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Old 11-09-2017, 10:12 AM
A2TRM A2TRM is offline
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Default Tax Cuts and Jobs Act, Section 3703: Computation of life insurance tax reserves

Apologies in advance if there's already a discussion of this elsewhere. I ran a few quick searches & came up empty.

The House tax reform bill (Tax Cuts and Jobs Act) contains a provision (Section 3703) relating to life insurance tax reserves. I'm curious to find out what others in the industry are reading/hearing about this provision.

This site contains links to the full bill, the section-by-section summary provided by the Ways & Means Committee, and some commentary by KPMG: https://home.kpmg.com/us/en/home/ins...ovember-2.html

Here's a quote from the Ways & Means Committee Summary Document:
Quote:
Sec. 3703. Computation of life insurance tax reserves.
Current law: Under current law, life insurance companies may deduct net increases in life insurance company reserves, while net decreases in such reserves are included in gross income. In computing changes in reserves, the life insurance reserve for a contract generally is the greater of the net surrender value of the contract or the reserve determined under rules provided in the Code, which for discounting purposes employ a prescribed interest rate that is equal to the greater of the applicable Federal rate or the prevailing State assumed interest rate. The “prevailing State assumed interest rate” is equal to the highest assumed interest rate permitted to be used in at least 26 States in computing regulatory life insurance reserves. The discount rate used by property and casualty (P&C) insurance companies for reserves is the average applicable Federal mid-term rate over the 60 months ending before the beginning of the calendar year for which the determination is made.
Provision: Under the provision, life insurance companies would take into account a specific percentage, 76.5 percent, of the increase or decrease in reserves for future un-accrued claims [as reported on the insurer's regulatory annual statement and on tax schedule M-3] in computing taxable income. Deficiency reserves, asset adequacy reserves or other types of reserves would not be included. The provision would generally be effective for tax years beginning after 2017. The effect of the provision on computing reserves for contracts issued before the effective date would be taken into account ratably over the succeeding eight tax years.
Considerations:
• Insurance regulators have been changing how life insurance companies must calculate and maintain reserves. The current rules in the Tax Code do not provide how reserves measured in the new matter should be taken into account for tax purposes.
• The provision would replace the current-law prescribed reserve rules with rules taking into account reserves on an economically neutral basis. The current-law rule that uses a regulatory-based measurement generally understates income.
JCT estimate: According to JCT, the provision would increase revenues by $14.9 billion over 2018-2027.
And a quote from the KPMG observations:
Quote:
Computation of life insurance tax reserves (section 3703 of the tax bill)

Under this provision, life insurance companies would take into account a specific percentage—76.5%—of the increase or decrease in reserves for future un-accrued claims (as reported on the insurer’s regulatory annual statement and on tax schedule M-3) in computing taxable income. Deficiency reserves, asset adequacy reserves or other types of reserves would not be included.



KPMG observation

This proposal is scored as the largest revenue raiser under the changes to the subchapter L provisions. This reflects a significant departure from the current rules under section 807 which calculate tax reserves based on (albeit conservative) actuarial principles. The 23.5% “haircut” on statutory reserves would create a reduced tax reserve amount without incorporating the time value of money or other actuarial principles.

The Ways and Means section-by-section summary states that the new rules take into account reserves on an economically neutral basis, and that the current law uses a regulatory-based measurement that generally understates income. However, the resulting tax reserves would be significantly less than the actuarial reserves that are used for any other purpose by the actuarial community.

The proposal also excludes deficiency reserves, asset adequacy reserves, and certain other unidentified reserves from section 807 reserves. It is unclear whether these reserves are expected to follow statutory accounting definitions or tax specific definitions.

The tax reform bill appears to eliminate the section 807 floor that stipulates tax reserves cannot be less than the contract’s cash surrender value. As a result, certain contracts, such as certain deferred annuities, could have tax reserves that are significantly less than the contract’s cash surrender value.

In addition, these provisions could result in a significant impact on surplus in light of the statutory accounting limitations on admissibility of deferred tax assets.
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Old 11-09-2017, 10:13 AM
A2TRM A2TRM is offline
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I have also found these two references from the WSJ:

https://www.wsj.com/livecoverage/tax...ard/1510060084

Quote:
There could be more changes coming to the treatment of pass-through businesses and to policies affecting insurers, according to Rep. Kevin Brady (R., Texas), chairman of the House Ways and Means Committee
Quote:
Life-Insurance Execs Talk with GOP Tax-Bill Author About Unintended Consequences
As House lawmakers debated the GOP tax bill Wednesday, top executives from nearly 20 life insurers visited Capitol Hill to express concerns about adverse consequences of a provision pertaining to reserve calculations. They met with the bill's author, Texas Rep. Kevin Brady. The industry is worried the proposed change will haul in far more revenue than estimated, hurting the industry.

