Loyola University School of Law, JD 2020
A provision within the new tax overhaul is emerging as a leading concern for the property and casualty insurance sector. The industry recently experienced growing uncertainties about how a vaguely worded provision within the Base Erosion and Anti-Abuse Tax (BEAT) may affect their bottom line. However, the insurance industry is not the only group that may experience these unintentional ramifications; consumers and small businesses are also likely to see an increase in their premiums due to implications of BEAT.
Base Erosion and Anti-Abuse Tax
On December 22, 2017 one of the most comprehensive reforms of U.S. tax law was passed. The reform impacted multiple areas focused on individuals such as home ownership, tax deductions, dependents, and tax brackets. Not only did the reform impact individual tax payers, but it also intended to make U.S. companies more globally competitive. Within this reform is the Base Erosion and Anti-Abuse Tax (BEAT) which was designed to keep companies from moving profits overseas with lower tax rates. The idea behind the tax is that large multinational companies that operate in the United States, but make large transactions to foreign related-parties, could be susceptible to profit sharing which should be subjected to a minimum tax.
The tax is expected to raise approximately $150 billion for the federal government in 10 years by applying a 10% tax from 2019 through 2025 and 12.5% thereafter on taxable income adjusted for base erosion payments. To compute the BEAT, certain “base erosion tax benefits,” such as interest, payments for services, and royalties to related foreign parties, are added back to taxable income. This “modified taxable income” is then multiplied by the above-noted BEAT percentage.
Effect of BEAT on Insurance
Insurance companies are concerned about the vague language within the BEAT provision and the potentially devasting impact on their bottom line. The problematic section of the provision states that there is liability for, “any premium or other consideration paid…for any reinsurance payments.” Reinsurance is essentially insurance for insurance companies in which the reinsurer agrees to cover a portion of the insurer’s policy. Insurance companies’ concerns are growing because the reinsurance agreements are typically conducted through related parties overseas and therefore subject to the broad language in BEAT.
Furthermore, this liability would affect the companies when they are paying out claims and thus at their most vulnerable. Executives have expressed their concern that they could be heavily subjected to the tax when their company is acting as a reinsurer and making payments to their foreign related-party. For example, imagine a U.S. based company running a loss (and generating deductions), and then subsequently paying sizable claims overseas. If the claims are greater than 3% of the deductions, BEAT liability could be triggered. This vulnerability not only creates a warranted uneasiness, but the risk of magnified vulnerability in situations of major catastrophes such as hurricanes have some insurance companies unnerved.
Insurance Companies Response to BEAT
Many critics have argued that the BEAT tax is a form of double taxation on foreign insurance and reinsurance companies. On the other hand, domestic U.S. insurers seem to favor BEAT because it may discourage offshoring profits to tax havens. Nonetheless, other experts argue that in response to the reform, insurance companies should attempt to restructure or avoid the multinational agreements as much as possible.
Some companies have heeded this advice and eliminated old company reinsurance agreements. However, for the insurance industry this is difficult because the reinsurance agreements are largely created overseas which triggers the tax liability. One company reported that had that provision been in effect in 2017, BEAT liability would have amounted to $10 million. Considering that the provision applies to a certain class of companies, it is possible that similarly situated insurance companies could see the same – if not more – liability. Thus, the insurance industry has begun to lobby for additional clarification for this provision.
The Indirect Effect of BEAT on Insureds
Not only does the BEAT provision affect the insurance companies, but it will also have an indirect effect on consumers because negative effects on an insurance company ultimately affects those that purchase insurance. Prior to the implementation of the tax overhaul, the Washington-based Coalition for American Insurance (Coalition) expressed a deep disappointment at the inclusion of the BEAT provision because of its impact on U.S. consumers and businesses. The Coalition argued that the anticipated tax relief was essentially undone because consumers and small businesses would be hit with higher insurance premiums.
The provision has effectively decreased capacity benefits to the global insurance markets and thus increased U.S. prices. Therefore, with this potential risk to their bottom line, insurance companies are bound to compensate for their risk and subsequently drive up the cost of insurance overall. This will pose an exceptional problem to states that frequently experience natural disasters and rely on affordable insurance from insurance companies. For example, consider that you are an insurance buyer living in an area that is frequently subjected to hurricanes, and you reach out to an insurance company looking to insure yourself against this risk. The insurance company is simultaneously handling the risks of BEAT, and therefore to compensate for that risk, will charge you more to cover your risk. Now multiply this issue by the vast number of insureds attempting to manage their hurricane risk.
Overall, the BEAT tax has unintentionally created fearfulness within the insurance industry – and for good reason; their bottom lines are being attacked. More importantly, the biggest losers in this situation could be the consumers that need affordable insurance coverage. While the insurance companies are lobbying for their own benefit, regulators should keep in mind any ripple effects this tax may have.