AIG Raises Concerns With BEAT's Effect on Inbound Reinsurance Deals

From: Poms, Douglas

To: Byrd, Kimberly

Subject: FW: BEAT/Supplemental Materials

Date: Friday, August 24, 2018 11:57:43 AM

Attachments: Response to Treasury on Example of a Reinsurance Transaction v3.pdf
Significant Ambiguities in Statutory Provisions Relating to the Base Ero....pdf

For FOIA. Thanks.

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From: Trigonoplos, Darren <Darren.Trigonoplos@aig.com>

Sent: Friday, August 24, 2018 11:54 AM

To: Kranbuhl, Kipp <Kipp.Kranbuhl@treasury.gov>; Williams, Tyler <Tyler.Williams@treasury.gov>; Poms, Douglas <Douglas.Poms@treasury.gov>; Seitz, Steven <Steven.Seitz@treasury.gov>

Cc: Bekker, Angela <Angela.Bekker@AIG.com>; Miller, Eric <Eric.Miller@aig.com>; Gallagher, Shawn <Shawn.Gallagher@aig.com>

Subject: BEAT/Supplemental Materials

Gentlemen, good morning,

We have appreciated our dialogue with you regarding the adverse impacts to AIG and, we believe, the US tax base if the Base Erosion and Anti-Avoidance Tax (BEAT) is applied to certain payments relating to inbound reinsurance transactions. The two attached documents respond to comments or concerns you have expressed during our recent meetings/conversations.

Kipp, during our meeting last week, you requested an outline of a typical inbound reinsurance transaction and how the BEAT could affect it. The first attached paper provides a hypothetical, but very typical, example and details how application of the BEAT could affect such transactions to the point of making them uneconomical to undertake. This underscores our belief that it seems directly contrary to the BEAT's concern with securing the US tax base to apply it in a manner that discourages inbound reinsurance transactions that have a base enhancing, rather than base eroding, effect.

Doug, when we last spoke by phone, you had indicated your team was thinking through, among other things, whether there is sufficient ambiguity around the BEAT provisions to warrant the Department stepping in to provide clarification through regulations. We believe there is quite considerable ambiguity arising from numerous aspects of the BEAT provisions, and in the second attached paper have tried to capture and detail some of those ambiguities.

We hope these are fully responsive to your comments and concerns. Could we trouble you to confirm you've received them in good order, and we would be more than happy to provide further examples, details and clarifications if that is of help.

Many thanks for your consideration.

Darren

Darren Trigonoplos
AIG
Vice President & Head of Federal Government Affairs
901 K Street, NW, Suite 350, Washington, DC 20001
Office: + 1 202 393 9240 | Cell: +1 202 538 1200
darren.trigonoplos@aig.com | https://hyperlink.services.treasury.gov/agency.do?origin=www.aig.com

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Significant Ambiguities in Statutory Provisions Relating to the Base Erosion and Anti-Abuse Tax

• Although reinsurance transactions, including their integral elements — ceding commissions and claims payments on the one hand, and premiums on the other — can flow in both outbound or inbound directions, it is only outbound reinsurance transactions that cause the base erosion effect connoted by the very name of the tax. The statutory language is therefore ambiguous in that it does not precisely delineate between outbound reinsurance transactions that cause base erosion and inbound reinsurance transactions that cause base enhancement.

• Although the statute defines (at Sec. 59A(d)) base erosion payments, it does not specify whether the different components of those transactions (ceding commissions and claims payments, on the one hand, and premium payments, on the other) should be analyzed on a gross basis or a net basis to determine their base erosion effect, if any. Outbound transactions (where premiums paid to foreign related parties typically are larger than ceding commissions and claims received from those third parties) cause base erosion, whereas inbound transactions (where premiums received from foreign related parties are typically larger than ceding commissions and claims paid to those parties) cause base enhancement. The statutory language is therefore ambiguous in that it does not delineate whether base erosion payments are those in which there is any element that causes outflow from the US tax base, or only those where there is a net outflow from the US tax base.

