Descriptions of the formulas and regression models used to conduct this analysis can be found in the technical appendix.
Reforming the federal tax code is long overdue, but comprehensive reform may have unintended consequences. Since Republicans in the House of Representatives released their “blueprint” for tax reform more than a year ago, details about how it would operate in practice have been sparse. The nebulous possibility that a border-adjustment tax system could be applied to cross-border purchases of insurance and other financial services is of particular concern.
This paper examines how such a tax would impact the availability and affordability of life insurance and annuity products within the United States. It finds that, should insurers be disallowed from deducting the cost of internationally sourced reinsurance, then under an assumed U.S. corporate income tax of 20 percent, the cost of life insurance over a 20-year period—the average term of a policy—would increase by $59 billion, while simultaneously driving down the amount of life insurance and annuity considerations sold by $24.6 billion over the same period.
This projection is derived by examining the impact a border-adjustment tax (“BAT”) system would have on the supply of international reinsurance and calculating the effects that changes in price and availability would have on the nation’s insurance market and its policyholders. Because more than a tenth of the life insurance and annuity premiums written by life insurers in the United States are ceded to international reinsurers, the market is particularly vulnerable to the impact of a BAT.
The effects of these market distortions will be unwelcome for Americans. Life insurance premiums will have to increase, an additional cost that will almost certainly be borne by individual consumers. Simultaneously, there will be a decline in investment in private life insurance products. The second order impacts associated with these market distortions will be dramatic, and will grow over time.
New affordability barriers will lead to an increase in the amount of public assistance needed to sustain the living standards of those who become unable to purchase private life and annuity products. This will lead to an expansion in various federal welfare programs and even to the obligations secured by the federal Pension Benefit Guaranty Corp. The decrease in premiums written also will have an undesirable impact on general economic growth; the U.S. life insurance industry currently invests 75 percent of every new premium dollar in fixed-income debt markets. Funding this debt is a vital component of long-term capital formation. Additionally, as a result of the fall in written premiums, state revenues also would fall, due largely to a decrease in the amount of gross premium tax collected. In other words, lower life insurance industry growth will limit both the availability and cost of capital to support U.S. economic growth.
The scale of these distortions would dwarf the capital generated by the tax cuts funded by applying a BAT system to internationally sourced insurance and reinsurance. The same is true for other similar proposals like a “partial” BAT, a reciprocal tax, territorial tax, a discriminatory tax on insurance affiliates or a minimum tax, insofar as each would constrict the ability of U.S. life insurers to access international capital.
Ultimately, if Congress moves forward with a BAT as part of its tax-reform package, it should note that developed nations that employ the conceptually similar value-added tax (VAT) system almost universally exempt financial services like reinsurance from the tax.
Image by Tashatuvango