Obama budget would hurt U.S. policyholders
Hidden in President Barack Obama’s newly released $3.8 trillion Fiscal Year 2013 Budget Proposal is a provision that would do serious damage to U.S. property and casualty insurance markets, while also violating international commitments made to U.S. trading partners.
The proposal would change current U.S. tax law, which allows U.S. insurers to deduct reinsurance premiums paid either to affiliated or unaffiliated reinsurers regardless of where the reinsurer is based, by disallowing “the deduction for non-taxed reinsurance premiums paid to affiliates.” Essentially, if an affiliate of a U.S. insurer is based abroad where they are not subject to U.S. tax law, then premiums paid to that affiliate could not be deducted as an expense.
As described in the U.S. Treasury Department’s Green Book for 2013, the proposal would:
- deny an insurance company a deduction for premiums and other amounts paid to affiliated foreign companies with respect to reinsurance of property and casualty risks to the extent that the foreign reinsurer (or its parent company) is not subject to U.S. income tax with respect to the premiums received; and
- would exclude from the insurance company’s income (in the same proportion in which the premium deduction was denied) any return premiums, ceding commissions, reinsurance recovered, or other amounts received with respect to reinsurance policies for which a premium deduction is wholly or partially denied.
The White House Office of Management and Budget estimates implementing these changes would reduce the federal deficit by $111 million in 2013, by $1.04 billion over the next five years, and by $2.449 billion over the next decade. For reasons that were not explained, that’s down from the $2.614 billion OMB projected over the next decade for a nearly identical provision in the FY 2012 Budget Proposal.
It also remains unclear why the administration’s projections are so much lower than those put forward by the Joint Committee on Taxation, which has estimated a very similar legislative proposal from Rep. Richard Neal, D-Mass., and Sen. Bob Menendez, D-N.J., would raise $12 billion over the next decade.
All estimates are, of course, going to amount to mere guesswork, because there is no question that international insurers and reinsurers would respond to the new tax treatment by regarding the United States as a less favorable market in which to do business. As the reinsurance market, in particular, is a global one, squeezing reinsurers’ ability to profitably write U.S. risks would have the predictable effect of causing them to redeploy some of their capacity elsewhere.
The reasons this proposal makes for bad policy should be fairly obvious. It threatens to reduce capacity and increase costs for several key U.S. insurance markets, including coastal property catastrophe business, earthquake risks, crop insurance and large account directors and officers liability. It also would have the perverse effect of concentrating U.S. risks within the United States, rather than allowing the global reinsurance system to spread them throughout the globe.
But the plan also would violate several key concepts that lay at the heart of international trade and tax agreements to which the United States is a party. Currently, there are more than 50 in-force double-tax treaties to which the United States is a party, and central to these are the concept of non-discrimination. You cannot subject companies to more punitive or burdensome taxation based solely on where the company is based. The General Agreement on Trade in Services does offer a general exception to that rule, but as the Peterson Institute for International Economics recently opined with respect to the Neal/Menendez legislation, it certainly doesn’t seem like it would apply here:
The general exception relates to GATS Article XIV(d), which permits a difference in the manner of imposing “direct taxes in respect of services or service suppliers of other Members,” provided that the difference does not “constitute a means of arbitrary or unjustifiable discrimination… or a disguised restriction on trade in services.” This exception does not come into play for two reasons: The Neal bill imposes an indirect tax not a direct tax; and whatever the label, the difference in taxation between US and foreign insurance companies amounts to “arbitrary or unjustifiable discrimination.”