Deep in the heart of taxes
Insurance & Risk Professional, August 2008
By Alex Sanchez, General Manager Policy in the Insurance Council of Australia’s Economics and Taxation Directorate. This is an edited version of presentation he gave to a recent conference in Sydney
Private sector general insurance plays a vital role in the health and well-being of communities. After a natural disaster or major weather event, the presence of insurance serves to manage the after-effects of loss and to expedite recovery. And in modern societies, where governments often play the role of supporter of last resort, private general insurance should interest all taxpayers. After all, by and large, when someone who fails to insure themselves comes to grief, then inevitably it is the state – that is, taxpayers – which funds the loss.
At the Insurance Council we believe that at a time of increasing concern over climate change, the case for a strong general insurance sector has become ever more fundamental.
Policy settings that enable private insurance markets to operate effectively become fundamental to the needs of individuals, businesses and communities. As more erratic weather patterns are experienced, the public interest becomes served by policy settings that strengthen community resilience. Reform of taxes on general insurance is integral to this challenge.
By any measure the general insurance sector is a major contributor to Australia’s economy.
It generates premium revenue of around $29 billion and Australian Prudential Regulation Authority-regulated insurers have assets totalling $88 billion. The industry employs some 40,000 people nationally and pays out some $70 million nationally in claims in each working day. 
Graph 1: This applies APRA data and applies a Henderson moving average technique, commonly used by the Australian Bureau of Statistics, to provide trend estimates. We use this technique to get to the underlying trends in some of the key industry aggregates.
The underwriting result for the general insurance sector has been under pressure. Suffice to say that while the soft market is certainly a factor, we are also seeing a discernible trend in claims costs, particularly for short-tail business. 
Graph 2: This is a similar chart but gives us the change in the quarter. As you can see, the underwriting result has gone backwards for the five quarters to last December. Investment income supported insurer performance over this period. 
Graph 3: The mix of business by class of insurance in aggregate has remained fairly constant over the past five years. Over a third of all business is the retail short-tail businesses of domestic motor (excluding CTP) and domestic homeowners insurance.
Although not large by any means, a decline in CTP motor vehicle shows the benefits of tort reform and robust competition flowing through into lower premiums.
But what is discernible in this chart is the small shares, relative to others, of what could be described as the personal or bodily injury insurances – CTP and workers’ compensation. This reflects in part the balance of private and public provision of these insurances. Australia lags the rest of the world in the role that the private sector plays in insurance markets.
Claims Trends
Some of the previous charts presented the aggregate trends in underwriting performance. I want to now turn to some of the micro trends, especially in claims costs and claim trends, for the short-tail business lines. 
Graph 4: This chart outlines some of the long-term trends in loss ratios for comprehensive motor and home and contents insurance. The blue line represents the trend in home and contents loss ratios while the grey line represents the equivalent for comprehensive motor.
There has been a discernible trend upwards in the loss ratio for home and contents insurances. In fact, the trend measure is at levels approaching the spike that occurred as a result of the Sydney hailstorms in April 1999.
Given the recent extreme weather events in New South Wales and Queensland, this upwards trend should come as no surprise.
Graph 5: The average claim size for home insurance has been on the rise since the third quarter of 2005. Apart from a slight downturn in late 2006, since the September quarter 2005, the average claim size for home insurance has been escalating. Again, this should come as no surprise given asset price inflation and rising living standards reflecting themselves as improved housing conditions.
Although Australia is a mature market, considerable scope exists to grow the general insurance market domestically. Australia as a whole lags other nations in the expenditure per capita on general insurance. 
Graph 6: This OECD data measures insurance density per capita, and demonstrates that Australia rates well below the OECD average on general insurance outlay per capita, and well below our peers in the United Kingdom, United States and Canada.
If Australia was to enjoy the density ratio of say the UK, then the value of gross written premium in Australia would be double what it is today.
Previous graphs have indicated the small shares of private insurance in some of the personal injury lines, such as compulsory third party and workers’ compensation. The role of public insurers in these markets serves to crowd out private general insurance and limit insurance density. 
