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 Selected International Tax Reforms Other Implications of Federal Tax Reform State Taxes RBC and Financial Accounting 2
Tax Reform at Lightning Speed Nov. 2 Initial House Bill Nov. 9 Initial Senate Bill Nov. 16 House Bill Passed Dec. 2 Senate Bill Passed Dec. 20 Compromise Bill Passed Dec. 22 Signed by President Jan. 1 Most Provisions Effective 1 3
… vs. the 1986 Tax Reform Timeline President Reagan Treasury Dept. 36 days of Senate 30 days of Ways and Administration called for reform in submitted Finance Committee Means Committee submitted State of the Union hearings began comprehensive study hearings began proposal to address on reform Congress 1984 1985 Jan. 25 Nov. 27 Feb. 27 May 9 May 29 Senate Ways and Means approved Senate Finance conference Committee House passed Conference Committee approved bill report filed report bill by voice President Reagan approved bill House vote signed bill Senate passed approved Ways and Means Senate Finance amended bill, conference (Public Law 99-514) Committee Committee 97-3 report markup began markup began 1985 1986 Sept. 18 Dec. 3 Dec. 17 June 24 Aug. 16 Sept. 25 Sept. 26 Oct. 22 March 19 May 6 4
What’s in a name? 5
Overview of Key Reforms Permanently reduced 35% corporate tax rate to flat 21% Repealed the corporate alternative minimum tax (AMT) Temporarily allows 100% expensing for certain capital assets Fundamentally changed taxation of multinational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 6
Overview of Key Reforms (cont.) Temporarily reduced individual income tax rates, widened tax brackets, and increased and indexed the standard deduction while repealing personal exemptions and limiting certain itemized deductions Temporarily doubled the estate and gift tax exclusion 7
General Corporate Reforms Corporate tax rate lowered to 21% Conforming changes: 70% dividends received deduction (DRD) reduced to 50% and 80% DRD reduced to 65% Corporate AMT repealed Unutilized credits refundable from 2018-2020 at 50% / year Any leftovers in 2021 are refundable that year Sequestration issue: Refundable credits are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 8
General Corporate Reforms (cont.) 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 Net interest expense deductions Capped at 30% of adjusted taxable income (with special rules) 9
General Corporate Reforms (cont.) 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 limited Restrictions on fringe benefits Limits on deducting fines, penalties, certain settlements 10
Life Insurance Reserves: Prior Law 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 11
Life Insurance Reserves: New Rules 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 12
Life Insurance Reserves: New Rules (cont.) 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 13
Life Insurance Reserves: New Rules (cont.) Effective date and transition rule: New rules apply to tax years starting after 12/31/17 Deduct or include differences ratably over 8 years 14
Life Insurance Reserves: New Rules (cont.) 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” 15
Proration: Prior Law 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 16
Proration: New Rules Company’s share of dividends received is set at 70% Policyholders’ share of tax-exempt interest and the increase in the cash values of company-owned life insurance and annuity contracts is set at 30% Replaces formulaic approach based on older regulations that caused controversy between the industry and IRS Similar to P&C company tax rules 17
Proration: New Rules (cont.) Base for computing a life insurers’ general account and separate account DRD also was impacted by a conforming change to the general corporate DRD 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 is a 50% general DRD The proration percentage of 70% is multiplied by the general DRD percentage of 50% 18
DAC Tax: Prior Law 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 19
DAC Tax: New Rules 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 20
DAC Tax: New Rules (cont.) New rules apply to net premiums received after 12/31/17 Existing DAC balances continue on their current amortization schedules; not re-amortized 21
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