This report considers the effect of State-based insurance taxes on non-insurance.
Rates of non-insurance are found to be closely correlated with insurance taxes when examined over time and across jurisdictions. Following the removal of the Fire Services Levy in Western Australia (which came into effect 1 January 2004), the level of non-insurance in both building and contents (as measured from the Roy Morgan Research data) declined, while rates climbed elsewhere.
The Roy Morgan Research data and the Australian Bureau of Statistics (“ABS”) Household Expenditure Survey (“HES”) data support the finding that States with higher tax rates on insurance premiums have higher rates of non-insurance for both building and contents insurance. NSW and Victoria continue to maintain a Fire Service Levy on building and contents insurance, adding 15 to 20% on to insurance costs. There is a notable gap between rates of non-insurance in these States and those that do not have such a levy. This gap in the rate of non-insurance appears to occur across age groups, income profiles and stages of life.
The effect of State taxes is much more noticeable for contents insurance, consistent with the view that households are more price-sensitive with regard to contents insurance.
1. Introduction & Background
In Australia, there are three effective ‘taxes’ commonly applied to general insurance product sales (insurance providers, like other companies, pay other forms of company-related taxes). These are:
- Stamp Duty, which applies to all general insurance products.
- Fire Service Levy (“FSL”), applied to home insurances. The FSL is used to raise funds for Fire Brigade Services (ranges from 0 per cent to 20 per cent depending on region).
- The 10% Goods & Services Tax (“GST”).
These taxes are applied on each other, resulting in a compounding effect, such that for some households the total premium is 45% higher than would be the case in a non-taxed environment.
In NSW there is an additional ‘tax’ related to premium volumes. The Insurance Protection Tax (“IPT”) Act 2001 requires that insurers contribute amounts proportionate to their market share. This IPT may add about an additional 1% on home insurance premiums. Although the Act stipulates insurers “must not charge…any amount that is directly attributable to that tax”, it would be inconsistent with economic theory if the cost was not passed on to consumers.
The rate of FSL and stamp duty varies greatly by State. A summary of the taxes for home insurance and their cumulative effect is reported in the table below. As at April 2007, the effective taxes on home insurance were:
State Taxes on Home Insurance Premiums
Source: Insurance Council
These taxes have gained significant attention. Opponents of the taxes point out that general insurance, and in particular home based insurance, is very heavily taxed relative to international standards and relative to other goods and services. The CIE (2005) provided a comparison of international differences in insurance taxes and noted that: “Taxes on property insurance in most Australian States and Territories are higher than in the majority of the comparator countries”; and “International taxes as a proportion of premiums are as low as 2% in Ireland and Singapore, and 2.4% in the USA (California)” CIE (2005, pg.24).
The taxes are also very high compared with that of other goods and services within Australia. As noted by CIE (2005) the taxes on insurance in most States are higher than those applied on ‘bads’ such as cigarettes and alcohol (cigarettes and alcohol are described as ‘bads’ as they are associated with costs to society over and above those borne by the user and reflected in their cost of production).
2. The Societal Cost of Insurance Taxes
Taxes on insurance (as with taxes on other goods and services) may impose a cost to society by distorting purchasing behaviour with regard to insurance. The size of the cost to society is directly related to how much behaviour is distorted. It has been generally argued (and there appears little disagreement) that insurance taxes are relatively inefficient taxes that impose a large cost on society. It is, however, difficult to assess the extent of the distortion and thus the cost imposed by insurance taxes.
There are a number of distortions of behaviour that taxation on insurance premiums may cause. In response to higher taxes, people may simply not purchase insurance, in effect choosing to self-insure. In this case, all else being equal, we would expect to see a low take-up of insurance when and where insurance taxes are higher. Such a hypothesis might be tested with data sets such as the Roy Morgan Research data and the ABS HES.
People may also respond to higher insurance taxes by reducing their level of cover or by increasing their excess, thereby reducing their insurance premium. Some evidence for this was found in an audit conducted following the WA removal of FSL. The audit (Sigma Plus Consulting 2004) concluded the cost savings of the reduction in insurance were passed on and, as a result of the cost savings, consumers increased their levels of cover.
A third distortion is that consumers may seek alternative methods to avoid the taxation on insurance. For example, there is some potential for consumers in Australia to do this through use of Direct Offshore Foreign Insurers (“DOFIs”).
