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Insurer’s insolvency risk and tax deductions for the individual’s net losses

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  • Rachel Huang

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  • Larry Tzeng

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Abstract

Using the representative agent approach as in Kaplow (Am Econ Rev 82:1013–1017, 1992b), this paper shows that providing tax deductions for the individual's net losses is socially optimal when the insurer faces the risk of insolvency. We further show that the government should adopt a higher tax deduction rate for net losses when the insurer is insolvent than when the insurer is solvent. Thus, tax deductions for net losses could be used to provide an insurance for individuals against the insurer's risk of insolvency. These findings could also be used to explain why a government provides supplementary public insurance or government relief. Finally, we discuss that, if the individuals are heterogeneous in terms of loss severity, loss probability, or income level, providing a tax deduction for the individual's net losses may not always achieve a Pareto improvement, and cross subsidization should be taken into consideration. The Geneva Risk and Insurance Review (2007) 32, 129–145. doi:10.1007/s10713-007-0006-0
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Suggested Citation

  • Rachel Huang & Larry Tzeng, 2007. "Insurer’s insolvency risk and tax deductions for the individual’s net losses," The Geneva Papers on Risk and Insurance Theory, Springer;International Association for the Study of Insurance Economics (The Geneva Association), vol. 32(2), pages 129-145, December.
  • Handle: RePEc:kap:geneva:v:32:y:2007:i:2:p:129-145
    DOI: 10.1007/s10713-007-0006-0
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    References listed on IDEAS

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    1. David Cummins, J. & Sommer, David W., 1996. "Capital and risk in property-liability insurance markets," Journal of Banking & Finance, Elsevier, vol. 20(6), pages 1069-1092, July.
    2. Kaplow, Louis, 1991. "Incentives and Government Relief for Risk," Journal of Risk and Uncertainty, Springer, vol. 4(2), pages 167-175, April.
    3. Blomqvist, A. & Johansson, P-O., 1997. "Economic efficiency and mixed public/private insurance," Journal of Public Economics, Elsevier, vol. 66(3), pages 505-516, December.
    4. Neil A. Doherty & Harris Schlesinger, 1990. "Rational Insurance Purchasing: Consideration of Contract Nonperformance," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 243-253.
    5. Kaplow, Louis, 1992. "Income Tax Deductions for Losses as Insurance," American Economic Review, American Economic Association, vol. 82(4), pages 1013-1017, September.
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    Citations

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    Cited by:

    1. Wu, T.C. Michael & Yang, C.C., 2014. "Income tax deductions for losses as insurance revisited," Economic Modelling, Elsevier, vol. 41(C), pages 274-280.
    2. Huang, Rachel J. & Tsai, Jeffrey T. & Tzeng, Larry Y., 2008. "Government-provided annuities under insolvency risk," Insurance: Mathematics and Economics, Elsevier, vol. 43(3), pages 377-385, December.
    3. Rachel J. Huang & Larry Y. Tzeng, 2008. "Consumption Externality and Equilibrium Underinsurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 75(4), pages 1039-1054.

    More about this item

    Keywords

    Tax deduction; Insolvency risk; Public insurance; Government relief; Cross subsidization; G22; H24; D50;

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General

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