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Mack Would Let Insurers Create Tax-Deferred Disaster Reserve Funds

NOV. 10, 1999

S14532, S14561-S14562

DATED NOV. 10, 1999
DOCUMENT ATTRIBUTES
  • Authors
    Mack, Sen. Connie
    Hutchison, Sen. Kay Bailey
  • Institutional Authors
    Senate
  • Cross-Reference
    For text of S. 1914, see Doc 1999-37076 (22 original pages).

    For text of H.R. 2749, see Doc 1999-27396 (17 original pages).
  • Subject Area/Tax Topics
  • Index Terms
    legislation, tax
    insurance companies, property/casualty
  • Industry Groups
    Insurance
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 1999-37059 (3 original pages)
  • Tax Analysts Electronic Citation
    1999 TNT 229-23
Citations: S14532, S14561-S14562

Policyholder Disaster Protection Act of 1999

 

=============== SUMMARY ===============

 

Finance Committee member Connie Mack, R-Fla., has introduced S. 1914, which would let property and casualty insurers create pre-tax disaster protection funds for payment of policyholder claims arising from future catastrophes. Similar legislation was introduced in the House as H.R. 2749.

Current tax laws and accounting rules "discourage private market preparation for future major disasters" because premiums needed to fund catastrophic losses in future years are subject to current tax if not used in a particular year, Mack told the Senate. Under this bill, insurers would be allowed to draw down the disaster reserves only if the event is officially proclaimed a disaster and the amount of losses exceeds a specific high level, he said. Amounts distributed from the funds become taxable income for the year of distribution.

The most any insurer could set aside in a given year would be determined "by reference to each insurance company's exposure to the risk of catastrophic loss events," Mack said. Deductible contributions to the disaster funds would be voluntary but irrevocable, and "no company could use these funds to shelter income from taxation," he noted.

Insurers would pay taxes on income generated when funds in the disaster reserve are invested, and the maximum reserve would be phased in at the rate of 5 percent per year over 20 years. "Industry estimates indicate private reserves of $40 billion would be built up over this time," Mack said.

 

=============== FULL TEXT ===============

 

S. 1914. A bill to amend the Internal Revenue Code of 1986 to provide for the creation of disaster protection funds by property and casualty insurance companies for the payment of policy-holders' claims arising from future catastrophic events; to the Committee on Finance.

POLICYHOLDER DISASTER PROTECTION ACT

Mr. MACK. Mr. President, I rise today to address a problem that ought to be a concern to all of us: natural disasters and the exposure of the private insurance industry to catastrophic risks. In my state of Florida, we have a particular concern about hurricane risk, but many areas of the country are exposed to the risks of other major catastrophes -- whether they be volcanoes, earthquakes or tornadoes. Increasingly, I am concerned about the state of the private insurance industry and its ability to withstand a major catastrophe -- a catastrophe of Hurricane Andrew size ($15 billion in insured losses) or greater.

Today, I am introducing legislation to help address this problem and strengthen disaster protection for homeowners and businesses while protecting the interests of the taxpayer. I am pleased my friend from Texas, Senator HUTCHISON, has joined me in this effort. I believe our approach is an innovative, private-sector solution to the problem of catastrophic risk and I encourage my colleagues to review this proposal carefully.

Consumers of property and casualty insurance must be able to rely on their insurers for protection against the risk of catastrophic loss. However, protection for policyholders in today's system is weak; a major future catastrophe could leave consumers without protection and -- if past experience is any indication -- the government would intervene to ensure the people in the disaster areas receive timely compensation. It is important to note that current law actually poses a disincentive for insurers to set aside special reserves for catastrophic events. Any money set aside to cover potential risk is considered taxable income. To fix this flaw in America's insurance system, we need to provide incentives for insurers to set aside a portion of their policy premiums in secure reserve funds that will be available to meet policyholder needs in the event of future catastrophes. Our bill does just that.

The typical property and casualty insurance company in the United States is exposed to multiple forms of catastrophic risk. This risk can take the form of major disasters that occur only once in a decade or once in several decades (e.g., severe earthquakes, major hurricanes). These can also be in the form of localized natural disasters (e.g., tornadoes, wildfires, floods, winter storms) that cause unusually large policyholder losses in a region and imperil the ability of smaller insurance companies to help their policyholders in the area.

The nation's exposure to these large natural disasters is staggering. While millions of families and small businesses rely on insurance payments to recover from natural disasters, it is important to remember that -- under our current insurance tax and regulatory systems -- many private insurers may not be able to pay all claims arising from a major disaster. Hurricane Andrew and the Northridge Earthquake opened our eyes to the country's massive exposure to catastrophic losses. Insured losses in my state from Hurricane Andrew exceeded $15 billion. But if this storm had passed over Miami, rather than Homestead just 40 miles south, insured losses could have reached $50 billion, leaving the Florida economy crippled and more than a third of all insurers in that market insolvent.