"We're just talking through some of the main provisions in the tax reform plan making sure that the scores are right and the impacts are predictable," Mr. Brady told The Wall Street Journal. "And if they're not, making the corrections going forward. And making sure we've got the policies right."

—Leslie Scism and Richard Rubin
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Old 11-09-2017, 10:44 PM
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They also want to
change DAC expense deferral from 7% to 11%

Remove small company deduction
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Old 11-10-2017, 08:21 AM
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The Ways & Means Summary:

https://waysandmeansforms.house.gov/...ection_hr1.pdf

Estimates by item:

Quote:
Sec. 3702. Repeal of small life insurance company deduction.
....

JCT estimate: According to JCT, the provision would increase revenues by $0.2 billion over
2018-2027.


Sec. 3703. Computation of life insurance tax reserves.
....
JCT estimate: According to JCT, the provision would increase revenues by $14.9 billion over
2018-2027.


Sec. 3704. Adjustment for change in computing reserves.

.....
JCT estimate: According to JCT, the provision would increase revenues by $1.2 billion over
2018-2027.

Sec. 3705. Modification of rules for life insurance proration for purposes of determining
the dividends received deduction.

.....
JCT estimate: According to JCT, the provision would increase revenues by $1.1 billion over
2018-2027.

Sec. 3706. Repeal of special rule for distributions to shareholders from pre-
1984 policyholders surplus account.

.....
JCT estimate: According to JCT, the provision would increase revenues by less than $50
million over 2018-2027.
.....
Sec. 3710. Capitalization of certain policy acquisition expenses.
....
JCT estimate: According to JCT, the provision would increase revenues by $7.0 billion over
2018-2027.
Adding up all these items is an increase in taxes of $24.5 billion over that 10 year period.
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Old 11-10-2017, 11:19 AM
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Senate bill for markup:
https://www.finance.senate.gov/imo/m...9;s%20Mark.pdf

I see this in there:

Spoiler:

