Session 26 PD, Product Taxation Update. Moderator: Paul Fedchak, FSA, MAAA. Presenters: Art Dunlavy Alison R. Peak Craig W. Reynolds, FSA, MAAA

Transcription

1 Session 26 PD, Product Taxation Update Moderator: Paul Fedchak, FSA, MAAA Presenters: Art Dunlavy Alison R. Peak Craig W. Reynolds, FSA, MAAA SOA Antitrust Disclaimer SOA Presentation Disclaimer

2 2018 SOA Life & Annuity Symposium Product Tax Update May 7, 2018

3 SOCIETY OF ACTUARIES Antitrust Compliance Guidelines Active participation in the Society of Actuaries is an important aspect of membership. While the positive contributions of professional societies and associations are well-recognized and encouraged, association activities are vulnerable to close antitrust scrutiny. By their very nature, associations bring together industry competitors and other market participants. The United States antitrust laws aim to protect consumers by preserving the free economy and prohibiting anti-competitive business practices; they promote competition. There are both state and federal antitrust laws, although state antitrust laws closely follow federal law. The Sherman Act, is the primary U.S. antitrust law pertaining to association activities. The Sherman Act prohibits every contract, combination or conspiracy that places an unreasonable restraint on trade. There are, however, some activities that are illegal under all circumstances, such as price fixing, market allocation and collusive bidding. There is no safe harbor under the antitrust law for professional association activities. Therefore, association meeting participants should refrain from discussing any activity that could potentially be construed as having an anti-competitive effect. Discussions relating to product or service pricing, market allocations, membership restrictions, product standardization or other conditions on trade could arguably be perceived as a restraint on trade and may expose the SOA and its members to antitrust enforcement procedures. While participating in all SOA in person meetings, webinars, teleconferences or side discussions, you should avoid discussing competitively sensitive information with competitors and follow these guidelines: Do not discuss prices for services or products or anything else that might affect prices Do not discuss what you or other entities plan to do in a particular geographic or product markets or with particular customers. Do not speak on behalf of the SOA or any of its committees unless specifically authorized to do so. Doleave a meeting where any anticompetitive pricing or market allocation discussion occurs. Do alert SOA staff and/or legal counsel to any concerning discussions Do consult with legal counsel before raising any matter or making a statement that may involve competitively sensitive information. Adherence to these guidelines involves not only avoidance of antitrust violations, but avoidance of behavior which might be so construed. These guidelines only provide an overview of prohibited activities. SOA legal counsel reviews meeting agenda and materials as deemed appropriate and any discussion that departs from the formal agenda should be scrutinized carefully. Antitrust compliance is everyone s responsibility; however, please seek legal counsel if you have any questions or concerns. 2

4 Presentation Disclaimer 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 the sessions are audio-recorded and may be published in various media, including print, audio and video formats without further notice. The views and opinions expressed are solely those of the presenters and not those of Ernst & Young LLP, Milliman, or Davis & Harman LLP. 3

5 Presenters Moderator Paul Fedchak, Milliman Presenter Alison Peak, Davis & Harman LLP Presenter Craig Reynolds, Milliman Presenter Art Dunlavy, Ernst & Young, LLP 4 4

6 Overview Tax law changes relating to insurance products In general Tax law Changes - Case study on life insurance and annuity pricing Product tax considerations for the low interest rate environment and 2017 CSO mortality tables 5 5

7 To Participate, look for Polls in the SOA Event App or visit las.cnf.io in your browser Find The Polls Feature Under More In The Event App Type las.cnf.io In Your Browser Choose your session or 6

8 Tax Law Changes Affecting Insurance Products In General Alison Peak Davis & Harman LLP

9 Reasonable mortality rule Prior law: In general, NSPs, GLPs, and 7-pay premiums required use of reasonable mortality charges not more than the prevailing commissioners standard table crossreferenced in section 807(d)(5) New law: Requires reasonable mortality charges that meet the requirements of regulations or that do not exceed the prevailing commissioners standard tables as defined in newly added subsection (f)(10), which largely tracks prior law section 807(d)(5) Reason for change: The change is intended to maintain prior law under section 7702 even though section 807 was modified

