Tax-Dodge Scrutiny in U.S. Repels Bidders From Bermuda Takeovers

The IRS’s scrutiny of tax avoidance in offshore locations has discouraged bidders from taking over reinsurers, potentially reducing the companies’ value.

Montpelier Re Holdings Ltd. and Platinum Underwriters Holdings Ltd., both based in Bermuda, have each said in recent regulatory filings that potential suitors backed away last year because of risks tied to taxes.

Lawmakers and government agencies have been seeking to limit what they see as loopholes. Senator Ron Wyden pressed in June to crack down on the use of reinsurers as tax shelters for hedge-fund investors and managers. Then in September, Treasury Secretary Jacob J. Lew issued rules to discourage the tax-avoidance technique known as inversions -- including language that some said might prevent legitimate insurance mergers.

“The clock struck midnight, the U.S. government put more scrutiny on these things,” Ryan Byrnes, an analyst at Janney Montgomery Scott, said by telephone. “Until there becomes some clear guidelines as to what’s allowed, I think we’re not going to see too many U.S. companies buying Bermuda companies.”

Montpelier and Platinum each eventually agreed to be purchased by Bermuda-based insurers. Montpelier, in a May 8 document tied to its deal with Endurance Specialty Holdings Ltd., said that it was approached in August by the another company in the insurance industry about a possible combination.

The suitor, identified in the document as “Party A,” made a preliminary proposal and arranged a meeting between senior managers of the companies.

‘Party A’

Then, on Sept. 23, the potential partner said that “as a result of proposed changes to tax regulations that had recently been announced, Party A was no longer interested in pursuing a potential transaction with Montpelier,” the document shows.

That was a day after Lew issued rules to discourage inversions, where U.S. companies avoid taxes by shifting their legal addresses abroad, usually through an acquisition of a smaller foreign firm.

Among other things, the rules invalidate an inversion if the target is a mere “cash box” with little business activity. Insurers have warned that the definition of cash box could be interpreted too broadly, penalizing those who want to acquire bona fide operations.

Bermuda for years has been attracting reinsurers, companies that provide backup coverage to primary carriers guarding against unusual or large risks, such as hurricanes. Some of the more recent ventures there are tied to hedge funds, like Dan Loeb’s Third Point Reinsurance Ltd. and John Paulson’s Pacre Ltd.

Some reinsurers backed by hedge funds are set up to provide the manager a pool of capital that isn’t subject to client withdrawals, as well as the opportunity to expand assets under management by investing premium dollars before paying claims. Others are more geared toward allowing U.S. investors, including fund managers, to reduce taxes due on gains.

‘Regulatory Risk’

Platinum, which eventually was acquired by RenaissanceRe Holdings Ltd., said it received a separate offer from a suitor called “Party F” in June. Wyden, an Oregon Democrat, wrote a letter to the Treasury Department days later asking why hedge-fund reinsurers continue to proliferate after the Internal Revenue Service promised a crackdown in 2003.

On June 23, Platinum was notified that the bidder was “unwilling to move forward with the proposed transaction due to the substantially elevated regulatory risk to Party F resulting from the Wyden letter,” the target company said in a January filing.

The Treasury told Wyden in August that it was concerned about the “loophole” used by hedge fund managers. Last month the IRS said it plans rules to determine if some companies are holding more assets than they need to back their insurance operations -- a sign that they might be getting a tax break inappropriately.

‘Much Uncertainty’

“There was a window of time where, theoretically, a hedge fund could have bought Platinum, but they would have been disinclined to do so last year because there was so much uncertainty around rules,” Josh Stirling, an analyst with Sanford C. Bernstein & Co., said in an interview.

PartnerRe Ltd., the Bermuda-based company seeking to fend off a hostile bid from Italy’s Exor SpA and instead merge with Axis Capital Holding Ltd., also has disclosed that it had another opportunity. PartnerRe decided in June that no transaction was possible with the potential partner, which wasn’t identified in a March regulatory filing.

Given the timing, tax considerations may have discouraged the potential PartnerRe party as well, Byrnes said. Celia Powell, a spokeswoman for PartnerRe declined to comment, as did Kekst & Co.’s Jim David and Peter Hill, who represent Montpelier and RenaissanceRe.

The Treasury hasn’t yet issued formal, detailed rules to implement its September announcement, and insurance industry representatives have asked for language to protect what they see as legitimate mergers.

Stirling said U.S. insurers may avoid inversions in Bermuda because of the reputational risk after deals in other industries drew criticism from some lawmakers and President Barack Obama. Hedge-fund firms may eventually become more willing to pursue deals there once IRS regulations are finalized, he said.

Seeking Clarity

“People like the idea of there being clarity,” Stirling said. “If there were actually rules, it might actually lead to more activity.”

Stirling and Janney’s Byrnes said that for the time being, it easier for Bermuda companies to combine with one other. Platinum said Party F had offered $82 a share in cash. That’s 7.9 percent higher than what RenaissanceRe agreed to pay.

“The scrutiny has probably made some of those potential asset managers pause at looking to do a deal” in Bermuda, Byrnes said. “It’s maybe made less competition.”

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