The process of rebuilding the areas damaged by last month’s Hurricane Irene will take months and cost billions of dollars. Federal, state, and local governments will pay part of the bills (mostly to repair infrastructure), and many individuals and businesses will have to dip into reserves or borrow money. But the single largest portion of the bill–several billion dollars at minimum–will flow from private insurance companies.
Those insurers will largely turn to insurance of their own, reinsurance, in order to pay policyholders. Without private insurance and reinsurance, the demands on savings, charity, and government would be greater. That’s why it’s puzzling and disturbing that the Obama administration and a few members of Congress are pushing proposals that would (at best) make insurance more expensive and (at worst) make it impossible for some people to get insurance.
The proposals in question are officially known by the only-a-bureaucrat-could-love-it name of “deduction disallowance for reinsurance premiums paid to affiliates.” They’re easily among the worst of the many tax increases currently under consideration in Congress. The taxes are likely to cost consumers billions of dollars, make the nation less resilient in the face of disasters, and generate less revenue than expected.
Nearly all “primary” insurance companies that sell the types of insurance consumers purchase–homeowners, auto, and commercial–buy reinsurance to deal with catastrophic events they might have trouble paying for out of reserves. Nearly all insurers buy some reinsurance from unconnected enterprises and some from firms that share ownership and management ties. Transactions with these “affiliates” are closely regulated to make sure real risk transfer takes place, and they are taxed in the same way as “unaffiliated” transactions.
For companies that operate internationally–as all major reinsurers do–these affiliated transactions are key to the risk management practices at the heart of insurance. By using reinsurance transactions to pool their capital, reinsurers can combine the risks of hurricanes in the United States with, say, the risks of earthquakes in Japan and industrial accidents in Brazil. Since these disasters are very unlikely to happen simultaneously, reinsurers can make profits off of one kind of transaction while paying out claims on another. This, all other things being equal, lets reinsurers charge less while making the same or greater profits. Consumers share in the savings.
The proposal in President Barack Obama’s budget and about to be introduced in the House by Rep. Richard Neal (D-MA) would impose massive new taxes on non-U.S.-based companies that do the same thing as all U.S.-based insurers do. This would cause huge problems.
First, insurance rates would soar. The Brattle Group, an economic research and consulting firm, estimates consumers’ total premiums could rise by as much as $130 billion over the course of a decade.
Second, and just as importantly, at least some people who now purchase insurance would likely go without and have to rely on government or charitable assistance after a major disaster.
Third, without international reinsurance, disasters would have even worse effects on the economy than they do now. Because foreign reinsurers would play a smaller role in the U.S. market, a much greater percentage of disaster repair costs would have to be paid directly by American enterprises, which would then be unable to devote those funds to other, more productive uses.
Finally, the taxes appear almost certain to collect less revenue than forecast. Large reinsurers all operate globally and can easily move their capital elsewhere. The Obama administration and its allies in Congress are proposing such high tax rates on usual business transactions that many offshore reinsurers will simply do business elsewhere rather than pay them.
The bottom line is simple: This obscure tax proposal with a wonky name is a terrible idea that would hurt consumers and the public. It deserves a speedy rejection in Congress.
Eli Lehrer ([email protected]) is vice president of Washington, DC operations for The Heartland Institute and national director of its Center on Finance, Insurance, and Real Estate.