Session 58 PD, Tax Considerations for the Life Actuary. Moderator: Jacqueline F. Yang, FSA, ACIA, MAAA

Transcription

1 Session 58 PD, Tax Considerations for the Life Actuary Moderator: Jacqueline F. Yang, FSA, ACIA, MAAA Presenters: Jean Baxley, JD, LLM Timothy Gregory Branch, FSA, MAAA Mark S. Smith, CPA, Esq.

2 Session 58: Tax Considerations for the Life Actuary Jean Baxley, JD/LLM Tim Branch, FSA, MAAA Mark Smith, Esq., CPA May 17, 2016

3 Disclaimer This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. Presentations are intended for educational purposes only and do not replace independent professional judgment. Statements of fact and opinions expressed are those of the participants individually and, unless expressly stated to the contrary, are not the opinion or position of the Society of Actuaries, its cosponsors, or its committees. The Society of Actuaries does not endorse or approve, and assumes no responsibility for, the content, accuracy or completeness of the information presented. Attendees should note that sessions are audiorecorded and may be published in various media, including print, audio and video formats without further notice. The views expressed by the presenters are not necessarily those of Phoenix Life Insurance Comany, PricewaterhouseCoopers LLP, or KPMG LLP. 2

4 Agenda Tax policy and the regime for taxing life insurance companies Reserve topics Other topics Closing 3

5 Tax policy and the regime for taxing life insurance companies 4

6 Tax Policy and the taxation of life insurers Principles of Tax Policy: Clear reflection of income Ability to pay Horizontal equity By industry, by company, by product Administrability The actuary s role in computing reserves is important to each of these principles. 5

7 Current regime for taxing life insurers Goal is matching income and deduction Starting point is statutory accounting (the annual statement) Tax principles trump in situations where they differ from statutory accounting Many of the rules for other accrual basis taxpayers apply in the same way to life insurers Tax reserves are generally the largest deduction for a life insurer Some rules are candidates for change if Congress succeeds in Tax Reform 6

8 IRS Priority Guidance Plan (PGP) Insurance companies and products Final regulations under 72 on the exchange of property for an annuity contract. Proposed regulations were published on October 18, 2006 Regulation under 72 and 7702 defining cash surrender value Guidance on annuity contracts with a long term care insurance rider under 72 and 7702B Guidance under 807 and 816 regarding the determination of life insurance reserve for life insurance and annuity contracts using principles based methodologies, including stochastic reserves based on conditional tail expectation Guidance under 833 Guidance on exchanges under 1035 of annuities for long term care insurance contracts Guidance relating to captive insurance companies See Q1 Update (Oct. 23, 2015); Notice (comments due (May 16, 2016) 7

9 Reserve Topics 8

10 Definition of life insurance reserves IRC 816(b) defines life insurance reserves Computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest Set aside to mature or liquidate, either by payment or reinsurance, future unaccrued claims Required by law 9

11 Life insurance company reserves classification Code section 807(c)(1) 807(c)(2) 807(c)(3) 807(c)(4) Category of reserves Life insurance reserves ( 816(b) definition) Unearned premiums and unpaid losses Discounted amounts under ins./annuity contracts that do not currently involve life or A&H contingencies Dividend accumulations and other amounts held at interest under ins./annuity contracts NAIC Annual Statement analogue (generally) Exh. 5 + Exh. 6 NC/GR A&H Exh. 6 canc. A&H + Exh. 8.1 PVANYD Exh. 7 Exh (c)(5) Advance premiums and premium deposit funds Exh (c)(6) Special contingency reserves under group insurance (retired lives or premium stabilization) Exh. 5 or 6 NC/GR = non cancellable or guaranteed renewable (under tax definitions; Treas. Reg (c) and (d)) PVANYD = present value of amounts not yet due (i.e., claim reserve) 10

12 Life insurance company reserves under 807 exclusions Reserves NOT taken into account Deficiency reserves Reserves attributable to deferred and uncollected premiums Reserves for excess interest beyond end of taxable year Solvency reserves (such as for asset adequacy testing) Any reserves not required by law CTE excess under AG 43 Other reserves likely NOT taken into account Deterministic reserve excess under AG 38 Ex. 8D Deterministic and stochastic reserve excesses under Life PBR CTE = conditional tail expectation (stochastic reserve) AG = Actuarial Guideline PBR = principle-based reserves 11

