these companies. There is real capital in these organisations that are subject to inspection, oversight, investment management, ERM testing and corporate governance.”