2. Repeal of small life insurance company deduction
Present Law
The small life insurance company deduction for any taxable year is 60 percent of so
much of the tentative life insurance company taxable income (“LICTI”) for such taxable year as
does not exceed $3 million, reduced by 15 percent of the excess of tentative LICTI over
$3 million. The maximum deduction that can be claimed by a small company is $1.8 million,
and a company with a tentative LICTI of $15 million or more is not entitled to any small
company deduction. A small life insurance company for this purpose is one with less than
$500 million of assets.
Description of Proposal
The proposal repeals the small life insurance company deduction.
Effective Date
The proposal applies to taxable years beginning after December 31, 2017.
3. Adjustment for change in computing reserves
Present Law
Change in method of accounting
In general, a taxpayer may change its method of accounting under section 446 with the
consent of the Secretary (or may be required to change its method of accounting by the
Secretary). In such instances, a taxpayer generally is required to make an adjustment (a
“section 481(a) adjustment”) to prevent amounts from being duplicated in, or omitted from, the
calculation of the taxpayer’s income. Pursuant to IRS procedures, negative section 481(a)
adjustments generally are deducted from income in the year of the change whereas positive
section 481(a) adjustments generally are required to be included in income ratably over four
taxable years.461
However, section 807(f) explicitly provides that changes in the basis for determining life
insurance company reserves are to be taken into account ratably over 10 years.
10-year spread for change in computing life insurance company reserves
For Federal income tax purposes, a life insurance company includes in gross income any
net decrease in reserves, and deducts a net increase in reserves.462 Methods for determining
461 See, e.g., Rev. Proc. 2015-13, 2015-5 I.R.B. 419, and Rev. Proc. 2017-30, 2017-18 I.R.B. 1131.
462 Sec. 807.
134
reserves for tax purposes generally are based on reserves prescribed by the National Association
of Insurance Commissioners for purposes of financial reporting under State regulatory rules.
Income or loss resulting from a change in the method of computing reserves is taken into
account ratably over a 10-year period.463 The rule for a change in basis in computing reserves
applies only if there is a change in basis in computing the Federally prescribed reserve (as
distinguished from the net surrender value). Although life insurance tax reserves require the use
of a Federally prescribed method, interest rate, and mortality or morbidity table, changes in other
assumptions for computing statutory reserves (e.g., when premiums are collected and claims are
paid) may cause increases or decreases in a company’s life insurance reserves that must be
spread over a 10-year period. Changes in the net surrender value of a contract are not subject to
the 10-year spread because, apart from its use as a minimum in determining the amount of life
insurance tax reserves, the net surrender value is not a reserve but a current liability.
If for any taxable year the taxpayer is not a life insurance company, the balance of any
adjustments to reserves is taken into account for the preceding taxable year.
Description of Proposal
Income or loss resulting from a change in method of computing life insurance company
reserves is taken into account consistent with IRS procedures, generally ratably over a four-year
period, instead of over a 10-year period.
Effective Date
The proposal applies to taxable years beginning after December 31, 2017.
4. Repeal of special rule for distributions to shareholders from pre-1984 policyholders
surplus account
Present and Prior Law
Under the law in effect from 1959 through 1983, a life insurance company was subject to
a three-phase taxable income computation under Federal tax law. Under the three-phase system,
a company was taxed on the lesser of its gain from operations or its taxable investment income
(Phase I) and, if its gain from operations exceeded its taxable investment income, 50 percent of
such excess (Phase II). Federal income tax on the other 50 percent of the gain from operations
was deferred, and was accounted for as part of a policyholder’s surplus account and, subject to
certain limitations, taxed only when distributed to stockholders or upon corporate dissolution
(Phase III). To determine whether amounts had been distributed, a company maintained a
shareholders surplus account, which generally included the company’s previously taxed income
that would be available for distribution to shareholders. Distributions to shareholders were
463 Sec. 807(f).
135
treated as being first out of the shareholders surplus account, then out of the policyholders
surplus account, and finally out of other accounts.
The Deficit Reduction Act of 1984464 included provisions that, for 1984 and later years,
eliminated further deferral of tax on amounts (described above) that previously would have been
deferred under the three-phase system. Although for taxable years after 1983, life insurance
companies may not enlarge their policyholders surplus account, the companies are not taxed on
previously deferred amounts unless the amounts are treated as distributed to shareholders or
subtracted from the policyholders surplus account.465
Any direct or indirect distribution to shareholders from an existing policyholders surplus
account of a stock life insurance company is subject to tax at the corporate rate in the taxable
year of the distribution. Present law (like prior law) provides that any distribution to
shareholders is treated as made (1) first out of the shareholders surplus account, to the extent
thereof, (2) then out of the policyholders surplus account, to the extent thereof, and (3) finally,
out of other accounts.
For taxable years beginning after December 31, 2004, and before January 1, 2007, the
application of the rules imposing income tax on distributions to shareholders from the
policyholders surplus account of a life insurance company were suspended. Distributions in
those years were treated as first made out of the policyholders surplus account, to the extent
thereof, and then out of the shareholders surplus account, and lastly out of other accounts.
Description of Proposal
The proposal repeals section 815, the rules imposing income tax on distributions to
shareholders from the policyholders surplus account of a stock life insurance company.
In the case of any stock life insurance company with an existing policyholders surplus
account (as defined in section 815 before its repeal), tax is imposed on the balance of the account
as of December 31, 2017. A life insurance company is required to pay tax on the balance of the
account ratably over the first eight taxable years beginning after December 31, 2017.
Specifically, the tax imposed on a life insurance company is the tax on the sum of life insurance
company taxable income for the taxable year (but not less than zero) plus 1/8 of the balance of
the existing policyholders surplus account as of December 31, 2017. Thus, life insurance
company losses are not allowed to offset the amount of the policyholders surplus account
balance subject to tax.
Effective Date
The proposal applies to taxable years beginning after December 31, 2017.
464 Pub. L. No. 98-369.
465 Sec. 815.

.....
7. Capitalization of certain policy acquisition expenses
Present Law
In the case of an insurance company, specified policy acquisition expenses for any
taxable year are required to be capitalized, and generally are amortized over the 120-month
period beginning with the first month in the second half of the taxable year.469
A special rule provides for 60-month amortization of the first $5 million of specified
policy acquisition expenses with a phase-out. The phase-out reduces the amount amortized over
60 months by the excess of the insurance company’s specified policy acquisition expenses for
the taxable year over $10 million.
Specified policy acquisition expenses are determined as that portion of the insurance
company’s general deductions for the taxable year that does not exceed a specific percentage of
the net premiums for the taxable year on each of three categories of insurance contracts. For
annuity contracts, the percentage is 1.75; for group life insurance contracts, the percentage is
2.05; and for all other specified insurance contracts, the percentage is 7.7.
With certain exceptions, a specified insurance contract is any life insurance, annuity, or
noncancellable accident and health insurance contract or combination thereof. A group life
insurance contract is any life insurance contract that covers a group of individuals defined by
reference to employment relationship, membership in an organization, or similar factor, the
premiums for which are determined on a group basis, and the proceeds of which are payable to
(or for the benefit of) persons other than the employer of the insured, an organization to which
the insured belongs, or other similar person.
Description of Proposal
The proposal extends the amortization period for specified policy acquisition expenses
from a 120-month period to the 600-month period beginning with the first month in the second
half of the taxable year. The proposal does not change the special rule providing for 60-month
amortization of the first $5 million of specified policy acquisition expenses (with phaseout). The
proposal provides that for annuity contracts, the percentage is 3.17; for group life insurance
contracts, the percentage is 3.72; and for all other specified insurance contracts, the percentage is
13.97.
Effective Date
The proposal applies to taxable years beginning after December 31, 2017.

