The way the political winds are blowing, coastal insurance rates could go up
As it girds for hurricane season, Texas has plenty to worry about. The Texas Windstorm Insurance Association (TWIA)—which provides coverage for high risk coastal properties — has ended up at the brink of insolvency paying Hurricane Ike claims. Insurers operating near the coasts have begun to cut back on coverage and make noises about leaving the state. If that wasn't enough, some members of Congress now want to change tax law in a way that will drive already expensive coastal Texas insurance premiums even higher. The tax law change involves something called "offshore affiliated reinsurance" — a rather esoteric product that matters a lot here in Texas.
Explaining why requires some background. To begin with, all sizeable primary insurers — companies like State Farm, Allstate, and Farmers' — that deal with consumers, buy insurance of their own—reinsurance — to help cover particularly large losses and diversify their own portfolios. (TWIA itself purchased about $1.5 billion in reinsurance prior to Hurricane Ike.) Particularly in high-hurricane-risk areas like Galveston, many companies find it advantageous to buy some or all of their reinsurance from a parent or sister company that they know won't abandon them following a major storm.
Most reinsurance companies have headquarters outside of the U.S. and TWIA, like most other U.S. insurance companies, buys most of its reinsurance from these "offshore companies." The existence of offshore companies benefits everyone: through international markets Texas's hurricane risk gets pooled with Indonesia's risk of cyclones. Since the events never occur at the same time—the storm seasons happen at different points in year — -the reinsurance costs less. Offshore reinsurance competition drives down prices and, in some cases, "affiliated" reinsurance from a sister company proves the best deal of all.
Right now, international and U.S. reinsurance transactions get taxed at just about the same overall rates. Sometimes U.S. companies get a better deal and sometimes companies from elsewhere do a little better. But this could change: A proposal winding its way through Congress—sponsored by Richard Neal (D-Ma.) — would impose an enormous tax on these international affiliated reinsurance transactions that would place non-U.S. companies at a huge disadvantage. This would force many offshore companies to write less coverage or even withdraw from the Texas market altogether. Although U.S.-based reinsurers would take advantage of this by selling more reinsurance to other U.S. primary insurers (including their own affiliates) they still have limited capacity. As a result, primary insurers that couldn't buy enough reinsurance would have to raise rates and reduce coverage in order to build the financial cushion they typically would get from affiliated offshore reinsurance.
And consumers would pay the tab. The economic research and consulting firm the Brattle Group has estimated that, under Neal's proposal, total reinsurance capacity would fall 20 percent and insurers would have to raise premiums by an estimated $10 to $12 billion to give them the cushion they would otherwise have if they could buy enough reinsurance. Texans who live near the coast would pay a lot of this — at least $350 million. Since Texas' Gulf Coast counties rank among the state's poorest, furthermore, already disadvantaged Texans would see premiums soar. And, because international insurers would probably stop doing business in the U.S. rather than pay the tax, the federal government wouldn't get much revenue. Even worse, some European officials have threatened a trade war over the issue.
Raising taxes on offshore affiliated reinsurance is bad idea. If Rep. Neal's bill moves forward, Texans will see their homeowners' insurance bills soar. Members of the Texas Congressional delegation should tell their colleague from Massachusetts to stop tinkering with the federal tax code. Ike hurt Texas badly enough. Congress needs to avoid tax law changes that could make things even worse.
Eli Lehrer is a senior fellow at the Competitive Enterprise Institute, where he directs the Center for Risk, Regulation, and Markets.