IIA insurance Company reserves average duration six years. With $100 million in reserves, cost of these reserves in the same manner as the cost of debt. The yield to the six-year duration of the reserves is 6 percent and IIA has a marginal tax rate of 40 percent. Which one of the following is the after-tax rate of these reserves?

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Multiple Choice

IIA insurance Company reserves average duration six years. With $100 million in reserves, cost of these reserves in the same manner as the cost of debt. The yield to the six-year duration of the reserves is 6 percent and IIA has a marginal tax rate of 40 percent. Which one of the following is the after-tax rate of these reserves?

The cost of reserves behaves like debt for an insurer—the rate you pay to fund those reserves is reduced by taxes because interest on debt is deductible. So the after-tax cost equals the pretax yield on the reserves times (1 minus the tax rate). Here, the yield is 6% and the marginal tax rate is 40%, giving 6% × 0.60 = 3.6%. The $100 million amount and the six-year duration set the scale and timing, but the rate itself depends only on the yield and the tax rate. Therefore, the after-tax rate is 3.6%.

The cost of reserves behaves like debt for an insurer—the rate you pay to fund those reserves is reduced by taxes because interest on debt is deductible. So the after-tax cost equals the pretax yield on the reserves times (1 minus the tax rate). Here, the yield is 6% and the marginal tax rate is 40%, giving 6% × 0.60 = 3.6%. The $100 million amount and the six-year duration set the scale and timing, but the rate itself depends only on the yield and the tax rate. Therefore, the after-tax rate is 3.6%.

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