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Tuesday
Dec132016

Tax reformers must take care not to kill reinsurance market

By Lori Sanders

During the 2016 presidential election, one theme from President-elect Donald Trump rang louder than any other: the importance of keeping jobs in America and finding ways to encourage (or perhaps force) companies that have sent jobs overseas to bring them back. The PEOTUS suggested countless ways to do so, from imposing tariffs to rolling back regulations to renegotiating trade deals.

While some of Trump’s ideas make congressional Republicans squirm, one place of firm agreement between the Republican in the White House and those in Congress is tax reform, and for good reason. Our nation’s corporate tax code combines the highest rates in the OECD with a complex system of loopholes and deductions to create a behemoth that only serves to drive businesses (and jobs) overseas.

But in their efforts to entice jobs back to our shores, Congress must be careful not to bring an outsized portion of insurance risk back with them inadvertently. The issue at-hand is a deduction for reinsurance premiums taken by U.S. companies who cede premiums to offshore affiliates.

An insurance company purchases reinsurance to help cover its losses in the case of unexpectedly high claims – for example, massive property damage in a region due to a hurricane. The ceding premiums as a business cost, and it becomes income for the reinsurer receiving the premium payments. If that reinsurer is based in the United States, those premiums are part of their U.S. taxable income. If an insurance company’s losses turn out to be high and their reinsurance contract kicks in, then the reinsurance payouts made can become a loss that is carried forward on future taxes. Obviously, if the reinsurer is foreign, they neither pay U.S. taxes on any income nor can carry forward any loss for reduced U.S. tax liability.

For more than a decade, bills have been introduced in each session of Congress to deny this deduction to U.S. insurers who purchase reinsurance from foreign affiliates. It’s also made it into the president’s budget for the last five years. Proponents of this change claim that it would reap billions in tax revenue, despite outside analysis that shows the federal revenues to only come to $440 million. It has been floated as a pay-for in recent tax-reform efforts, but never made it across the finish line.

This is fortunate, because proponents’ second claim is even more dangerous. Supporters of ending the deduction claim that these offshore reinsurance purchases are simply done for tax avoidance purposes, encouraging capital to fly overseas. However, this is simply not the case.

First, these purchases are screened and approved by insurance commissioners to verify that the purchase is legitimate, rather than for the purpose of income stripping. But second and more significantly, it’s incredibly important to the structure of the reinsurance system that risk is spread all over the globe. This helps reinsurers to diversify their exposure to any given geography or line of business, which would pose solvency concerns and require higher premiums to justify the increased risk. Under the global reinsurance system, when Louisiana is hit by a large hurricane or a devastating earthquake hits Japan, the capital needed to rebuild floods in from all over the world.

Discouraging the purchase of foreign reinsurance would obviously provide incentives for more reinsurance purchases from U.S. companies, but only by distorting the global risk pool and reducing competition. According to a study by J. David Cummins of the Wharton School, along with the Brattle Group, reinsurance costs could rise between $11 and $13 billion from this change.

It doesn’t stop supporters from continuing to press their case, however, and unfortunately for consumers, the chief architect of the legislation to end the deduction—Rep. Richard Neal, D-Mass.—soon will sit as the ranking member on the House Ways and Means Committee, which is charged with crafting U.S. tax policy. Also of concern is that House Republicans appear to be considering the proposal as part of their “blueprint” for tax reform – specifically in the context of a “border adjustment” system, in which all sales to U.S. customers are taxed and all sales to foreign customers are exempt.

Closing the outlandish number of tax loopholes riddled throughout our corporate tax code is a Herculean task, but one that is necessary to ensure lower corporate rates don’t drive up our already high national debt. However, the point of tax reform is to create a level playing field that attracts companies, jobs and products to our shores, and Congress should be wary of calls to disadvantage one segment of an industry over another.

Driving up the cost of insurance for consumers and increasing our exposure to risk from disaster is a wrongheaded way to pay for tax reform. After all, each of the companies we hope will expand their U.S. presence will need insurance. It would be a shame for them to not bring the jobs back due to higher operating costs created by the very tax reform intended to lower them.

Lori Sanders is outreach director and senior fellow at the R Street Institute.