10 Reasonable mortality rule Interpretation questions Removes Treasury s express authority to limit the mortality assumptions to amounts less than prevailing standard tables Leaves in place the reasonable standard Eliminates lowest reserves language from former section 807(d)(5) Effective date: Taxable years beginning after Dec. 31,

11 Rev. Proc Provides safe harbor for contracts that have mortality guarantees based upon CSO tables that extend beyond age 100 and continue in force after age 100 E.g., 2001 CSO and 2017 CSO Extends Age 100 Safe Harbor Testing Methodologies to 2017 CSO tables No substantive changes to the testing methodologies

12 Reportable policy sales Prior law: If a life contract is transferred for value, the death benefit that is excluded from gross income is limited to the consideration paid for a life insurance contract Exceptions exist where (1) the contract has a basis determined by reference to the transferor, or (2) the transfer is to the insured or certain other parties No reporting was required

13 Reportable policy sales New law: Section 6050Y requires information reporting on reportable policy sales, meaning the acquisition of an interest in a life insurance contract directly or indirectly, if the acquirer has no other substantial family, business, or financial relationship with insured Buyer must report certain information to the IRS, the seller, and the insurance company Upon notice, insurance company must report certain information to the IRS and the seller Reportable death benefit must be reported too Guidance is forthcoming from the IRS (on Priority Guidance Plan) Reasons for change: Ensure that reportable policy sales are reported to the IRS and taxed appropriately 12

14 Transfer for value Prior law: As noted, there are two exceptions for the transfer for value rule: (1) the contract has a basis determined by reference to the transferor, or (2) the transfer is to the insured or certain other parties New law: Section 101(a)(3) provides that the exceptions to the transfer for value rules do not apply in the case of a reportable policy sale Reasons for change: Ensure that some portion of the death benefit is ultimately includable in income

15 Basis of a life insurance contract Prior law: The basis of a life insurance contract is reduced by cost of insurance charges See Rev. Rul New law: Section 1016 provides that no adjustment to basis will be made for mortality, expense, or other reasonable charges incurred under an annuity or life insurance contract ( cost of insurance charges ) Reasons for change: Align cost basis with the investment in the contract under section 72 Effective date: August 25, 2009; clarifying the law

16 Roth IRAs Prior law: A contribution made to one type of IRA can be recharacterized and treated as having been made to a different type of IRA prior to the due date for filing the individual s tax return (including extensions) New law: A conversion from a traditional, SEP, or SIMPLE IRA to a Roth IRA cannot be recharacterized and a rollover contribution of non-roth money to a Roth IRA cannot be recharacterized Section 408A(d)(6)(B)(iii) Reasons for change: Prevent recharacterizations following a market downturn that have the effect of reducing taxable income

17 DAC tax Prior law: Life insurance companies must capitalize their specified policy acquisition expenses (DAC tax) The amount to be capitalized is a set percentage of the net premiums received for three categories of specified insurance contracts New law: The DAC tax rules extend the amortization period from 10 years to 15 years and increase the percentage amount that must be capitalized Reasons for change: Increase tax revenue *Learn more about the DAC tax changes at the Company Tax Update panel.

18 IRS Priority Guidance Plan Guidance projects the IRS plans to complete July 2017-June 2018 Removed many items from the Guidance Plan relating to insurance products: Regulations on the meaning of CSV under sections 72 and 7702 Guidance under sections 72 and 7702B on annuity contracts with LTC feature Guidance under section 1035 on exchanges of annuities for LTC contracts Guidance relating to captive insurance companies 17

19 IRS Priority Guidance Plan Items remaining on Priority Guidance Plan for insurance products Guidance under sections 807 and 816 relating to PBR Guidance under section 72 relating to private annuities Guidance regarding the new reportable policy sales of life contracts Changes to items relating to employee benefits E.g., IRAs, QLACs, RMDs 18

20 Tax Law Changes - Case study on life insurance and annuity pricing Craig Reynolds Milliman

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22 Overview of KEY Changes Tax rate change from 35% to 21% Small company deduction removed DAC tax amortization period extended from 10 years to 15 years, with rate changes: Life: 7.70% --> 9.20% Non-qualified annuity: 1.75% --> 2.09% Group life: 2.05% --> 2.45% Non variable reserves = Max(CV,.9281 * Tax Reserve Method), Tax Reserve Method = Min Stat reserves w/o deficiencies Variable reserves = Max(CSV, SA Res) *Max(0, Tax reserve method Max(CSV, SA Res)) CSV floor and stat reserve ceiling still applies Must be based on current CARVM/CRVM with original assumptions

