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Association of Life Insurance Counsel May 7, 2018 Aditi Banerjee Bryan Keene Pete Bautz Prudential Davis & Harman LLP ACLI Agenda The Legislative Process Overview and General Tax Reforms Life Insurance Industry Tax Reforms
Association of Life Insurance Counsel May 7, 2018
Prudential
Davis & Harman LLP
ACLI
State Taxes RBC and Financial Accounting
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Initial House Bill
Initial Senate Bill
House Bill Passed
Senate Bill Passed
Compromise Bill Passed
Signed by President
Most Provisions Effective
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President Reagan called for reform in State of the Union address Treasury Dept. submitted comprehensive study
30 days of Ways and Means Committee hearings began 36 days of Senate Finance Committee hearings began Administration submitted proposal to Congress
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1985
May 9 May 29 Ways and Means Committee approved bill House passed bill by voice vote Senate Finance Committee approved bill Conference report filed Senate approved conference report Ways and Means Committee markup began Senate Finance Committee markup began Senate passed amended bill, 97-3 House approved conference report President Reagan signed bill (Public Law 99-514) March 19 May 6 June 24
1986 1985
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Permanently reduced 35% corporate tax rate to flat 21% Repealed the corporate alternative minimum tax (AMT) Temporarily allows 100% expensing for certain capital assets Fundamentally changed taxation of multinational entities Temporary new deduction for certain income of individuals,
trusts, and estates from passthrough entities, sole proprietorships
Paid for these business changes through various base-
broadening measures and nearly $1.5 trillion of deficit spending
Life insurers in particular were targeted with industry-specific
revenue raisers
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Conforming changes: 70% dividends received deduction
(DRD) reduced to 50% and 80% DRD reduced to 65%
Unutilized credits refundable from 2018-2020 at 50% / year Any leftovers in 2021 are refundable that year Sequestration issue:
Refundable credits are sequestered: 6.6% reduction for 2018 Balanced Budget and Emergency Deficit Control Act of 1985
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Net Operating Losses (NOLs)
Special rules for life insurance companies repealed
3-year carryback and 15-year carryforward eliminated
General corporate rules modified (and apply to life companies)
No carryback, unlimited carryforward Use of loss carryovers limited to 80% of taxable income
P&C company rules unchanged
2-year carryback; 20-year carryforward; no percentage limit
Capped at 30% of adjusted taxable income (with special rules)
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Passthrough entities:
20% deduction for “qualified business income” Financial services and other “service” businesses: deduction
phases out at $315,000 taxable income (joint returns)
Limits on executive compensation under section 162(m) Deductions for meals, entertainment expenses further
Restrictions on fringe benefits Limits on deducting fines, penalties, certain settlements
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Tax reserves generally were the greater of a contract’s NSV and
the “federally prescribed reserve”
The federally prescribed reserve was based on:
the “tax reserve method” applicable to the contract, the greater of the “applicable Federal interest rate” or the
“prevailing State assumed interest rate,” and
the prevailing commissioners’ standard tables, all determined at issuance of the contract.
