Policy Studies Catastrophe Insurance

Impact on the New Madrid zone of taxing reinsurance transactions

The enormous devastation caused by Hurricane Harvey, still being tallied at the time this paper went to press, has prompted renewed public discussion of appropriate policies to prepare for and finance the recovery from major disasters. Such conversations arrive at a fortuitous time, as Congress also is set to consider a major restructuring of the U.S. tax code for the first time in more than 30 years.

While the precise contours of congressional tax-reform efforts are yet to be determined, potential changes to the taxation of cross-border reinsurance transactions—such as through the use of a territorial tax, a discriminatory tax on insurance affiliates or a full or partial border-adjustment tax—would affect insurers’ ability to use reinsurance to spread risk globally. Hurricane Harvey offers evidence of the folly of such an approach, as early estimates suggest as much as half of the insured cost of Harvey’s damages could fall to global reinsurance companies.

This paper, continuing a series of R Street Institute publications that examine the impact of such tax schemes on local U.S. insurance markets, finds the impact to consumers within the New Madrid Seismic Zone of taxing cross-border reinsurance transactions would be an additional $740 million in higher property-casualty insurance premiums over the next decade.

This projection is derived by examining the impact that discriminatory tax treatment of cross-border reinsurance transactions would have on the supply of international reinsurance, and calculating the effects that subsequent changes in price and availability would have on insurance markets and policyholders. Because property and casualty insurers that do business in the New Madrid Seismic Zone —as in other states and regions exposed to major natural disasters—cede a large volume of risks to foreign reinsurers, these states would experience dramatically higher insurance premiums under tax systems that disallow deductions for cross-border reinsurance transactions. Such changes to the tax could would therefore disproportionately harm consumers’ ability to secure insurance coverage for their homes, cars and businesses.

This is of particular concern in the New Madrid states, which face substantial exposure to earthquake risk. The ability of consumers exposed to such risks to obtain affordable coverage for earthquakes would be hampered should the cost of reinsurance rise significantly. The less that private property owners insure their earthquake risk, the more such risk will be shunted onto the backs of taxpayers via unsecured mortgage loans, particularly those held or guaranteed by the government-sponsored enterprises Fannie Mae and Freddie Mac.

The New Madrid Seismic Zone covers an eight-state area in the interior of the continental United States. Of those states, three stand out in their exposure to seismic risk: Arkansas, Missouri and Tennessee. They are situated squarely above a series of fault lines in a weak spot in the continental crust known as the Reelfoot Rift. As a historical matter, they have experienced the worst of the New Madrid system’s tectonic disruption and are, as a result, heavily reliant on insurance to manage their 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 the New Madrid Zone’s ability to obtain coverage affordably.

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