The Effects of Tax-Law Changes on Property-Casualty Insurance Prices

During the 1980s, the federal income tax treatment of property-casualty insurers and their policyholders underwent several important changes, the most significant of which came in 1986. This paper develops theoretical predictions for how these changes should have affected the equilibrium prices of property-casualty insurance policies, and explores the extent to which the theoretical predictions are reflected in data on industry experience. The paper is devoted mainly to a careful specification of the income tax rules, and to deriving the connection between predictions about simple forms of insurance policy and industry data on premiums earned. Although the predicted impact of the changes in the tax rules enacted in 1986 translates into a tax on premiums (net of the cost of acquisition) of up to 13 percent (on medical malpractice, the longest-tail line of insurance, in 1987), it is small relative to the variability of the actual loss experience.