All else being equal, we would expect these distortions to be greater the more sensitive that supply and demand are to changes in price. (NB. Much of the existing arguments and evidence on the sensitivity of supply and demand to price are documented in the CIE report – CIE, 2005). It is generally thought that supply is very price-sensitive, particularly in the long term. This will be the case if the marginal cost of providing an insurance cover does not increase as industry output increases. There appears to be little reason for costs to increase with increased coverage. To the contrary, there appear to be economies of scale in insurance operations and benefits to greater volume in risk pooling (CIE 2005).
There has been limited research on the sensitivity of demand to price changes. Grace, Klein and Kleindorler (2002) estimated the elasticity of demand for home insurance products in the US, and found demand to be quite elastic. (The CIE report also provides some evidence on the price elasticity of demand for a firm, ie. sensitivity of consumers to changes in prices charged by individual firms. As taxes are applied industry-wide, the firm’s price elasticity of demand is of limited relevance to a debate on taxes). The CIE (2005) report on a range of organisations expressed the view that the consumer demand is sensitive to price, and thus insurance taxes are relatively inefficient. To date, there has been limited direct evidence as to the extent of the distortion caused by insurance taxes.
The results of the NRMA survey in 2001 provide some support for insurance taxes being a cause of non-insurance. Consistent with the effect of higher tax rates, lower rates of contents insurance were recorded in NSW and Victoria than in Queensland and other States (see NRMA, 2001, p.8). The differences, however, were not significant enough to draw comment by the author. The NRMA 2001 survey also asked those not insured, why they did not insure and whether a reduction in taxes would make them more likely to insure. Of those without building or contents insurance, 22% listed “insurance is too expensive” as the primary reason (only one reason could be given), and 30% stated they would be “much more likely” to purchase insurance if taxes were reduced.
3. Analysis of Insurance Taxes
The Roy Morgan Research and the HES data can potentially be used to analyse the effect of taxes by comparing rates of insurance across jurisdictions and across time. As documented in the table provided in the previous section titled ‘Introduction & Background’, there is significant variation in the level of taxes across States.
Since the beginning of 2002 (for which we have the Roy Morgan Research data), there have been changes in insurance taxes in NSW and in Western Australia. In NSW there have been recent changes to stamp duty taxes. NSW state stamp duly was reduced from 10% to 5% from 1 August 2002, but then later increased from 5% to 9% from 1 September 2005.
In Western Australia, a more significant change occurred, when the fire services levy (“FSL”) was phased out over 2003. The levy, which was typically 19% for house and contents, was removed for policies written after 2003. The FSL was phased out over a year, so an annual policy would only be proportioned the FSL for the period of the year that it covered. The removal of FSL was partially offset by a small increase in stamp duty from 8% to 10% as at 1 July 2003 (the changes and the response of insurance company pricing to the changes are detailed in Sigma Plus Consulting, 2004).
There have also been a number of notable changes in years to 2002, that can be potentially examined using the ABS HES data (source: VACC, 2003):
- In South Australia, on 1 July 1999, the insurance-based levy for fire brigade funding was abolished and replaced with a broad-based system.
- In the ACT, from 1 July 2000, an insurance-based levy was abolished.
- In Queensland, in 1985, an insurance-based levy for funding fire and emergency services was replaced with an Urban Fire Levy Scheme.
4. Analysis over Time
Using the Roy Morgan Research data, the removal of FSL in Western Australia provides most scope for analysis. The change in NSW was relatively small, and occurred at a time associated with change in the industry, including the demutualisation of the NRMA and the fallout of the collapse of HIH. The shifts in stamp duty that occurred during this period do not appear to be significant enough to be detected.
The removal of FSL in Western Australia is more significant. The figure below shows the change in rates of non-insurance in Western Australia and the Australian average in the period following the removal of FSL in Western Australia.
Rates of non-insurance following removal of FSL
Base – (i) No building insurance: Main income earner 18+, paying off or own a detached house
(ii) No contents insurance: Main income earner 25+, not in shared type accommodation
Rolling 12-month data (source: Roy Morgan Research)
The survey data appears to support the view that removal of FSL resulted in lower rates of non-insurance. The apparent rates of non-insurance for building and contents insurance fell in Western Australia in 2004, while the Australian average was increasing. That the fall in non-insurance is more significant for contents insurance than for buildings insurance is consistent with contents insurance being more price-sensitive.