TAX MANAGEMENT AND INVESTMENT STRATEGIES OF PROPERTY-LIABILITY INSURERS

The Tax Reform Act (TRA) of 1986 reduced the incentives for institutio nal investors to participate in the tax exempt bond market. This paper develops a model of profit maximization incorporating the TRA provisi ons applicable to property-liability (PL) insurers. The theory predict s that PL insurers will use underwriting losses to shelter taxable inv estment income and invest the balance of their portfolios in tax favor ed securities. Our empirical evidence reveals that insurers continued to invest in tax exempts following the TRA, suggesting that implicit t ax rates are low enough to attract insurers into the long-term tax exe mpt market. However, insurers reduced the proportions of income derive d from tax exempt interest and dividends following the TRA.