As the 2009 hurricane season enters its early weeks, Alabama residents need to check their windows, stock up on non-perishable food and make sure they have working battery-powered radios.
After all, major storms have made landfall in the state, on average, about once a decade; and a year rarely passes without heavy rainfall, rip tides or high winds that spin off from a hurricane that hits somewhere else.
For example, last year’s Hurricane Fay never made a direct hit on Alabama, but rain, high tides and thunderstorms still caused millions of dollars in damage in the state.
Unfortunately, the Legislature went home earlier this year having done little to change Alabama’s insurance system or relieve residents from rising coastal insurance rates. And now, legislation pending in Congress could have major consequences for coastal Alabama homeowners.
In particular, some members of Congress want to change the tax law in a way that would drive already expensive coastal Alabama insurance premiums even higher.
The proposed changes would affect the tax treatment of something called "offshore affiliated reinsurance." Although the name of the product alone is enough to make many people’s eyes glaze over, such reinsurance matters a lot in every Gulf Coast state.
Explaining why requires some background. To begin with, all sizeable primary insurers — companies like Allstate, ALFA and Nationwide that sell directly to consumers — buy insurance of their own to cover their expenses after major catastrophes and diversify their risks.
Particularly in high-hurricane-risk areas, many companies buy some or all of this reinsurance from a parent or sister company that they know will continue to write coverage following a big loss.
A lot of this coverage comes from companies that have headquarters outside of the United States. This global risk-management is a good thing for everyone.
Insurance prices, in general, fall when insurers manage risks across a broader pool of similar risks unlikely to happen at the same time; and international pools make it easier to group such risks together.
Through such markets, Alabama’s hurricane risk gets pooled with Japan’s risk of earthquakes, and since hurricanes and earthquakes are unlikely to happen at the same time, reinsurers can make profits off of one type of cov erage while paying out claims for the other.
As a result, the reinsurance costs less.
Right now, companies engaging in U.S. and international reinsurance transactions pay roughly the same amount of taxes. Sometimes U.S.-based companies have a small advantage, and sometimes offshore companies do a little better.
But this could change. A law making its way through Congress, sponsored by Rep. Richard Neal, D-Mass., would impose a big tax on these international affiliated reinsurance transactions.
Indeed, the tax would be so large that most offshore companies would have to cut back in every Gulf Coast market.
Although some U.S.-based reinsurers would take advantage of this by selling more reinsurance to other U.S. primary insurers, including companies they are affiliated with, such U.S. companies still have limited capacity. Primary insurers would have to raise rates and reduce coverage in order to build the financial cushion they typically would get from affiliated offshore reinsurance.
This could get expensive for consumers. The economic research and consulting firm known as the Brattle Group has estimated that, under Rep. Neal’s proposal, insurers would have to raise premiums by an estimated $10 billion to $12 billion to give them the cushion they would otherwise have if they could buy enough reinsurance.
Reinsurance capacity would also fall by about a fifth.
Alabama residents who live near the coast would bear a disproportionate chunk of this staggering bill. And, if international insurers pulled out of the United States rather than pay the tax, the federal government wouldn’t get much revenue, either.
Alabama has plenty of coastal insurance problems that its Legislature should address. Federal meddling could easily make a bad situation worse.
Members of Alabama’s congressional delegation should send a clear message to their colleague from Massachusetts: His proposed tinkering with the tax code is a bad idea.