Increasing Reinsurance Taxes Would be a Manmade Disaster
With the new Congress underway, tax reform is at the top of the agenda. Many of the ideas now being proposed, such as proposals to fix our punitive corporate tax system, have merit. Also included among the proposals, however, are changes to the tax code that could result in higher costs of basics, such as housing and health care, and thus potentially harm Americans.
Particularly concerning is legislation that could negatively impact the market for reinsurance. Reinsurance is a special type of insurance purchased mainly by property and casualty insurance companies to deal with risks caused by rare but extremely costly events, such as hurricanes and terrorist attacks.
Currently, an insurance company that takes out a reinsurance policy can take a tax deduction for the premiums it pays as a cost of doing business. Legislation filed in the 114th Congress by Sen. Mark Warner (D-VA) and current House Ways and Means Committee Ranking Member Richard Neal (D-MA) would eliminate this deduction for companies that purchase reinsurance from foreign affiliates.
But the House Republican “blueprint” for tax reform has even more far-reaching provisions. Depending on how the details of the plan are fleshed out, the GOP proposal could effectively result in a 20 percent tax on all reinsurance purchased from foreign companies.
Supporters of the proposed changes claim they are necessary to prevent tax avoidance. Yet in reality, the Warner-Neal bill is only expected to raise $440 million annually, according to an analysis by the Tax Foundation. This is a puny amount compared to an industry measured in the trillions.
The bill would, however, make purchasing reinsurance less attractive. The result? Insurance companies will rely less on reinsurance and more on costly alternatives such as tying up valuable capital that might otherwise be invested in the economy.
Making it harder to get foreign reinsurance will leave the United States with more risk. The global nature of the reinsurance market makes it easier for companies to spread risk. For instance, it’s less costly to insure against the risk of a hurricane in Florida and an earthquake in Japan together, rather than separately, because the two events are not likely to be correlated and premiums from one event can be used to cover the losses from the other. This is especially important to the United States, which has faced more than its fair share of natural disasters and other large claims. Eight out of the top 10 costliest insurance losses worldwide between 1970 and 2015 involved the United States.
The effect of making it harder to get foreign reinsurance, then, would be to increase premiums and decrease coverage for American consumers. By limiting risk spreading, the measure would force companies to keep greater capital reserves, making them more costly and less efficient. A recent analysis by the Brattle Group found that under the Warner-Neal bill, net supply of reinsurance would drop by $18.3 billion, or one-eighth of the total for non-affiliate and affiliate reinsurance combined. American consumers would have to pay an additional $9.3 billion per year to receive the same coverage they currently have.
These increased costs would result in a 2.2 percent decline in insurance coverage, with certain lines of business facing declines of as much as 17 percent. The situation would be even worse in coastal states such as Texas, which face a variety of risks from rare but high-impact events. Premiums for home insurance in Texas could rise by as much as $60 million a year, plus $81 million in additional costs for business insurance.
America desperately needs tax reform. But reforms should not leave Americans poorer and less safe.
Josiah Neeley is senior fellow and Texas director at the R Street Institute.