23 RBC: The elephant in the room Original capital factors developed to absorb an after-tax loss, which equates to a given pre-tax loss RBC factors should, in theory, generally increase by a factor of (1 -.21) / (1 -.35) 1 = 21.54% Academy and ACLI are lobbying 22

24 Exposed RBC factors maybe to be effective for 12/31/

25 The government gave, and the government hath taken away. Tax rate: DAC tax: DAC amortization period: Lower tax reserves: Higher capital: Great! Bummer! Bummer! Bummer! Ouch! Net impact will depend on facts and circumstances of individual products and company tax situation 24

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27 Current Assumption UL step changes (All results conservatively assume full RBC gross up) IRR PROFIT MARGIN BEFORE TAX REFORM 15.2% 6.3% CHANGE DAC TAX 13.7% 5.9% CHANGE TAX RESERVES 12.2% 5.6% CHANGE TAX RATE 17.1% 8.1% CHANGE RBC 15.4% 7.9% 26

28 CAUL Distributable profit step changes 27

29 Whole Life step changes IRR PROFIT MARGIN BEFORE TAX REFORM 10.0% 3.4% CHANGE DAC TAX 9.3% 2.7% CHANGE TAX RESERVES 6.9% -0.2% CHANGE TAX RATE 9.1% 3.0% CHANGE RBC 8.9% 2.8% 28

30 Term under PBR step changes IRR PROFIT MARGIN BEFORE TAX REFORM 9.6% 5.1% CHANGE DAC TAX 9.1% 4.8% CHANGE TAX RESERVES 8.8% 4.6% CHANGE TAX RATE 10.1% 6.6% CHANGE RBC 9.8% 6.5% 29

31 Term under AG48 step changes IRR PROFIT MARGIN BEFORE TAX REFORM 26.5% 9.5% CHANGE DAC TAX 25.7% 9.1% CHANGE TAX RESERVES 22.4% 7.9% CHANGE TAX RATE 9.9% 4.0% CHANGE RBC 8.7% 3.6% 30

32 IUL step changes IRR PROFIT MARGIN BEFORE TAX REFORM 10.0% 5.2% CHANGE DAC TAX 9.4% 4.8% CHANGE TAX RESERVES 8.7% 4.5% CHANGE TAX RATE 10.2% 6.5% CHANGE RBC 10.0% 6.4% 31

33 FIA step changes IRR PROFIT MARGIN BEFORE TAX REFORM 10.2% 5.9% CHANGE DAC TAX 10.1% 5.9% CHANGE TAX RESERVES 8.8% 5.0% CHANGE TAX RATE 10.6% 7.5% CHANGE RBC 10.0% 7.4% 32

34 Design changes to neutralize profit margin at 5% discount rate CAUL: Decrease COI by 8% Par WL: Decrease CV interest rate by 0.5% & Cut dividends by 8% Term (PBR): Decrease premiums by 3% Term (AG 48): Increase premiums by 10% IUL: Decrease COI by 8% FIA: Increase option budget by 21 bps 33

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36 Product tax considerations for the low-interest rate environment and 2017 Commissioner s Standard Ordinary (CSO) mortality tables Art Dunlavy Ernst & Young LLP

37 Impact of 2017 CSO under Section 7702 Overview of Internal Revenue Code (IRC) Section 7702* mortality requirements Internal Revenue Service (IRS) guidance related to the 2017 CSO tables: IRS Notice Revenue Procedure (RP) Universal life (UL) case study: Impact of 2017 CSO on Section 7702 funding limitations Product tax considerations of UL contracts designed to qualify under guideline premium test (GPT) *All references to code sections are to the IRC unless otherwise noted. 36

