In recent years, segregated account companies have become popular for entities in all lines of business in various jurisdictions, especially tax-friendly locations. This structure provides investors the ability to capitalize a sub-account within a company, and the assets attributable to that ‘cell’ will be separated from the assets and liabilities of all other cells within the same company, as well as from the general liabilities of the company itself. Since the financial crisis of 2008, many investors feel their assets are safer if separated, rather than pooled with those of other investors, such as in a hedge fund.
These segregated cells are one element of a larger structure proving beneficial to U.S. insurance carriers seeking the tax benefits of offshore asset management. Like any other taxable American investor, for-profit insurance carriers generally steer clear of offshore investments to avoid the labyrinth of regulations – and possible pitfalls – surrounding a passive foreign investment company (“PFIC”), and reporting regulations for a Controlled Foreign Corporations (“CFC”). However, revenue from insurance operations is exempt from PFIC regulations, and CFC status can be avoided with some careful planning, making investment in an offshore reinsurance company possible.
Bermuda, a tax-friendly jurisdiction, is widely recognized as the global capital for reinsurance companies. The segregated cell structure means a U.S. carrier can capitalize a segregated cell (i.e., subscribe for shares backed by the cash/assets contributed) in a Bermuda reinsurance operation (“Bermuda Re”) and benefit from a deferment on unrealized insurance gains. As any insurance professional will tell you, however, operating profit is only half the story; gains from proper asset management are just as important. Bermuda Re can manage the aggregate company assets themselves through a preferred manager, or through a manager of the U.S. carrier’s choice outside of the U.S. Bermuda Re is the investor, so there is no tax effect to the American carrier, but the value of the shares backed by assets in the segregated cell can increase on a tax-deferred basis if the manager is successful. As a further benefit, structured properly Bermuda law permits capitalization of cells with assets other than cash, and under certain circumstances Bermuda Re will permit segregated cell owners to choose reinsurance deals for participation.
Presumably, an American carrier understands the reinsurance business, and so has the ability to evaluate an investment in Bermuda Re. The PFIC carve out generally allows the carrier to see its investment grow tax deferred on unrealized operating gains, and also allows that carrier to participate in an offshore investment market on a tax-deferred basis. Other factors such as quality of ceded premium, quota share agreements, collateral requirements, leadership and management experience and financial stability of Bermuda Re naturally play a role, and cannot be discarded; the potential advantages of the opportunity herein described cannot be the only considerations in making an investment decision.
If you are a U.S. insurance carrier considering an investment into an offshore structure, we can help. Contact John Doherty at (646) 201-9100 or firstname.lastname@example.org to discuss your options.