HD22 - The Taxation of Insurance Companies in Virginia

  • Published: 1986
  • Author: Secretary of Finance
  • Enabling Authority: House Joint Resolution 311 (Regular Session, 1985)

Executive Summary:
Virginia levies a gross premium tax on the insurance industry. In fiscal year 1985, this tax generated $108.6 million, making it the fifth largest source of revenue in the Commonwealth's General Fund. Although the characteristics of the insurance industry have changed dramatically over the years, the rate structure has not changed from the original form recommended to the General Assembly in the 1914 Report of the Joint Committee on Tax Revision.

House Joint Resolution 311 passed by the 1985 General Assembly requested the Secretary of Finance to study the taxation of insurance companies in Virginia. The objectives of the study were:

1. To examine the philosophy and derivation of the gross premium tax;

2. To evaluate the rationale for applying different tax rates to gross premium income;

3. To assess the tax burden and equity of taxing gross premium income; and

4. To evaluate the criteria for exempting certain types of insurers from the gross premium tax.

The gross premium tax is the most prevalent form of insurance taxation nationwide. However, Virginia's tax structure is more complex than that of most other states. The complexity is due primarily to Virginia's three different rates and numerous fees and special assessments. The overall tax structure is comprised of these basic components:

• the gross premium tax ranging from 1% to 2.75%;

• a corporate income tax that is applied to for-profit health maintenance organizations;

• six different license fees ranging from $20 to $200;

• two assessments to offset the costs of regulatory agencies, and

• a fire programs tax of .8%.

Present law also provides for several exclusions and deductions from the premium tax base.

Certain types of insurers are exempt by law from paying the gross premium tax in Virginia. These include: mutual assessment fire companies serving four counties or less; prepaid hospital, medical, surgical, dental, and optometric plans; and fraternal benefit societies. Because health maintenance organizations (HMOs) are not legally defined as insurance companies, they also are not subject to the premium tax.

Virginia's tax structure appears to have rates that are higher than most states. The 2.75 percent rate on property and casualty companies is especially high, and the addition of the .8 percent fire programs tax results in greater retaliatory taxes paid by Virginia-domiciled companies to other states where they do business. This comparatively high rate is viewed by industry representatives as one reason why the domestic insurance industry is relatively small in Virginia.

Nominal rankings of premium tax rates are one way of comparing tax burdens on insurance companies in Virginia with those in other states. Another way of measuring relative tax burden is to examine how Virginia's taxes are distributed among types of insurance companies. This type of analysis is essentially the same as that conducted in 1914. In order to perform this analysis, a comparable income figure was calculated for the different lines of insurance, and total revenue collected from taxes, fees, and assessments was determined. The percentage of income that goes to pay taxes, fees, and other assessments provides an indicator of relative tax burden.

The analysis of tax burden showed that among domestic insurers, the highest relative tax burden is on the property and casualty companies, mutual assessment fire companies, and the workers' compensation self-insured groups. This finding is essentially the same as the key finding in the 1914 study. At that time, the rate structure was adjusted to reduce the burden on property and casualty companies.

The fact that Blue Cross/Blue Shield (BC/BS) plans, HMOs, and fraternal benefit societies are not subject to the gross premium tax is viewed by many commercial insurers as another inequity in Virginia's tax structure. They believe that these organizations provide insurance protection that is largely indistinguishable from that sold by companies that are subject to the tax. According to commercial insurers, this preferential tax status gives these organizations a compet1tive edge in the market.

The tax-exempt groups counter that they provide certain public benefits and charitable work that they would have to reduce or eliminate if they were subject to the tax. Furthermore, the BC/BS plans and HMOs indicate that if they eliminated the open enrollment and unrestricted conversion provisions in their contracts, the state would have to assume the risk for large numbers of individuals who would not be able to get affordable insurance coverage.

The long-standing tax-exempt status of these organizations is currently being considered in a number of forums. Not only are other states reassessing their tax treatment, but Congress will likely be addressing this issue over the next few years.