38 Section 7702 mortality requirements Section 7702(c)(3)(B)(i) requires guideline, net single and 7-pay premiums be calculated using: reasonable mortality charges which meet the requirements prescribed in regulations to be promulgated by the secretary or that do not exceed the mortality charges specified in the prevailing commissioners standard tables as defined in subsection (f)(10) * The 2017 CSO mortality tables were approved for use for valuation and non-forfeiture purposes as a result of the adoption of the Valuation Manual (VM) and have both a permitted and required date of use as follows: Permitted date: January 1, 2017 Required date: January 1, 2020 Technical and Miscellaneous Revenue Act of 1986 (TAMRA) interim rule *Prevailing commissioners standard tables previously defined in Section 807(d)(5) 9

39 IRS guidance relating to 2017 CSO Notice : Continuing with its long-standing practice of issuing safe harbor notices to address reasonable mortality requirements related to adoption of new mortality tables, IRS issued Notice Provided safe harbor rules for 2017 CSO contracts Provided effective-date rules governing contract issue dates: Set forth requirements for continued use of 1980 or 2001 CSO mortality tables following a policy change Changes to prior guidance under Notice : Extended list of example policy changes that will not affect determination of issue date of a contract for purposes of reasonable mortality charge safe harbor, which now includes: Reduction or deletion of benefits Reinstatements pursuant to applicable state or foreign law 10

40 IRS guidance relating to 2017 CSO (continued) RP Provides safe harbor for contracts that have mortality guarantees based upon CSO tables that extend beyond age 100 and continue in force after age 100 E.g., 2001 CSO and 2017 CSO Extends Age 100 Safe Harbor Testing Methodologies to 2017 CSO tables No substantive changes to the testing methodologies

41 UL case study Purpose of the analysis Assess the ability to fund UL contracts under a GPT design, given: The current low-interest-rate environment The adoption of the 2017 CSO mortality table Determine the impact current assumptions have on cash values relative to those assumed in calculation of the guideline level premium (GLP): Interest: Assumed current credited interest rate = 3.0% Interest rate assumed in calculation of the GLP = 4.0% Current cash values growing at slower rate relative to 4.0% interest rate assumed in calculation of the GLP: An interest shortfall of 100 basis points exists Absent other differences between current assumptions and those assumed in calculation of GLP, a policy paying the GLP will not endow on a current basis because of interest shortfall 11

42 UL case study Purpose of the analysis (continued) Impact of current assumptions on relationship between cash value (CV) and GLP Mortality: Assumed current mortality costs = 2017 CSO unloaded table Mortality rates assumed in calculation of the GLP = 2001 or 2017 CSO loaded table Current cash values growing at a higher rate than those assumed in calculation of GLPs because of difference in mortality assumptions A mortality excess exists, equal to difference between unloaded and loaded tables 11

43 UL case study Purpose of the analysis (continued) Solved for interest rate needed to endow contract based on payment of GLP and current cost of insurance (COI) charges (the Endowment Rate) The cash value excess/shortfall can be defined as: (1) 3.0% (actual credited rate), less (2) The Endowment Rate Analysis will determine if contract will be in a cash value excess or shortfall position based on combination of the mortality excess and interest shortfall Will payment of GLPs keep contract in force to maturity under current assumptions? Contract will be in cash value shortfall position if Endowment Rate exceeds 3.0% (current credited rate) 12

44 UL case study Test case characteristics Section 7702 qualification test: guideline premium/cash value corridor test Funding level: Section 7702 GLP (monthly curtate calculation) Risk class: male, nonsmoker (various issue ages) Face amount: $100,000 Maturity age: 100 Expenses: 2.5% premium load and $5 monthly administration fee Mortality: Current mortality charges: 2017 CSO unloaded table male, nonsmoker, age last birthday (ALB) Guaranteed maximum mortality charges ( loaded table ) Scenario 1: 2001 CSO male, nonsmoker, ALB Scenario 2: 2017 CSO male, nonsmoker, ALB Interest: current credited rate = 3.0% No riders 13

45 UL case study Scenario 1 results Scenario 1 Guaranteed Maximum Mortality 2001 CSO male, nonsmoker, ALB Issue age GLP Credited rate GLP rate Endowment rate Excess or shortfall % 4.00% 3.21% -0.21% % 4.00% 3.13% -0.13% % 4.00% 3.04% -0.04% 35 1, % 4.00% 2.92% 0.08% 40 1, % 4.00% 2.72% 0.28% 45 1, % 4.00% 2.45% 0.55% 50 2, % 4.00% 2.13% 0.87% 55 2, % 4.00% 1.68% 1.32% 60 3, % 4.00% 1.12% 1.88% 65 4, % 4.00% 0.42% 2.58% 70 6, % 4.00% 0.00% 3.00% 75 8, % 4.00% 0.00% 3.00% 80 11, % 4.00% 0.00% 3.00% 14

