Bermuda awaits IRS ruling on new rules targeting hedge funds

Bermuda may discover on Friday (September 18) whether overtures to the US government’s Internal Revenue Service (IRS) by its representative bodies to amend proposed regulation regarding hedge fund insurers have been heeded.

Hopes are high that the US Treasury will re-examine rules it has proposed concerning what constitutes a legitimate insurance entity, following the submission of a detailed document from the Association of Bermuda Insurers and Reinsurers (ABIR).

The Exemption from Passive Income from Certain Foreign Insurance Companies, a proposed policy developed by the IRS, sought to impose minimum standards for insurers in an effort to distinguish between firms that carry out genuine underwriting and those seeking profits from investment returns made on those insurance premiums in a tax-efficient way.

The IRS focused on employee headcount and reserves to test the credentials of companies and potentially weed out those simply exploiting a perceived tax loophole. Its main target was hedge fund-backed reinsurers and proposed blanket regulation to close the alleged loophole.

There are fears that, if the rules were adopted in their original form, many firms operating on Bermuda would fall foul of the proposed new rules.

Speaking to Monte Carlo Today ahead of Friday’s hearing in Washington DC, Brad Kading, president of the ABIR, said he was hopeful that the IRS would take the ABIR’s submission on board.

“The Treasury and the IRS are level-headed. There are other ways to measure whether a company is or is not an insurer; if a company is managing an insurance risk then it is an insurer,” he said.

“The Treasury says it understands that the target is the hedge fund that camouflages itself as a reinsurer. But the ‘hedge fund’ is often the asset manager because that’s what it wants to do—but there is still insurance risk being written.

“The US authorities have also asked for advice concerning assets and the insurance business and it could be that we see a new definition here.”

In its submission to the Treasury, the ABIR suggested adopting a “bright line safe harbour test” of a 15 percent reserves-to-assets ratio. However, even this could be viewed as being an imperfect baseline as a reinsurer’s reserves may fall below 15 percent for a variety of reasons.

Kading, like others, describes the whole issue as a red herring. “It will not gain the Treasury any extra revenue but it is a huge politicisation of the whole hedge fund issue. It has the attention of members of Congress,” he said.

Hedge funds account for only about 10 percent of the total alternative capital in Bermuda, according to AM Best. Ten to 15 percent of US insurers would be disqualified from carrying on business if the rules were adopted in their current form and applied to them.

“Nevertheless, we are taking it very seriously because the scope of the regulation could affect many insurance legal entities,” he said.

“We could see a new consultation period being triggered after the hearing, or they could come up with a new proposal after the hearing. We will wait and see,” Kading said.