Several alternatives exist for addressing tax inequities while maintaining current levels of revenue. The options are not mutually exclusive and are open to combination and refinement. The present system could be restructured in the following ways:

• Equalize the base of taxation. The major inequity here is the inability of property and casualty companies to deduct assessments paid to guaranty associations, whereas life companies are permitted this deduction. To remedy this situation, either eliminate or permit this deduction for all companies. If the status quo is maintained, a deduction for annuity claims should be disallowed.

• Equalize license fees. There is no justification for the variation in amounts or application of annual license fees. They should either be repealed, equalized, or, if different, tied to a defensible rationale.

• Require all companies to equitably bear the cost of regulation. Self-insured workers '·compensation groups pay administrative assessments to both the Bureau of Insurance and the Industrial Commission. Fraternal benefit societies pay no administrative assessments.

• Reduce the tax burden for property and casualty companies. These companies bear a far greater tax burden than other lines of insurance. Ways to reduce the burden include decreasing the premium tax rate and eliminating or crediting the fire programs tax.

• Move toward a simplified rate structure. Virginia's multi-tiered structure can be simplified without a major loss in revenue. A single or two-tiered structure should be considered.

A major issue that should be addressed definitively is the tax-exempt status of BC/BS plans and HMOs. Much of the information necessary to make a decision to maintain or alter the status does not now exist, but should be collected in a subsequent study. Based on the results of that study, the tax structure should be addressed in one of the following ways:

1. eliminate the tax on all health insurance;

2. tax all health insurance at one rate, or;

3. establish a rate differential based on criteria that are regulated by the State Corporation Commission.

Most alternatives result in revenue adjustments. In addition to revenue impacts, changes in the current system can have other unanticipated impacts, especially in the area of retaliatory taxes, self-insurance, costs to consumers, uninsured risks, and availability of care.

• Retaliatory Taxes: Any increase in the effective rate of taxation in Virginia (through increased premium tax rate, fees, licenses, and special taxes) can result in higher retaliatory taxes for Virginia-domiciled companies that do business in other states.

• Self-Insurance: As the costs of coverage increase (especially for health and liability coverage), many employers may turn to methods of self-insuring. Under federal, law it is not clear whether self-insurance can be taxed by the states.

• Costs to Consumers: If higher tax rates are levied on insurance and if tax-exempt companies lose their preferential status, consumers may bear a share of the rate increase in higher premiums. However, if rates are reduced, there is no guarantee that consumers will benefit from the savings.

• Uninsured Risks: If tax-exempt health insurance is taxed and open enrollment and conversion policies are no longer, available, the government may be faced with a greater need for charity or subsidized care.

• Availability of Care: If all health insurance is taxed, BC/BS plans might eliminate "charity care allowances" which could place a severe financial burden on certain hospitals. Also, the availability of health insurance might be concentrated in the highly profitable metropolitan areas at the expense of rural areas.

This study should be continued in 1986 to respond to the following recommendations:

Recommendation 1: The inequities in the tax structure identified in this report should be addressed by the Governor and the General Assembly in the following manner:

• The continued study should propose specific revisions of the tax structure to bring about equity between life and casualty companies and rectify other inequities in the structure.

• Legislation should be recommended to the 1987 Session of the General Assembly to effect those changes for tax years beginning on and after January 1, 1988.

• Anticipated revenue adjustments should be incorporated in the general fund revenue forecast for the 1988-90 biennium and beyond.

Recommendation 2: The study should document the possible ramifications of taxing exempt organizations such as escalating hospital costs and increasing numbers of high risk and uninsurable individuals whose health care coverage would be Jeopardized if open enrollment periods were no longer available.

Recommendation 3: The study should include the views of the Attorney General regarding the Commonwealth's authority to tax self-insured groups under federal law.

Recommendation 4: If federal tax reform results in eliminating the tax-exempt status of BC/BS plans. HMOs and fraternal benefit organizations, consideration should be given by the Governor and the General Assembly to imposing the gross premium tax on these entities.