Graph 7: A clear drag on the general insurance sector in Australia are state taxes on general insurance products. This graph compares Australian taxes on general insurance internationally, and regrettably Australia is well behind.
Insurance tax reform remains an incomplete project. Following the introduction of the new tax system in 2000, a program of state tax reform took place which saw a number of state transaction taxes removed in exchange for the states’ receipt of GST revenue. Unfortunately, insurance taxes were not included in this reform program, leaving insurance taxes intact and states increasingly dependent on them to fund their outlays. 
Graphs 8 and 9: Australia’s general insurance markets suffer from the distortions created by state taxation regimes. In the two largest states, NSW and Victoria, the general insurance sector is subject to the cascading effects of three types of taxation – fire contributions, GST and insurance stamp duties.
Together, these tax-on-tax effects can add over 40% extra to the cost of a basic household property premium and up to 60% for a commercial insurance premium in the case of Victoria.
This punishing tax regime discourages adaptation behaviours on the part of individuals, businesses and communities.
In 2006/07 state stamp duties on general insurance amounted to some $2.6 billion.
Since fiscal 2000, stamp duties on insurance have increased by more than 76%, compared with an increase in overall state taxes excluding insurance taxes of 27%. State governments now accrue more in insurance duties than they do in taxes on gaming machines. 
Graph 10: And notwithstanding the impacts they have on the affordability of insurance and the concerning features of non-insurance, the states are now in the unfortunate position where they are structurally dependent on inefficient state insurance taxes to the extent that around 8% of all state taxes are drawn from insurance premiums.
Non-insurance
It is not surprising that high levels of taxation detract from insurance take-up and hence additions to the insurance pool. In May 2007, the Insurance Council undertook a landmark review into non-insurance in the Australian community. The study concluded that high levels of taxation were correlated with high levels of non-insurance.
Graph 11: The Insurance Council has modelled the impacts of insurance taxes on the insurance take-up. If state taxes on insurance were removed some 300,000 extra households would take out contents insurance.
Similarly, if state taxes on insurance were removed some 70,000 extra households would take up buildings insurance. The reduction in non-insurance in buildings would be more than a third.
This represents a significant increase to the insurance pool. And for the industry, the sustainable approach to manage escalating claims costs is to increase the size of the pool and thereby reduce the average cost per policy.
Importantly, the gains in insurance are likely to benefit those on lower incomes and the young. Non-insurance in most prevalent in the lower-income quintiles and among the young. Given that insurance is relatively price-elastic (confirmed by the Insurance Council elasticity study) then households with budget constraints are the households more likely to benefit from insurance tax relief.
Compared to other state taxes, stamp duties on general insurance result in large deadweight costs and retard economic efficiency.
Graph 12: Reform of insurance taxes would significantly improve economic welfare and boost growth. According to research from Access Economics, reform of stamp duties on general insurance would deliver a permanent increase in real household consumption of 0.48%.
Access Economics has measured the combined benefits to be derived from using more efficient bases for funding emergency services and from lowering or removing stamp duties on general insurance. It says it would be “substantial, adding perhaps 0.5% (or $2.6 billion) to real household consumption over time”.
From a broader national perspective, future programs of microeconomic reform will be heavily dependent on action from state governments.
Reform of insurance taxation falls into this responsibility. According to Access Economics, the net cost to the states of abolishing all stamp duties on general insurance is $1.7 billion after allowing for revenue clawbacks to the states from efficiency gains.
Reform of insurance taxes is affordable and at the very least, should be included as part of any discussions on Commonwealth- State financial relations.
At a time of increasing concern over climate change and the impact climate has on the insurance sector, it is fundamental that we get the policy settings right for the sector. Despite the widespread benefits that accrue to society from the availability of robust general insurance markets, the Australian general insurance sector remains burdened by inefficient policy settings.
Reform of these settings is timely, as we look to develop policies that respond to climate change. Public policies that encourage adaptive behaviours and enable private insurance markets are essential.
The sector would be well served by settings that remove distortions and deepen private general insurance market uptake – whether by increasing private insurance densities or by removing constraints that prudent insurance cover.
Building community resilience to the challenge of climate change presents a unique opportunity for decision-makers to address these long-standing inadequacies in the general insurance market.