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Saturday
Nov182017

Egads! - a Hurricane Harvey recovery tax

By Ian Adams

As appeared in The Houston Chronicle.

Hurricane Harvey appears likely to go down as the costliest hurricane in U.S. history. The estimates are wide-ranging - from $70 billion in damages projected by catastrophe modeling firm RMS, to Ball State University's eye-popping tally of $196 billion in direct and indirect losses - but nearly all project the storm will top the records set by Hurricane Katrina in 2005. Still, dire as the situation is, a tax reform proposal under consideration in Congress could make it worse.

One element of the tax reform plan - a tax on payments made by U.S. firms to offshore affiliates - could have serious unintended consequences for the insurance market. According to a study by the Brattle Group, a tax like the one included in the proposal from the House GOP would reduce the net supply of reinsurance by 18 percent. The annual cost of property insurance coverage in Texas would increase by $271 million.

The reason is straightforward. Well-known insurance carriers, the ones that advertise using goofy personalities during football games, do not maintain enough capital to satisfy the rush of claims that often follows a natural disaster. Special firms known as reinsurers sell "insurance for insurance companies" to cover such eventualities. Geographical diversification is the key to keeping their rates low, and political actions that make spreading risk internationally more difficult are likely to lead to higher rates.

Hurricane Harvey's impact - combined with other major 2017 catastrophes such as Hurricane Irma and the California wildfires - will be felt for years to come. Insurance and reinsurance companies' coffers have been depleted by at least $100 billion in claims, which means that the supply of insurance available to cover future events is expected to drop and rates to rise at least modestly. But the cost of next year's coverage - and, indeed, the pace of recovery and the region's capacity for resilience in the future - may prove to be as much a question of congressional action as anything else.

While the principle of expanding the tax base to pay for growth-enhancing tax cuts has merit, policymakers could not have chosen a worse time to target the global reinsurance market, particularly for cities such as Houston that were recently visited by natural disaster.

By taxing the transactions that allow insurers to spread risk outside the United States, the cost of reinsurance is forced up, as risk is concentrated locally. This ultimately will lead to higher rates for home insurance, auto insurance, business insurance and workers' compensation. Hence, a tariff on affiliate insurance transactions really is a tax on hurricane-prone regions like Houston.

The surge of claims from huge natural catastrophes this year has predictably led to increased demand for reinsurance, just as supply, as a result of loss payments, has dropped. Come the first of the year, prices for reinsurance will inevitably increase. The real question is: Will those premium increases also have to reflect the cost of a brand-new hurricane recovery tax?

Increases like that have an impact not only on the policyholders who have to pay more for the same coverage, but also on those who are priced out of coverage by premium increases. In the event of another major storm in any of the areas impacted this year, a drop in the insurance takeup rate is an enormous price to pay for marginal revenue gains. When a disaster hits a large number of uninsured individuals, the government is inclined to bail them out, generally at a very high cost.

Tax reform is long overdue. But rushing to broaden the base with misplaced priorities can create back-end costs that outstrip both the revenue gained and the economic growth created. Republican members of Congress will have to ask themselves: Is now really a good time for what, effectively, would be a hurricane recovery tax?

For coastal cities in Texas focused on recovery, the answer is a resounding no.

Adams is a senior fellow at the R Street Institute, a nonprofit, nonpartisan, public policy research organization.