Hedge fund moguls have avoided paying taxes on profits for a number of years now through a tax loophole involving setting setting up a reinsurance firm. This tax loophole has cost the U.S. government hundreds of millions if not billions in uncollected taxes as hedge funds claim to be reinsurers so they can park their profits tax free.
Democrat Ron Wyden unveiled his plan to stop what many consider to be this unfair tax loophole in the Senate Finance Committee last week.
A few years ago, hedge funds learned how to minimize taxes and delay payment indefinitely by routing investments through reinsurers in offshore locations such as Bermuda. John Paulson, David Einhorn and Dan Loeb are just a few of the hedge fund managers who have established foreign reinsurance firms. The funds claims these are legitimate businesses that do actually take on on risks from primary insurers, and not merely tax scams.
Dan Loeb's Third Point returned 11% in its flagship Offshore Fund and 13.2% in its Ultra Fund for the first quarter. For April, the Offshore Fund was up 1.7%, while the Ultra Fund gained 2.3%. The S&P 500 was up 6.2% for the first quarter, while the MSCI World Index gained 5%. Q1 2021 hedge Read More
Statement from Democratic Senator Ron Wyden
“For over 10 years now this loophole has allowed some hedge fund investors to avoid paying hundreds of millions of tax dollars,” Wyden note in a statement last Thursday. “It’s time we shut it down for good.”
Hedge fund reinsurance tax loophole: Details on Wyden’s proposal
Wyden’s bill calls for reinsurers to only be recognized as a legitimate business if insurance liabilities are more than 10% of the firm’s assets. The bill says that if the ratio of insurance is between 10% and 25% of assets, the determination for tax purposes will be based on “facts and circumstances,” according to the proposed legislation.
The overview of the Senate bill noted: “Legitimate insurance companies will be able to meet the 25 percent test.”
The IRS has also recently clamped down on the tax benefits enjoyed by hedge fund reinsurance firms. Back in April, the agency published a notice of proposed (Exception From Passive Income for Certain Foreign Insurance Companies). The proposed rules separate truly “active” reinsurance companies from those that just operate as vehicles for U.S. hedge fund investors to protect investment income from taxes.
Warren Buffett explains the tax dodge
Legendary investor Warren Buffett recently warned that the reinsurance industry was in a down cycle.
In his comments at the annual meeting of Berkshire Hathaway, Buffett explained that over the next decade, the reinsurance industry “will not be as good as it has been in the last 30.” He continued to say, “It’s a business whose prospects have turned for the worse and there’s not much we can do about it.”
Buffett noted that hedge funds have launched reinsurance companies registered abroad to take advantage of tax benefits over the last several years, and in most cases just underwrite a small amount of insurance as a “façade.” He also pointed out that tougher competition in the reinsurance sector has hurt pricing and low interest rates have weighed on the firms’ bond portfolios.