For years, some Democratic members of Congress have been pushing a “reinsurance” measure that is protectionist in nature. Reinsurance is insurance purchased by insurance companies, and is of particular importance for Californians because of its role in protecting against widespread calamity – i.e., if a major earthquake or wildfire hits a particular region.

“The key function of reinsurance is risk-pooling to lower insurance company risk through global diversification. An insurer can reduce the impact of large losses by sharing (i.e., ceding) its exposure to particular risks,” explains a report released last week by the influential Brattle Group. It was produced on behalf of the Coalition for Competitive Insurance Rates and funded by the Association of Bermuda Insurers and Reinsurers.

In other words, in the case of a catastrophic event, it’s in the interests of insurance companies – and consumers – to have the risks spread across the globe, rather than concentrated in the United States or in one state in particular. Otherwise, unexpectedly high claims could threaten the solvency of the insurance companies. Without reinsurance to spread and pool different risks and kinds of catastrophes from all over the globe, insurers would have to charge significantly higher premiums to cover those risks.

Some congressional Democrats have for a decade been trying to pass tax legislation that would strip the U.S. subsidiaries of foreign-owned U.S. insurance companies from being able to write off the cost of reinsurance they buy from offshore affiliates. Advocates for this change argue that the transactions could be used to avoid U.S. corporate income taxes.

But it’s important to remember that more than 60 percent of the payments for the massive 2005 hurricanes (including Katrina) came from foreign insurance companies. In the event of an earthquake, it’s particularly important for insurance companies to be as diversified as possible, given that a major earthquake could have such an enormous impact on the resources of the U.S.-based insurance industry.

It’s not about tax avoidance, they say, but about the fundamentally sound insurance practice of diversifying their risk. They fear efforts to eliminate the tax deduction for these overseas reinsurance purchases would endanger their assets and distort U.S. insurance markets.

With the Trump administration in place, Capitol observers expect this seemingly arcane tax and insurance dispute to be addressed in his first budget – and they expect this traditionally Democratic idea to gain newfound support from congressional Republicans, who are eager to implement the new president’s agenda. The initial GOP budget blueprint could, in effect, impose a 20 percent import tax on reinsurance products. Those increased costs would not only inflate insurance prices for consumers, but reduce the number of insurance offerings or increase deductibles.

“We estimate that U.S. consumers would have to pay $9.3 billion more per year to obtain the same coverage,” according to the report. “In percentage terms, the proposed tax would increase the price of insurance by 0.8 percent, on average, and as much as 6 percent in some insurance lines.” In some business lines, the report pointed to a possible drop in available insurance coverage by 17 percent – even higher in regions where hurricanes and other risks are concentrated.

The national business-tax discussions center on efforts by the new administration to simplify the tax system for American businesses, by replacing the current corporate tax with a cash-flow tax. A U.S. Treasury Department report released this month explains that “By providing consumption tax treatment to business income, the cash flow tax creates incentives typically attributed to consumption taxes, such as increased incentives for investment, reduced distortions across different types of investment, and no distortion across the financing of investment.”

The Treasury report believes such a change would be beneficial in addressing issues such as income inequality, but finds that “globalization and the rise of multinational corporations has made clear the difficulties of attempting to tax income differentially based on where it accrues.” The international nature of the reinsurance industry highlights this particular problem in dealing with what is referred to as the “border adjustment system,” which taxes products and services where they are sold rather than where they are produced.

The goal of tax reformers is to encourage companies to produce more products in the United States and export them to other countries, but it’s unlikely that the insurance industry is what backers had in mind in proposing this change.

“Discouraging the purchase of foreign reinsurance would obviously provide incentives for more reinsurance purchases from U.S. companies, but only by distorting the global risk pool and reducing competition,” according to an Insurance Journal article last month by my R Street Institute colleague Lori Sanders. She backs the idea of eliminating “the outlandish number of tax loopholes riddled throughout our corporate tax code,” but cautions against doing so in a way that drives up domestic insurance prices and exposes Americans to additional risks.

