Policy Studies California

Impact of a border-adjustment tax on the California insurance market

As the nation’s most populous state, among the wealthiest states and a state that is vulnerable to the catastrophic effect of earthquakes, floods, wildfires and other natural catastrophes, California relies heavily on insurance to manage its significant risk. As Congress prepares to consider structural changes to the U.S. tax code, proposals that target international reinsurance would have adverse consequences on Californians’ ability to obtain coverage affordably.

Specifically, this report finds that applying a destination-based cash flow tax—better known as a “border-adjustment tax,” or BAT—to the import of reinsurance would cost California consumers an additional $1.91 billion in higher property-casualty insurance premiums over the next decade.

This projection is derived by examining the impact a BAT system would have on the supply of international reinsurance and calculating the effects that changes in price and avail-ability would have on the state’s insurance market and policyholders. Because property and casualty insurers that do business in California—as in other states exposed to major natural disasters—cede a large volume of risks to foreign reinsurers, the state would experience dramatically higher insurance premiums under a BAT system.

While the precise contours of congressional tax-reform efforts are yet to be determined, proposals such as a BAT or a partial BAT, a reciprocal tax, territorial tax, a discriminatory tax on insurance affiliates or a minimum tax all would affect insurers’ ability to use reinsurance to spread risk glob-ally, and hence disproportionately harm consumers in states like California and their ability to secure insurance coverage for their homes, cars and businesses.

This is of particular concern in California, where residents are overexposed and underinsured with regard to earthquake risk. The California Earthquake Authority has expended great effort to boost the takeup rate of earthquake insurance within the state in an actuarially sound manner. Its ability to continue to do so would be hampered seriously should the cost of reinsurance be driven up. The less that private property owners insure their earthquake risk, the more it will be shunted onto the backs of taxpayers via unprotected mortgage loans.

Should Congress ultimately consider a BAT as part of an overall 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 Victor Maschek


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