HD49 - Report on the Effect of Gross Premium Tax Rates on the Attraction of Insurance Business to the Commonwealth


Executive Summary:
The Commonwealth has been studying the status of taxes imposed on insurance companies since 1986. In 1987, the Commonwealth lowered its premium tax rate from 2.75% to the current rate of 2.25%. House Joint Resolution 202 (1996) established a select committee to study how Virginia's tax rate compared to other states. In 1998, the Assembly enacted a tax credit for Virginia insurance companies paying the retaliatory tax.

The domestic insurance business in Virginia has been stable and there have not been significant changes in the number of insurance companies domiciled in Virginia. Over the last five years, the amount of relocation activity involving the insurance industry has been relatively low within the Commonwealth. Nonetheless, the amount of investment and new jobs typically associated with the insurance industry make these companies an attractive economic development opportunity. Of the companies that discussed relocation with state economic development officials, one ultimately decided to locate in Virginia. During the same period, however, Virginia saw significant expansions in the operations of several insurance companies.

While a causal relationship between premium tax rates and insurance company relocations cannot be demonstrated with certainty, tax rates play a role in the perception companies have of a state's business climate. Given the way corporations consider sites for expansion or relocation, it is likely that a state's premium tax rate is a significant locational factor for insurance companies. To the extent that companies look at this factor, it is likely that many of the thirty-two states (with lower rates) would be considered as sites before Virginia. In addition, while reducing the premium tax rate may not cause new companies to domesticate in Virginia, it might expand the operations of out-of-state insurers here. Also, since Virginia companies have to pay retaliatory taxes in thirty-two states, the growth of domestic insurers may be impeded. That is, Virginia companies may decide not to expand operations outside the state because they will have to pay the retaliatory tax.

Virginia's current premium tax rate is 2.25%. According to the State Corporation Commission, if the rate were reduced to 2.0% over the course of 5 years, the cost to the Commonwealth in lost revenue would average approximately $20 million per year for that five-year period. As the premium tax rate goes down, however, one would expect, in theory, that revenue from the retaliatory tax to increase, if only modestly. In addition, as payments of retaliatory taxes by Virginia companies decrease, the Commonwealth's liability for claims on the retaliatory tax credit should decrease. Under current conditions, however, these two factors would not even approach offsetting the lost revenues from the premium tax reduction.

In 1997, the retaliatory tax burden borne by insurers domiciled in Virginia just exceeded $3 million. The true impact on the retaliatory tax burden cannot be determined with any certainty into the future. This is because the determining factors in calculating this impact are whether other states' regulatory costs and the amount of business conducted by Virginia companies in these states. These are factors that we cannot accurately predict. In theory, however, if Virginia were to lower its premium tax rate to 2.0%, Virginia companies would expect to pay retaliatory taxes in twelve states instead of thirty-two, which should reduce their tax burden further.

FINDINGS

• Virginia does not have a dominant Virginia-based insurance industry compared to traditional insurance states like New York and Connecticut.

• Since Virginia companies have to pay retaliatory taxes in thirty-two states, the external growth of domestic insurers may be impeded, but this situation may be offset at least in part by the retaliatory tax credit.

• While a causal relationship between premium tax rates and insurance company relocations cannot be demonstrated with certainty, tax rates play an important role in creating the perceptions companies have of a state's business climate.

• Over the last five years, there have been many relocations and consolidations due to mergers and acquisitions and expansions in operations; however, even with states lowering their premium tax rates during the same period, companies have not moved to change their state of domicile.

• It cannot be determined whether a reduction in the gross premium tax rate will necessarily have a significant effect on the Commonwealth's ability to attract new domestic insurance companies in the immediate future. It may be, however, that the expansion of operations by out-of-state and domestic companies would accelerate. Nevertheless, if large insurance companies were to approach the Commonwealth with a clear interest in locating in Virginia, the anticipated return on that new investment could change the calculations, making a premium tax reduction more feasible.