46 UL case study Scenario 1 observations Under a 2001 CSO product design, payment of GLP will generally allow contracts to endow based on current assumptions (e.g., crediting of current interest (of 3.0%) and assessing current mortality charges). For most issue ages, mortality excess exceeds interest shortfall. For certain younger ages, credited interest rates in excess of 3.0% are needed to endow the contract. 45

47 UL case study Scenario 2 results Scenario 2 Guaranteed Maximum Mortality 2017 CSO male, nonsmoker, ALB Issue age GLP Change in GLP relative to Scenario 1 Credited rate GLP rate Endowment rate Excess or shortfall % 3.00% 4.00% 3.77% -0.77% % 3.00% 4.00% 3.76% -0.76% % 3.00% 4.00% 3.74% -0.74% % 3.00% 4.00% 3.71% -0.71% 40 1, % 3.00% 4.00% 3.67% -0.67% 45 1, % 3.00% 4.00% 3.62% -0.62% 50 1, % 3.00% 4.00% 3.56% -0.56% 55 2, % 3.00% 4.00% 3.47% -0.47% 60 2, % 3.00% 4.00% 3.33% -0.33% 65 3, % 3.00% 4.00% 3.12% -0.12% 70 4, % 3.00% 4.00% 2.80% 0.20% 75 6, % 3.00% 4.00% 2.26% 0.74% 80 9, % 3.00% 4.00% 1.40% 1.60% 16

48 UL case study Scenario 2 observations Funding a 2017 CSO contract at GLP may not allow contract to endow at current credited rates: GLPs based on 2017 CSO generally 15% to 20% lower than those based on 2001 CSO Interest shortfalls exceed mortality excess for most issue ages Key assumption in our analysis is current COIs not impacted as a result of moving from 2001 CSO to 2017 CSO Potential consequences under other funding scenarios Implications for 2017 CSO UL products that qualify under GPT: Increasing prevalence of no-lapse guarantees Increasing reliance on Section 7702(f)(6) as a way to keep contracts from terminating as policy values reduce to zero for maximum funded contracts Continuing trend toward UL products that qualify under cash value accumulation test (CVAT) 47

49 No-lapse guarantees Section 7702 considerations Effect, if any, under reasonable mortality charge and reasonable expense charge rules: Interest and mortality guarantees relevant to Section 7702 are generally those applicable to contract s nonforfeiture cash values. Interaction with over-loan protection riders Issues with alternative cash values/benefits and secondary guarantees associated with such values 48

50 Section 7702(f)(6) Administrative considerations The good: Section 7702(f)(6) provides valuable exception under GPT that allows for payment of a premium that would otherwise cause a violation of GPT, provided two conditions are satisfied: Amount of such premium does not exceed amount necessary to prevent termination of the contract on or before the end of contract year. Contract will have no cash surrender value at end of such extension period. The bad: Contract holder essentially left funding life insurance contract as term insurance, which can be prohibitively expensive as insured ages The ugly: Challenges in administration of Section 7702(f)(6) Can systems effectively administer Section 7702(f)(6)? Do systems have ability to administer payment that would otherwise cause premiums paid to exceed guideline premium limitation? How should amount of permissible premium under Section 7702(f)(6) be determined? Error prone 49

51 UL CVAT design Product tax consideration Section 7702 considerations: Contract terms become important as CVAT compliance must be guaranteed by the terms of the contract : CVAT is a prospective test that must be met at all times. It must be impossible for cash surrender value to exceed net single premium (NSP) under contract s mechanics. No direct limitation on premiums Section 7702A considerations: Administration of 7-pay test for CVAT and GPT policies largely consistent, with one important exception necessary premium testing (NPT) compliance approaches for CVAT policies include: Full NPT system build-out that tests for unnecessary premiums Simplified approach under which material changes not deferred for contracts in corridor (based on lowest benefits) Other? 50

52 Questions?