There is always the potential for a major disaster in any given year in the United States. Estimates of insured losses from highly probable events range from about $75 billion in California and Florida to $100 billion or more in areas of the Midwest. The Gulf, Intermountain West, and Atlantic states all face exposures of approximately $20 billion or more.

Unfortunately, our current system of tax laws and accounting rules work against consumers and taxpayers because they discourage private market preparation for future major disasters. Present tax laws do not permit portions of consumers' insurance policy payments to be set aside and tax deferred in order to provide for the risk of truly catastrophic loss events. Ironically, our tax system allows insurers to set aside funds on a tax-deductible basis to address disasters that have already happened but it gives them no incentive to prepare for those major disasters that have not yet happened.

Policyholder premiums needed to fund policyholders' catastrophic losses in future years are subject to current tax if not used in a particular year. This diminishes the power of insurers to protect policyholders against future losses. This structure is inadequate for assuring that property-casualty policies will protect consumers from future major catastrophic losses.

The tax law should be revised in order to make accommodation for disaster protection reserves and bring about a more practical, and sensible, system for insurance companies and consumers.

Under the Policyholder Disaster Protection Act, insurers could set aside portions of policyholder payments in a tax-deferred disaster protection fund. Amounts from this fund used to pay for losses from a major disaster would be subject to taxation. This concept is similar to programs presently in place in many other developed countries.

I believe this legislation would result in greater stability for insurers providing catastrophic coverage and fewer insolvencies after a major disaster. A recent study by a major U.S. accounting firm determined that approximately $21 billion in pre-funded reserves would be accumulated within the first ten years of the program. Also, the tax incentive in the bill will encourage insurers to serve disasterprone areas in a responsible manner by setting aside funds to pay for major losses.

The treatment of the fund by insurers would be closely regulated. Following is a general description of the provisions of the bill:

Insurers would be able to set aside special tax-deferred reserves to cover potential catastrophic events.

The maximum amount any insurer could set aside in a given year would be determined by reference to each insurance company's exposure to the risk of catastrophic loss events.

Deductible contributions to disaster protection funds would be voluntary, but would be irrevocable once made (except to the extent of "drawdowns" for actual catastrophic loss events, or drawdowns otherwise required by state insurance regulators). No company could use these funds to shelter income from taxation.

The maximum allowable reserve for any given company will increase or decrease as they enter or exit lines of business that pose catastrophic risk.

Insurers would only be allowed to drawdown the disaster reserves if the loss event in question is declared an emergency or disaster by certain recognized bodies or government officials (for example, a disaster declared by the President under the Stafford Act) and that losses in a year exceed the specified high level. The amounts distributed from the fund are added to company's taxable income for the year in which the drawdown occurred.

Insurance companies would pay taxes on income generated when funds in the disaster reserve are invested. This income would be distributed out of the fund to the insurance company and taxed to the company on a current basis.

The maximum reserve (or "cap") would be phased in at the rate of five percent per year over 20 years. Industry estimates indicate private reserves of $40 billion would be built up over this time.

Various concepts to address the problem of catastrophic losses have been proposed over the years. I look forward to working with all of my colleagues to craft a comprehensive solution to both the short- term and long-term problems presented by the risk of catastrophic disasters. In my view, the private-sector focus of this bill, which puts a strengthened private insurance market for consumers in the forefront of disaster protection, is an approach designed to ensure disaster relief is efficient and cost-effective for taxpayers. While the federal government may still need to provide last-resort safety net for disaster victims, it is important to do what we can to ensure private insurance is available, affordable and secure for those citizens in those areas of the country at risk to a catastrophic disaster. This bill will help to bring precisely that availability, affordability and security to insurance policyholders throughout the country, and I believe it is worthy of support and consideration.

The bill we're introducing today mirrors a bill introduced by Congressman FOLEY and MATSUI in the House of Representatives. It is also supported by taxpayer, homeowner, consumer, business and emergency service organizations, as well as local and state policy makers and insurance organizations. I believe it is a sensible approach and I hope my colleagues will join me in this effort.

DOCUMENT ATTRIBUTES
  • Authors
    Mack, Sen. Connie
    Hutchison, Sen. Kay Bailey
  • Institutional Authors
    Senate
  • Cross-Reference
    For text of S. 1914, see Doc 1999-37076 (22 original pages).

    For text of H.R. 2749, see Doc 1999-27396 (17 original pages).
  • Subject Area/Tax Topics
  • Index Terms
    legislation, tax
    insurance companies, property/casualty
  • Industry Groups
    Insurance
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 1999-37059 (3 original pages)
  • Tax Analysts Electronic Citation
    1999 TNT 229-23
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