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Old 11-10-2017, 11:19 AM
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One more link although it is substantially similar to all the others: https://www.pwc.com/us/en/tax-servic...form-bill.html

For those who don't want to take time to read thru everything, here's what I see as the relevant points:
(+) Corporate tax rate going from 35% to 20% (in the current version, could change)
(-) Tax reserves will be equal to 76.5% of Stat reserves
(-) Tax DAC = 4% for group and 11% for everything else.

I can't find the source now, but I saw some article that showed the above items were a major revenue raiser for the IRS which implies that the above is a net negative for life insurers in spite of the lowering of the tax rate. Almost seems like they singled-out the life insurance industry to squeeze while all other industries will get a benefit from tax reform.

I personally don't understand at all the logic behind Tax Reserve = 76.5% Stat Reserves. At first I thought maybe there were going to let deficiency reserves be included in the definition and then take the haircut and maybe it would offset, but it turns out that deficiency reserves continue to be excluded.

I also wonder if annuity reserves will be subject to the 76.5% definition. I can see an IRS argument that says Life Stat reserves are redundant so that tax basis is going to be different, but taking a 23.5% haircut off of fixed annuity reserves just seems weird to me.

I know, I know. I shouldn't be trying to apply logic to this sort of thing.
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Old 11-10-2017, 11:22 AM
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Quote:
Originally Posted by elleminopee View Post
I can't find the source now, but I saw some article that showed the above items were a major revenue raiser for the IRS which implies that the above is a net negative for life insurers in spite of the lowering of the tax rate.
OK. So Mary Pat already linked and quoted this above. My oversight.
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Old 11-10-2017, 12:03 PM
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Well, things are moving.

Looks like some changes in the House bill, too:
https://www.bloomberg.com/news/artic...triation-rates

Quote:
Life Insurance

The amendment imposes an 8 percent surtax on life insurance company taxable income, which replaces parts of the original bill that had targeted deferred acquisition costs and reserves for companies in that sector.

The 8 percent surtax is listed as a placeholder. Still, the move is a “notable potential negative” for life insurers and could create substantial pushback from the industry, according to KBW Inc. analyst Ryan Krueger.

The JCT’s score for the surtax, and related provisions, found no 10-year effect.
??
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Old 11-10-2017, 12:51 PM
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I believe the life industry ^*^* enough that they realized the mistake and "fixed" it.

The way I read it....

Tax rate drop to 20%.

Proxy DAC goes away, tax reserves are the same as today

the 8% "surcharge" is basically just saying the tax rate is 28% vs 20%

I could be misreading this.. but this is a much better outcome.

Proxy DAC tax is not a "tax" it's an interest free loan to the treasury that you simply get back over time.

Tax reserves being different than stat reserves is not a "tax" either. It's just fronting tax, that you get the extra tax back over time as well. (again an interest free loan)
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Old 11-10-2017, 01:47 PM
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I like how this bit is put:
http://www.thinkadvisor.com/2017/11/...paign=11102017

Quote:
Life Insurance Tax Changes

Life insurance groups have kept quiet about the original version of H.R. 1, but they appear to have strong concerns about sections such as Section 3703.

The original version of the bill could have included 23.5% of changes in life insurance company reserves in taxable income computations.

Analysts at the Joint Committee on Taxation estimated the change could raise $14.9 billion over 10 years, or, in effect, pull about $1.5 billion from life insurers per year over 10 years.

Analysts at KPMG noted that the provision could have changed reserving rules in a way that would have left an annuity issuer with too little cash to pay cash surrenders to contract holders who give up their contracts.

The new amendment replaces the reserve taxation change with an 8% tax on life insurance company taxable income.

Life insurers may have some concerns about a new 8% tax on their income.
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