Reserve determined contract-by-contract Tax reserve capped at the statutory reserve Some types of reserves not deductible
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New general rule for life insurance tax reserves:
The greater of
The NSV for the contract, or 92.81% of the reserve computed using the NAIC-prescribed
method for the contract
The NAIC-prescribed method is determined at the valuation
date, not the issue date
Rules apply contract-by-contract, like prior law Capped at statutory reserves, like prior law
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New special rule for variable contracts:
Tax reserve equals the sum of (a) + (b), where …
(a) is the greater of (i) the NSV for the contract or (ii) the portion of
the reserve that is separately accounted for under Code § 817, and
(b) is 92.81% of the excess (if any) of (i) the reserve computed
using the NAIC-prescribed method for the contract over (ii) the amount in (a)
Also subject to statutory reserve cap
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Effective date and transition rule:
New rules apply to tax years starting after 12/31/17 Deduct or include differences ratably over 8 years
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Observations:
Change to NAIC-prescribed method as of valuation date is
generally helpful for principles-based reserving
Haircut has greater effect for products without cash values,
such as --
Immediate annuities, deferred income annuities, term life
insurance, long-term care, disability income
Non-deductible reserves:
Asset adequacy reserves Deficiency reserves and deferred and uncollected premiums No “double counting”
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Life insurance company deductions for dividends received are
limited to the “company’s share” of such dividends
Company’s share was percentage generally equal to:
the company’s net investment income reduced by “policy
interest,” divided by
the company’s total net investment income (95% of gross
separate account investment income; 90% for general account)
Proration also applies to tax-exempt interest and increases in
the cash value of life insurance and annuity contracts
Reserve decreases and increases are adjusted for the
“policyholders’ share” of those items
These rules applied based on older regulations that caused
controversy with the IRS
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Company’s share of dividends received is set at 70% Policyholders’ share of tax-exempt interest and the
Replaces formulaic approach based on older regulations
Similar to P&C company tax rules
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Base for computing a life insurers’ general account and
Reduced the 80% DRD to 65% and the 70% DRD to 50% Adjusts for the benefit of the lower corporate tax rate
This means the starting point for the proration calculation
The proration percentage of 70% is multiplied by the
general DRD percentage of 50%
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Must capitalize “specified policy acquisition expenses” A proxy was used that capitalizes a portion of general business
expenses based on the percentage of net premiums received for three categories of contracts:
1.75% for annuity contracts, 2.05% for group life insurance contracts, and 7.7% for all other specified insurance contracts (generally non-
group life insurance and non-cancelable A&H insurance)
Capitalized expenses deductible ratably over 10 years
5 years for first $5 million, subject to phase-out at $10 million
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Increases the proxy rates by roughly 20% each
2.09% for annuity contracts, 2.45% for group life insurance contracts, and 9.2% for all other specified insurance contracts But: drafting error means only the latter two rate categories
were modified; legislative correction may be needed
Lengthens amortization period from 10 to 15 years
Retains 5-year amortization schedule for smaller balances
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New rules apply to net premiums received after 12/31/17 Existing DAC balances continue on their current
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Life settlements
Reporting is required for any “reportable policy sale,” which
generally means a person acquires, directly or indirectly, a life insurance contract where the acquirer has no substantial family, business, or financial relationship with the insured.
The buyer must report information about the purchase to the IRS, to the
contract issuer, and to the seller.
The issuer must report certain information to the IRS, the purchaser, and
the payee of any death benefit. Exceptions to the transfer for value rule do not apply in a
reportable policy sale.
Rev. Rul. 2009-13 is effectively reversed, regarding COI charges
reducing adjusted basis in a life insurance contract.
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Definition of a life insurance contract
The reasonable mortality rules are modified to conform to the
changes to the reserve rules, which repeal the definition of “prevailing commissioners’ standard tables” in the Code
Determinations under Code § 7702 must be based on “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.”
The prevailing tables are defined in new Code § 7702(f)(10) in
the same manner as in current law, except that the definition
there is no prevailing table and contracts to which multiple tables may be prevailing.
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Small life insurance company deduction repealed 10-year spread rule for changes in a taxpayer’s basis for
Policyholder surplus account provisions repealed
Any PSA balances in existence as of December 31, 2017,
will be taxed ratably over the next 8 years
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Life / non-life consolidation Ordinary / capital mismatch Others?
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Moves to a quasi-territorial system with a 100% dividends
Replaces the current worldwide system of taxation with a
dividend-exemption system
Exempts from U.S. taxation 100% of the foreign-source
portion of dividends paid by a foreign corporation to a U.S. corporate shareholder owning at least 10% of the foreign corporation
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One-time tax on previously un-repatriated earnings
Generally requires a 10% U.S. shareholder of a CFC to
include in income its pro rata share of the CFC’s pre-2018 accumulated E&P that has not previously been subject to U.S. tax
The portion of the E&P comprising cash and cash
equivalents is taxed at 15.5% and the remainder at 8%
There is an election to pay the tax over eight years
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Base Erosion and Anti-Abuse (BEAT) Tax
Earnings stripping by certain foreign-headquartered
multinationals was long recognized as a problem by the U.S., with deductible royalty payments, interest payments, and service payments to a foreign parent reducing U.S. tax liabilities
H.R. 1 potentially subjects businesses with more than $500
million in annual gross receipts and more than a de minimis amount of certain related-party payments to a new 10% minimum tax (5% for 2018 and 12.5% for tax years beginning after 12/31/2025), called the BEAT
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BEAT (continued …)
The alternative tax base is similar to the regular tax base
except otherwise deductible payments to a foreign related party (base erosion payments and any NOLs attributed to such payments) are added back in arriving at the alternative tax base.
