Corporate America was a standout winner when President Donald Trump signed the Tax Cuts and Jobs Act into law in December last year. The bill cut the corporate tax rate from 35% to 21%, giving companies “more money to invest in their business and pay their workers,” explained Congressman Mike Conaway (R-Texas).
The Tax Cuts and Jobs Act is positive for lots of US-based insurers, but less so for their Bermuda-based reinsurance counterparts, according to Graham Coutts, director at Fitch Ratings. In fact, Coutts described the reforms as “certainly narrowing Bermuda’s relative advantage.” One particular reform – the base erosion and anti-abuse tax (BEAT) – is set to challenge the Bermuda market, because it alters ceded strategy.
Coutts explained: “The BEAT tax increased excise tax on business transferred from the US to offshore affiliates. It is being implemented on a step-by-step basis, with a 5% increase in 2018, 10% in 2019 and 12.5% by 2026. It quite substantially reduces the incentive of insurers to reinsure cede business from the US to Bermuda.
“I think the tax reforms will shrink the profitability gap between Bermuda and the US. It has already narrowed over the last few years due to competitive market conditions forcing a decline in market ROE, and tax reforms will probably accelerate that trend.”
While the outlook seems negative, Coutts said Fitch hasn’t taken any immediate rating actions on Bermuda as a result of the tax changes. However, the firm is closely monitoring how companies manage their offshore operations and how they mitigate the negative impact of any changes.
One thing Fitch does expect to see as a result of US tax reform is an increase in merger and acquisition (M&A) activity, according to Coutts. Companies might look to grow in scale or to diversify away from the Bermuda reinsurance market, he explained.
Another factor driving M&A, and therefore diversion from the Bermuda market, are the natural catastrophe losses of 2017. It helps insurers to have “scale and diversification,” said Coutts, especially if they took big economic hits in last year’s catastrophes.
“We have already seen quite a bit of M&A activity, and there are several big deals in the pipeline,” he commented. “The natural catastrophe losses of 2017 are one in a number of factors driving these M&A deals. For example, XL Group [a company that was negatively impacted by catastrophe losses] has already announced its merger with AXA. We’re also seeing other companies like Aspen now also getting involved in M&A activity.
“There’s no one overarching theme for why the M&A is happening, but certainly we’ve seen a number of transactions recently that have targeted some of the companies that were more adversely effected by last year’s natural catastrophe season.”