13 Deductible life insurance reserves 807(d)(1) defines a Federally prescribed reserve (FPR), which is bounded by a cap (statutory reserve) and a floor (net surrender value or NSV). 12

14 Federally prescribed reserves 807(d)(2) defines the federally prescribed reserve The amount of the reserve determined under this paragraph with respect to any contract shall be determined by using (A) the tax reserve method applicable to such contract, (B) the greater of (i) the applicable Federal interest rate [AFIR], or (ii) the prevailing State assumed interest rate [PSAIR], and (C) the prevailing commissioners' standard tables for mortality and morbidity adjusted as appropriate to reflect the risks (such as substandard risks) incurred under the contract which are not otherwise taken into account. 13

15 Federally prescribed reserves method Product Life insurance Annuities NC/GR A&H Qualified long-term care under 7702B, issued in 1998 or later Other contracts (i.e., not covered by CRVM or CARVM) Tax reserve method CRVM (if covered by CRVM) CARVM (if covered by CARVM) 2-year preliminary term 1-year preliminary term NAIC-prescribed method, or if none, a method consistent with CRVM/CARVM CRVM = Commissioners reserve valuation method CARVM = Commissioners annuity reserve valuation method Use the method prescribed by the National Association of Insurance Commissioners which is in effect on the date of the issuance of the contract 14

16 Federally prescribed reserves interest Generally, greater of AFIR or PSAIR 5 year reset allowed for AFIR (entity level, revocable only with IRS consent) Exceptions Modified guaranteed contracts (MGCs) under 817A constantmaturity Treasury rate 807(c)(3) reserves guaranteed rate, if higher Common pitfalls Using AFIR straight out Comparing to own stat rate, rather than to maximum prevailing rate Using state permitted practices to determine plan type or other parameters for annuity interest rates Discount rate vs. accumulation rate 15

17 Federally prescribed reserves mortality Year become prevailing Life Individual annuity Group annuity 1948 CSO 41 SA 37 SA CSO 58 (3-year setback) 1962 A 49 GA IA 71 GA CSO 58 (6-year setback) 1982 CSO 80 (smokercomposite) a 83 GAM 1986 CSO 80 (smoker-distinct; 1999 optional) Annuity GAR CSO IAR CSO Sources and abbreviations: Rev. Ruls and , NAIC Model Reg

18 Federally prescribed reserves mortality IRC 807(d)(5)(B) 3 year transition Example: 2001 CSO became prevailing in 2004 Optional for contracts issued in 2004, plus Required for contracts issued in 2008 (different from stat) Mortality improvement not allowed unless required under the table (94 GAR, 2012 IAR) Treas. Reg mortality or morbidity table to use if none is prevailing IRC 807(d)(5)(E) where two or more tables or table options apply to a category of risks, use table or option that generally yields the lowest reserves 17

19 Deductible life insurance reserves floor The NSV floor comparison is generally applied on a contract by contract basis, and aggregating all riders and benefits associated with each contract Life insurance contract with a supplemental benefit Given: Base contract FPR = 95 NSV = 100 Supplemental benefit FPR = 7 NSV = 0 Default approach: apply floor in aggregate for the contract Aggregate FPR = 102 Aggregate NSV = 100 Final deductible reserve (before cap) = MAX (102, 100) = 102 Separate contract treatment: if qualified supp. ben. (QSB) under 807(e)(3) Base deductible reserve = MAX (95, 100) = 100 Supplemental benefit reserve = MAX (7, 0) = 7 Final deductible reserve (before cap) = = 107 Generally no market value adjustments except MGCs under 817A 18

20 Deductible life insurance reserves cap The resulting reserve is then capped at the statutory reserve Statutory reserve = the aggregate amount set forth in the annual statement with respect to items described in 807(c), excluding reserves attributable to deferred and uncollected premiums Amounts included in statutory cap Deficiency reserves confirmed by Notice CTE excess under AG 43? AG 38 excesses? Life PBR deterministic and stochastic excesses? 19

21 Change in basis for computing reserves 807(f) Adjustments for Changes in Reserve Basis Changes in 807(c) reserves are either changes in basis or corrections of errors Changes in basis require a 10 year spread of the change, based on the difference between reserves under old and new method Need to pay attention to year of change and to newly issued contracts Rev. Rul gives guidance on what is a change in basis vs. correction of error Example 1: use of wrong mortality table in prior years Example 2: use of wrong interest rates Example 3: change from curtate to continuous reserves Example 4: missed range of contract cells in inforce file 20

