We’ve all heard stories of offshore bank accounts. Visions of white sand beaches, wire transfers, and heist films spring to mind.

But what are offshore affiliate insurance companies, how much are U.S. life insurance companies using them, and why? One Tippie researcher found out.

A forthcoming research paper by Tippie Associate Professor Jaron Wilde, along with Brad Hepfer (BBA07/MAc07/PhD16) of Texas A&M and Ryan Wilson of the University of Oregon, focuses on life insurance companies’ use of shadow insurance, a term regulators have coined for a class of related-party reinsurance transactions.

While shadow insurance is primarily designed to help insurance firms meet regulatory requirements, it can also be used to move earnings throughout an insurance group, which historically could reduce taxes for some firms if those earnings were sourced to low-tax jurisdictions (e.g., tax havens).

“We wanted to investigate whether shadow insurance was indeed associated with significant tax benefits and then explore some of the implications of its use,”  Wilde said.

The researchers found that foreign-owned life insurance companies in the U.S. were reaping significant benefits—to the tune of $25+ billion—through a loophole in the federal tax code. They also found evidence of significant growth in aggregate shadow insurance over time across the industry, increasing from $101 billion in 2004 to $390 billion in 2017.

That is until the Tax Cuts and Jobs Act of 2017 (TCJA) effectively closed this loophole.

Meanwhile, U.S.-owned life insurers did not enjoy the tax break, even if they used shadow insurance.

The research demonstrates that foreign firms did have an advantage, aided by the federal government through a gap in tax law. The TCJA appears to have leveled the playing field across foreign and U.S.-owned insurance firms.

The study also shows that, despite the lack of tax breaks, about one-third of U.S.-owned companies used shadow insurance, which allowed them to maneuver around arguably onerous capital requirements. The researchers found that most shadow insurance transactions are designed to circumvent what some insurance firms view as excessive statutory reserve requirements.

“Our study, which synthesizes accounting research and practice, highlights some of the nuances of tax and non-tax implications of shadow insurance use,” says Wilde, who has a Thomas and Margaret Kloet Fellowship as well as being a Palmer Faculty Fellow.

This makes the research useful not only to state insurance regulators, but also to tax policymakers, investors, and insurance company boards.

Their research lends evidence to the debate surrounding shadow insurance, with some arguing insurance regulations are excessively onerous and critics contending that shadow insurance could put the entire financial system at risk.

For example, the study quotes the New York Department of Financial Services as saying the practice “is reminiscent of certain practices used in the run up to the financial crisis” of 2008.

According to Wilde, “The magnitude of the practice, coupled with the essential role life insurers play in capital markets—holding roughly one-third of all U.S. corporate bonds—suggest additional study of shadow insurance is warranted.”

This article first appeared in the 2020 issue of Iowa Ledger.