The Impact of State Taxes on Self-Insurance: Alternative explanation

4.3 Alternative explanation
The results in this section also are consistent with an alternative explanation. Recall that Petroni and Shackelford (1999) report a disproportionate amount of premiums from multistate policies is reported as earned in low premium tax states. Suppose insurers also shift the losses associated with those premiums. Shifting the losses would not affect the premium tax liability, but perhaps it could mask the manipulation of the premiums. If the losses are shifted, then more insured losses are reported (though not necessary incurred) in low-tax states. If so, the relation between losses and taxes reported above is not evidence of taxes increasing self-insurance, but simply another manifestation of the premium tax avoidance found in Petroni and Shackelford (1999).
To test this alternative explanation requires investigating a line where manipulation of premiums is not expected. The following section examines such a setting, automobile insurance coverage.
4.4. AutomobUe msurance
As discussed above, Petroni and Shackelford (1999) document a disproportionate amount of premiums from multistate policies is reported as earned in low premium tax states. However, they find no such premium manipulation of automobile insurance premiums, which they attribute to the lack of multistate automobile policies. In other words, automobile insurance premiums are not shifted to manage taxes or regulation because automobile insurance is rarely packaged in multistate policies. Thus, the automobile premiums that insurers disclose in their annual accounting reports appear unmanaged. As a result, finding a relation between self-insurance and taxes in the automobile line would be inconsistent with the alternative explanation and increase confidence in the original interpretation of the results.
To examine automobile coverage requires dichotomizing the line into two broad classifications, liability and physical damage. As noted above, the demand curve for automobile liability insurance is expected to be less elastic than the demand curves for automobile physical insurance. Automobile liability insurance is strictly regulated in many states, and 39 states require motorists to carry automobile liability insurance. Moreover, every noncompulsory state has a system known as “financial responsibility.” In those states, self-insured motorists who fail to compensate parties that they injure are prohibited from driving until they purchase insurance or can establish the wherewithal to cover future damages. As a result, few motorists in noncompulsory states are without liability coverage.
On the other hand, no states require motorists to carry physical damage insurance. Consequently, the relation between self-insurance and state taxes for physical coverage is expected to be similar to the relation documented above for non-automobile lines, unless the alternative explanation is valid.