22 IRC 807(f) example of 10 year spread Year of change = 2013, with the change entirely on an in force block At year-end Old basis New basis Tax return Opening Schedule F Change in basis to spread = = 8 Amount per year = 8 10 = 0.8 Closing Deduction for year s increase in reserves Deduction for 807(f) spread of strengthening

23 Principles Based Reserves Life Life PBR General Framework Net Premium Reserve: Most like current guidelines Deterministic Reserve: Gross premium methodology, company's own factors Stochastic Reserve: Stochastic determinations, CTE 70 Some features raise novel issues under Section 807 Contract by contract determination versus aggregate Prescribed mortality tables and interest rates versus company specific Gross versus net premium methodologies 22

24 Principles Based Reserves Life IRS declined to address similar issues when it published AG 43 notice Priority Guidance Plan anticipates guidance in Industry has three broad asks Product Issues Transition Issues Substantive Reserve Issues 23

25 A word about nonlife reserves In general, nonlife reserves of a life insurance company are taxed differently from life reserves: An unearned premium reserve is maintained for tax purposes, as for statutory purposes, but is subject to a 20% haircut Unpaid losses are reported on a discounted basis, using prescribed discount rate and payment patterns No reserve deducted until loss event occurs (no catastrophe reserves) Special rules for some lines of business: title insurance, mortgage guaranty 24

26 Other topics 25

27 Capitalized policy acquisition costs ( Tax DAC ) IRC 848, enacted in Revenue Reconciliation Act of 1990 Has specified capitalization percentages and amortization periods for consistency and simplicity Policy acquisition costs are deemed to be a specified percentage of net premiums in each category of specified insurance contracts: Annuity contracts 1.75% Group life insurance contracts 2.05% Other contracts (i.e., indiv. life, ind./group NC/GR A&H) 7.70% Tax DAC is amortized on a straight line basis, generally over 120 months starting in second half of tax year Not tied to expected profits or actual experience on underlying contracts 26

28 Tax DAC example In 2013, Company A receives premiums as shown below (no reinsurance) Capitalization for Company A: Contract Premiums Capitalization % Tax DAC Annuity 400,000, % 7,000,000 Group life 38,000, % 779,000 Individual life 133,000, % 10,241,000 Total 571,000,000 18,020,000 Amortization for Company A: Tax year Amortization Expense % 901, % per year 1,802,000 per year % 901,000 Total 100% 18,020,000 27

29 Proration and the Company s Share Most corporations are entitled to a deduction (DRD), which is usually equal to 70% of dividends received from domestic corporations Proration concept: because part of every dollar of life insurer s investment income is credited to policyholder reserves, which in turn are deductible, insurer should be required to reduce deductions to prevent a double benefit (compare IRC section 265) Applies separately to general account and separate accounts 28

30 Proration and the Company s Share Only life insurance company s share of DRD and tax exempt interest is taken into account in determining taxable income Example: if policyholders share is 75%, company s share is 25%, so only 25% of tax exempt income would effectively be tax free Effectuated through deduction disallowance DRD allowed only for company s share of dividends Reserves reduced by policyholder s share of tax exempt income 29

31 Proration and the Company s Share Company s share = company s share of net investment income divided by net investment income Company s share of net investment income = net investment income less policy interest Net investment income = 90% of gross investment income; 95% for separate accounts Policy interest = required interest at greater of PSAIR or AFIR Although the formula is complex, the concept is simple: How much of the company s net investment income is required to satisfy obligations to policyholders? 30

32 Proration and the Company s Share Industry understanding of current law has been consistent, and a one time IRS controversy was resolved in 2014 Camp Discussion Draft proposes replacing existing regime with an approach based on the ratio of surplus to total assets Obama Administration FY 2016 Revenue Proposal is similar 31

33 Investments and hedging I.R.C. 446: LB&I Directive Related to Hedging of Variable Annuity Guaranteed Minimum Benefits by Insurance Companies was issued by LB&I commissioner in July 2014 Directive provides a safe harbor method of accounting for recognition of the portion of Eligible GMxB Hedge income, deductions, gains, and losses allocable to VA contracts issued before December 31, 2009 Net hedge gain recognized to the extent of the net tax deduction for the year relating to the VA contracts issued before December 31, 2009 Net hedge loss up to the increase for the taxable year in aggregate tax reserves for GMxB under VA contracts issued before December 31, 2009, is not recognized and is carried forward and taken into account in the succeeding year Any hedge gain/loss not taken into account within the five years following the year in which incurred is recognized no slower than ratably over the succeeding five years 32

