New Obama Tax Would Cost Connecticut

New Obama Tax Would Cost Connecticut
March 2, 2010

A proposal buried on page 161 of the Obama administration's 2011 budget could cost Connecticut millions of dollars over the next few decades.

Despite a name sure to induce yawns ("deduction disallowance for excess non-taxed reinsurance premiums paid to affiliates"), estimates that the provision will produce only about $50 million in federal revenue per year, and support from some Connecticut-based insurance companies, the proposal seems likely to do serious damage to Connecticut's economy.

Explaining the tax proposal and how it affects consumers requires a little background in how insurance and reinsurance work. To begin with, "primary" insurers that cover homes (Travelers) and businesses (HSB) buy insurance of their own--reinsurance--to diversify their risks against major disasters ranging from hurricanes to industrial accidents, such as the recent Kleen Energy Systems power plant disaster in Middletown. All sizeable insurers buy reinsurance: some of it comes from entirely separate corporations and some of it from parent or sister companies they know won't abandon them after a disaster.

Most U.S. reinsurance comes from companies in other nations. Because these companies often insure against events--a flood in the U.K., a factory explosion in Japan--unlikely to happen simultaneously with major claims in the United States, such reinsurance purchases cut prices by letting companies profit off of one type of coverage when they lose money on another. This is how insurance works, and even ardent trade protectionists realize international risk diversification is the best approach for insurance.

Currently, the non-U.S. companies that provide this coverage pay federal excise taxes and corporate taxes roughly equivalent to effective U.S. corporate income taxes. The administration's budget, however, would give U.S.-based companies an advantage by imposing a burdensome tax on many offshore companies' affiliated reinsurance transactions. That would destroy their business model.

Some Connecticut companies, such as Greenwich-based W. R. Berkeley, say the tax would produce higher profits for them, and they may be right. But even here in Connecticut--the state with the most insurance jobs per capita--international reinsurance coverage plays a major role in the economy. Kleen Energy Systems, operating right here in Connecticut, bought an estimated 60 percent of its coverage from companies that have either headquarters or major partners overseas. After 9/11, likewise, non-U.S. insurers paid almost 65 percent of World Trade Center claims.

If Obama's tax proposal becomes law, the offshore reinsurers that send money to Connecticut will withdraw from the market or downsize operations. The reduced competition would allow U.S. companies to raise prices. Thus even companies that don't directly carry out offshore-affiliated reinsurance transactions would get hit with higher costs.

Consumers would end up paying for it: A 2009 report from the economic consulting firm the Brattle Group estimated a proposal similar to the Obama administration's would raise prices by a cumulative $10 billion, with Connecticut businesses and consumers on the hook for millions of that. Homeowners in hurricane-prone coastal areas, teaching hospitals, and aerospace manufacturers would likely experience some of the largest tax increases.

Connecticut residents and businesses have a lot to lose if Obama's reinsurance tax becomes law. Governor Rell, every member of the legislature, and, most importantly, every member of the state's Congressional delegation should speak out against the proposal. Even if some local companies like it, Connecticut can't afford it.

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Eli Lehrer (elehrer@heartland.org) is a senior fellow of The Heartland Institute and director of its Center on Risk, Regulation, and Markets