The most prominent effort to repeal the tax deduction has come from Sen. Mark Warner, D-Va., and Rep. Richard E. Neal, D-Mass., but their legislation has not passed despite years of trying. This is a national issue rather than a California issue per se, but California’s susceptibility to catastrophic events is a major issue for those living here.

For instance, currently only a small percentage of Californians in earthquake-prone areas purchase earthquake insurance, with, for example, only 10 percent of them buying it in the San Francisco Bay Area. Any new laws or budgetary tweaks that drive up the cost or reduce the coverage (and increase the deductibles) can make Californians even more vulnerable to such risks. The California Earthquake Authority relies heavily on reinsurance, for instance, and reducing its availability even further increases the likelihood that taxpayers will be on the hook if the Big One strikes.

This tax-deduction issue is an example of how seemingly small changes in arcane tax policy can have a large, unforeseen impact – and how broad national political themes (buy American!) become difficult to implement when looking at the specifics of particular industries.

Steven Greenhut is Western region director for the R Street Institute. He is based in Sacramento. Write to him at sgreenhut@rstreet.org.

In his speech, Kashkari called for three crucial steps:

• “Breaking up large banks into smaller, less connected, less important entities.”
• “Turning large banks into public utilities by forcing them to hold so much capital that they virtually can’t fail (with regulation akin to that of a nuclear power plant).”
• “Taxing leverage throughout the financial system to reduce systemic risks wherever they lie.”

That’s from a Business Insider account of his speech.

Kashkari, who ran the Treasury Department’s Troubled Asset Relief Program under both President George W. Bush and President Obama, worked for Goldman Sachs’ San Francisco office before his government job. After leaving the Treasury Department, he joined Newport Beach-based PIMCO. While he lost to Gov. Jerry Brown in a landslide, he was still considered an up-and-comer in California politics before moving to Minneapolis last year, where he assumed the Fed post in November. If he does seek California office again, as some political observers expected, his speech will likely be a focus for its perceived populist themes.

‘It’s very hard to see crises coming’

The Washington Post, Politico and many other East Coast media treated Kashkari’s comments as highly newsworthy and provocative. Reuters called his ideas “radical.” In a subsequent interview with the Post, Kashkari said, given the unpredictability of the global economy, it’s smart to adopt reforms during relatively stable periods to prevent future shocks before they happen:

If you look around the global economy, there’s a lot of uncertainty. There are people who are concerned about China’s slowdown and whether it’s going to be a hard or soft landing. All of those are out there, but it’s very hard to see crises coming.

 

Nobody was omniscient enough to call $100 oil or $150 oil a bubble. I’m not saying that it was a bubble; I think it’s supply and demand forces. But certainly nobody forecast it going down to $30. That’s just an example of an exogenous shock. Everybody’s eyes were open. None of the smart people saw it coming. What else don’t we see coming? …

 

[It] isn’t clear to me that just keeping investment banking separated from depository lending is necessarily by itself a solution. If we go back to the root causes of ’08, we had a nationwide delusion that home prices only go up. I participated in that delusion: I bought a house in California in 2005. Traditional banks made a lot of bad loans based on the premise that if home prices keep going up, these loans are going to be okay. …

 

To really be strong enough against a shock we haven’t thought of, we would either need much, much higher capital requirements — the banks are already pushing back hard against the capital surcharges — or we need to look at much stronger or more intense stress scenarios.

Kashkari, 42, a Hindu native of Ohio, has undergraduate and graduate degrees in mechanical engineering from the University of Illinois/Urbana-Champaign. He worked as an engineer for TRW in Redondo Beach before going to the University of Pennsylvania’s Wharton School for his MBA, which led to his Goldman Sachs job. When Goldman Sachs chairman/CEO Henry Paulson became U.S. secretary of the treasury in 2006, he hired Kashkari as an aide, laying the groundwork for his appointment as the assistant treasury secretary overseeing TARP.