34 Investments and hedging Post December 31, 2009 contracts and hedges Directive says to use method consistent with the matching requirements in Treas. Reg (e)(1) Use method under Directive? Continue to use method pre Directive? New method to be consistent with Treas. Reg (e)(1)? GMxB tax reserves to use for purposes of Directive Allocation of pre/post December 31, 2009 contracts MTM values reported in the Company s Annual Statement Implementation and certification 33

35 Treatment of losses Net operating losses carried back 3 years and forward 15 years Camp Discussion Draft would carry back 2 years and forward 20 years Conform to rules for most other corporations Capital losses deductible only to extent of capital gains Unused capital losses generally may be carried back 3 years and forward 5 years Limitations apply to the filing of consolidated returns with nonlife companies 5 year waiting period to consolidate and to use losses nonlife losses limited to 35% of losses or 35% of life income, whichever is less 34

36 Reinsurance Basics of accounting Ceding party reduces premium income, reduces reserves Assuming party increases premium income, increases reserves Accrual accounting due premiums for reinsurance may be legally collectible and therefore meet the all events test to be treated as premium income and have a corresponding reserve deduction, unlike direct due premiums Reinsurance of inforce blocks Ceding commissions and capitalization 848 DAC applies if the underlying contracts are specified insurance contracts Assumption reinsurance can also lead to 197 amortization of the ceding commission related to acquisition of intangibles Courts have held that even indemnity reinsurance of non DAC able products can require capitalization of negative ceding commission 35

37 Reinsurance Reserves What is the issue date? How do you apply the net surrender value floor? Tax DAC All reinsurance cash flows affect DAC premiums, death claims, ceding commissions, allowances, experience rating adjustments, etc. Mod co and funds withheld if the money doesn t move, it s not a net reinsurance consideration Goal is keeping the books of the world in balance party with negative net reinsurance considerations can t take a greater DAC benefit than what the party with positive net considerations capitalizes 36

38 Reinsurance Is it insurance? Risk distribution and risk shifting, fortuity, business drivers other than tax IRC 845(a): Reinsurance between two related parties Treasury can reallocate income and deduction items between such parties or recharacterize any such items, to reflect the proper amount, source, or character of such income or deduction of each party IRC 845(b): Reinsurance between unrelated parties Same as above, except that Treasury has no obligation to make correlative adjustments to the other party, in the case of a significant tax avoidance effect [higher standard than for 845(a)] 37

39 Foreign life insurance reserves Foreign entities Branch part of U.S. legal entity Controlled foreign corporation (CFC) 953(d) company CFC elected to be treated as domestic company Qualified insurance branch Subpart F Income Insurance income ( 953) plus foreign base company income ( 954) Branches can use local country statutory reserves if they meet the qualified foreign contract requirements under 807(e)(4) Reserves for insurance income for CFC follow 954(i) U.S. methods apply, with local country interest and mortality, or Local country statutory reserves, if ruling granted by IRS 38

40 IRS examination process Big picture Selection of taxpayer for IRS examination Kickoff meeting Scope Agreed plan Timeline Information Document Requests (IDRs) Timelines Enforcement Notices of Proposed Adjustments Protest advocacy Appeals hazards of litigation Litigation Recent changes to LB&I potential implications Recent changes to partnership audit rules implications 39

41 IRS examination process Reserves Internal Revenue Manual ( Section Reserve Audit Procedures Qualification as Life Insurance Company Submit reserve questionnaire Calculation methods and changes in method Section IRC section 807 Reserve Questionnaire Numerical analysis and presentation by coverage type, issue year, interest rates, mortality and reserve method Application of statutory cap and net surrender value floor Calculation of federally prescribed reserves 40

42 In summary The Internal Revenue Code has very specific rules for taxing life insurance companies. Those rules, although straightforward in concept, are sometimes complex in practice and require the application of actuarial rules that sometimes differ from the statutory accounting rules that apply to the same block of business. The goals, again, are clear reflection of income, ability to pay, horizontal equity, and administrability. 41

43 Questions & Answers 42