• Although the statute contains a definition (at Sec. 59A(d)) of base erosion payments that includes payments to related parties that are deductible, that is not the same as saying that all deductible payments to related parties are base erosion payments. The conference report language describing the Senate Amendment that created the BEAT provision states: “A base erosion payment generally includes (emphasis added) any amount paid or accrued by a taxpayer to a foreign person that is a related party of the taxpayer and with respect to which a deduction is allowable under Chapter 1.” That language appears to allow for the possibility that — while base erosion payments are those that generally include payments to a related party that are deductible — not every payment to a related party that is deductible is a base erosion payment. The statutory language is therefore ambiguous in that it does not precisely specify whether all — or only some — deductible payments to a related party are base erosion payments. Indeed, the statute itself contains several delineated exceptions such as service payments (59A(d)(5)) and derivatives (59A(h)), and the legislative history contains further exceptions such as cost of goods sold.

• The statute also defines (at Sec. 59A(d)(5)) an exception from the definition of base erosion payments for certain service fees. While the definition of permissible service fees references certain transfer pricing rules, it makes changes to those rules, creating substantial ambiguity on what service charges are included and what constitutes a service charge. This allows the possibility that payments that compensate for service costs, such as ceding commissions, should also be excluded, wholly or just the cost component. In reinsurance transactions, the purpose of ceding commissions is to compensate the ceding company for the costs they incurred to source the business. The statute is therefore ambiguous around the scope of the service fee exception for ceding commissions.

• While the statute defines (at Sec. 59A(d)) base erosion payments as payments to a foreign related person, it does not specify how to treat payments that are ultimately for the benefit of unrelated third parties. Reinsurance claims payments are reimbursements for the ceding company for claims paid to customers who are unrelated third parties. In that sense, claims payments for genuine insurance transactions cannot be said to be related party payments in any economic sense since they ultimately go to customers. The statute is therefore ambiguous as to the definition of a related party payment in the sense of payments to the benefit of related or unrelated parties.

Example of a Reinsurance Transaction

A U.S.-headquartered insurance group maintains its capital base in the U.S. (USRe) but has a subsidiary in France (FranceCo) (as required by local regulations) in order to write automotive insurance.

The unrelated French customer pays $1,000 premium to insure their Peugeot to FranceCo. FranceCo supports its local capital through a 50% quota share reinsurance agreement with USRe. This arms-length reinsurance agreement includes a $175 ceding commission. The expected economics of the book of business is as follows:

Insurer View (pre-reinsurance)
Premium	1,000
Expected accident claims	(600)
Customer acquisition costs (e.g., brokers fees)	(200)
FranceCo general operating expenses	(100)
Expected profit	100

The ceding commission is calculated by reimbursing FranceCo for its expenses (customer acquisition costs and GOE) as well as a small profit component. The profit component generally represents the insurer and reinsurer splitting the expected profit on the 50% of the business reinsured. Economically, this transaction “de-risks” FranceCo by providing a fixed return (here 5% or $25) on half of its book of business while the remaining half is more volatile, i.e., FranceCo will either make more money if claims are lower than expected or incurs losses if claims are higher than expected.

Ceding Commission Calculation
50% of Customer acquisition costs	100
50% of FranceCo general operating expenses	50
Profit component	25
Total	175

USRe benefits from the transaction, because losses associated with French automotive risk are not correlated with losses associated with U.S. hurricanes or earthquakes. This diversification ensures USRe is more stable and able to handle catastrophic losses.

Reinsurer View
Premium	500
Ceding commission	(175)
Expected claims payments	(300)
Net profit	25

This transaction, which brings capital and profits into the US, generates expected net income of $25 under normal accounting procedures. Unfortunately, under the BEAT, the ceding commissions ($175) and, possibly the claims payments ($300) might be considered “base erosion payments.” Under the BEAT the tax liability would be $50 (500 x 10%) rather than $5.25 (25 x 21%) — making the transaction uneconomical under normal circumstances and far worse if claims payments are much higher (since losses in this book cannot offset gains elsewhere in the company because they are driven by claims payments to FranceCo).