Impact of Tax Reform on Insurance Carriers

Now that the Tax Cuts and Jobs Acts has become law, it is time to evaluate its impact on the insurance industry which on balance is positive.

The reduction of the corporate tax rate from 35% to 21% and the elimination of the corporate minimum tax will benefit insurers and insurance distributors that are organized as C corporations. The average insurer pays a tax rate in the low 30s so this benefit stands to be substantial. Insurance agencies organized as “pass-through” businesses, such as S corps, partnerships and sole proprietorships, benefit from the reduction of individual tax rates.

According to the Washington Examiner, the improved profitability from these actions has already manifested itself in an increase of 401(k) contributions at Nationwide and Aflac. In 4Q17 we may see an increase in reserve development to take advantage of the tax deductions at the higher rate. Longer term, we expect these higher levels of profitability will be curtailed in the highly competitive insurance marketplace resulting in lower rates.

For organizations with significant international operations, the shift to a territorial tax system may bring a repatriation of cash from offshore retained earnings. Chubb, for example, cites the lower tax rate and the impact of a territorial tax system on its deferred tax liability as the drivers of a $250 million one-time increase in earnings for 4Q17, as reported by The Insurance Journal.

The improvement in profitability and heightened cashflow will improve ROI on growth initiatives and provide additional capital to reinvest in the business. It may even provide some relief from expense pressures. All positives for supporting CIOs’ objectives.

The reduction in corporate tax rates is not completely salutary. Deferred tax assets (DTA) result from prior year losses. Their value is commensurate with the tax rate. For those entities with deferred tax assets (DTA), there will be a need to reduce the value of the DTA resulting in an earnings hit, especially at life and multi-line insurers. The balance sheet impact could be meaningful for firms with significant DTA, however S&P doesn’t expect this to have a ratings impact.

The new tax law contains provisions reducing the advantages of insurance activity in tax havens, such as Bermuda and the Cayman Islands. The impact here will be to non-US insurers and reinsurers with US subsidiaries, as well as US insurers that cede to non-US affiliates who will face higher excise taxes that reduce much of the tax advantages.

The effect of tax reform on the insurance industry is generally beneficial, reducing the tax burden of domestic insurers, brokers, and agencies, and ultimately providing policyholders with some rate relief. However, international insurers and domestic carriers with material deferred tax assets may be negatively impacted.

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