Base erosion payments include deductible payments to
related foreign persons for certain reinsurance arrangements, but not for costs of goods sold or for services provided at cost.
BEAT is not applicable to deductible payments to a foreign
corporation treated as a U.S. corporation pursuant to an election under section 953(d).
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Global Intangible Low-Taxed Income (GILTI)
H.R. 1 taxes U.S. corporate shareholders currently on their
portion of a CFC’s GILTI.
GILTI generally is income that is low-taxed – roughly, less
than a 10.5% effective tax rate (ETR), grading up to a 13.125% ETR for tax years beginning after 12/31/25 – and generates a high rate of return.
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Foreign-Derived Intangible Income (FDII)
H.R. 1 effectively creates a new preferential tax rate for
income derived by domestic corporations from serving foreign markets.
This is accomplished via a new deduction for FDII A lower effective tax rate of 13.125% on routine income
arising from foreign markets provides a new benefit for
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FDII (continued …)
The FDII deduction is available to domestic corporations
that are taxed as C corporations, including U.S. corporate subsidiaries of foreign-based multinationals.
Foreign corporations with income effectively connected
with a U.S. trade or business, S corporations, regulated investment companies, real estate investment trusts, partnerships, and individuals are not eligible.
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Passive Foreign Investment Companies (PFICs)
H.R. 1 amends the PFIC exception for insurance companies to
apply only if the foreign insurance company has insurance liabilities that constitute more than 25% of its total assets.
“Insurance liabilities” includes loss and loss adjustment expenses
and life and P&C reserves, but would exclude unearned premium, deficiency, and contingency reserves as reported on the insurer’s applicable financial statement.
If the foreign insurer’s reserve percentage falls below 25% solely
due to run-off or rating-related circumstances, an alternate test would be available for a company whose insurance liabilities constitute at least 10% of its assets.
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The dramatic changes in the federal tax base (for both
Many states conform their tax codes to the federal code In opening state tax codes to address the federal changes,
Tax credits, premium taxation, etc.
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Tax reform significantly impacts life insurers’ risk-based
capital (RBC) ratios due primarily to the drop in the corporate tax rate from 35% to 21%
In simplistic terms, RBC = available capital/required capital
Required capital, which is based on loss contingencies, is
determined on an after-tax basis
In a loss event, a lower corporate tax rate means the Federal
government’s share of the loss is reduced
The drop in the corporate tax rate also decreases the value of
deferred tax assets (DTAs) included in available capital
Elimination of the carryback period for life operating losses also
can lead to lower admitted DTAs
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Both of these factors drive RBC ratios down Overall, life company RBC ratios could decline in the
The industry is advocating that the effect of tax rate
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SAB 118 (issued 12.22.17, the same day President Trump
Provides important relief to companies filing 12.31.17
Allows them to take a reasonable period to determine and
recognize the effects of the new tax bill
Addresses the challenges entities may face in accounting for
and reporting on the effects of the new tax bill because of incomplete information and accounting
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On 1.10.18, FASB held a public board meeting and indicated
they would adopt the SEC reporting approach for U.S. GAAP reporting purposes
FASB also gave more specific guidance on financial reporting
issues related to tax reform, including how to properly restate deferred taxes on unrealized gains and losses on securities recorded through accumulated other comprehensive income, as requested by ACLI on 12.21.17
FASB subsequently issued guidance on the financial
accounting treatment of repatriation tax liabilities, AMT tax credit refund receivables, the BEAT and GILTI
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On 1.11.18, the NAIC exposed revisions to statutory
On 1.30.18, the NAIC Statutory Accounting Principles
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