ACLI Suggests Changes to Proposed Regs for Determining Life Insurance Reserves

June 1, 2020

CC:PA:LPD:PR (REG-132529-17)
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044

Re: REG-132529-17 Proposed Regulations on Computation and Reporting of Reserves for Life Insurance Companies

Dear Sir or Madam:

On April 2, 2020, the Internal Revenue Service (“IRS”) and Treasury Department published proposed regulations (REG-132529-17) in the Federal Register to provide guidance on the computation of life insurance reserves and the change in basis of computing certain reserves of insurance companies. These proposed regulations implement recent legislative changes to the Internal Revenue Code by the Tax Cuts and Jobs Act (the “TCJA”)¹ and generally would be effective for taxable years beginning on or after the date final regulations are published in the Federal Register. The preamble to the proposed regulations invites comments on all aspects of the proposed rules and the other proposed actions described in the notice of proposed rulemaking. On behalf of its member companies, the American Council of Life Insurers (“ACLI”)² is pleased to submit our comments on the following matters that are covered in the proposed regulations:

A. Computation of Life Insurance Reserves — Proposed Regulation § 1.807-1

Section 1.807-1 of the proposed regulations provides guidance on the computation of deductible life insurance reserves under section 807(d). Under section 807(d)(1) and (2), the starting point for computing life insurance reserves is the reserve determined using the "tax reserve method." The reserve so determined generally is multiplied by 92.81 percent to determine the tax-deductible life insurance reserve.³ Section 807(d)(3) defines the tax reserve method as either the CRVM for contracts covered by the CRVM, the CARVM for contracts covered by the CARVM,⁴ or the NAIC-prescribed reserve method for noncancellable accident and health contracts.⁵ As under the law before the TCJA, this means that no deduction is allowed for asset adequacy reserves (“AAR”). See H.R. Rep. No. 115-466, at 477 (2017) (“Conference Report”); Staff of the Joint Committee on Taxation, 115th Cong., General Explanation of Public Law 115-97, 235 (Comm. Print 2018) (“Blue Book”).

The first sentence of the proposed regulation provides that the life insurance reserve determined under section 807(d)(1) does not include any AAR. The second sentence provides that an AAR includes any reserve that is established as an additional reserve based on an analysis of the adequacy of reserves that would otherwise be established or any reserve that is not held with respect to a particular contract. The third sentence states that the label placed on a reserve is not determinative, provided, however, that any reserve or portion thereof that would have been established pursuant to an asset adequacy analysis required by the NAIC's Valuation Manual 30 ("VM-30") as it existed on December 22, 2017 (the date of enactment of the TCJA) is an AAR.

An important purpose of the TCJA amendments to section 807 was to accommodate the NAIC-prescribed principle-based reserve (“PBR”) methodology and to provide for less complex computation of the tax reserve amount [Blue Book at 235.] The Blue Book describes the provision as follows:

“Consistent with the purpose of the provision to accommodate the NAIC-prescribed principle-based reserve methodology and to provide for a tax reserve amount that is simpler, more transparent, and easier to compute than under prior law, the provision provides for a percentage reduction to address the inconsistency of insurance regulatory accounting with accurate measurement of income for Federal income tax purposes. Under NAIC-prescribed principle-based reserve methodology in effect at the time of the enactment of the provision, principle-based reserves for any contract do not include any asset adequacy reserve component. Therefore, no asset adequacy reserve-related reduction to the NAIC-prescribed PBR reserves as then in effect is necessary or required before applying the percentage reduction in computing tax reserves.” [Id.]

However, the proposed regulation does not explicitly exclude from AAR the reserves computed under CRVM, CARVM, or other NAIC-prescribed technical actuarial requirements on which the applicable section 807(d)(3) tax reserve method is based, nor does it clearly limit the scope of items includible in AAR. For these reasons, we are concerned that, as drafted, the proposed regulation could frustrate the purpose of the TCJA amendment to section 807(d) and generate unnecessary controversy in examination. Accordingly:

• Rather than merely identifying items that are included in AAR, the proposed regulation also should provide explicitly that reserves determined using the tax reserve method as defined in section 807(d)(3) are tax-deductible life insurance reserves and are excluded from AAR. In particular, the proposed regulation should provide that no portion of the CRVM or CARVM reserve under PBR includes an asset adequacy component. This clearly was Congress' intent when it enacted the TCJA.

• The second sentence of Prop. § 1.807-1(a) should remove the assertion that "any reserve that is not held with respect to a particular contract" is an AAR. The fact that a reserve is not allocated to a specific contract does not make it a nondeductible AAR. For example, IBNR reserves for future unaccrued claims under individual disability contracts, or long-term care contracts,⁶ are deductible and are not AAR solely because they are not associated with specific contracts.

Appendix A to this letter provides suggested changes to the proposed regulations. To set the context for these suggestions, it would be helpful to review the nontax concept of asset adequacy. Asset adequacy analysis and AAR are actuarial concepts. As further described below, an AAR is the additional reserve established under Section 2.C.2. of VM-30 as a result of asset adequacy analysis.

Section 3.B of the Standard Valuation Law (“SVL”) requires an actuarial opinion of reserves. Section 3.B.2 of the SVL requires that the actuarial opinion include an opinion as to whether the reserves and the related actuarial items held in support of the policies and contracts specified in the VM, when considered in light of the assets held by the company with respect to the reserves and related actuarial items, make adequate provision for the company's obligations under the policies and contracts, including but not limited to the benefits under and expenses associated with the policies and contracts.

The provisions of VM-30 contain the requirements for the actuarial opinion of reserves and for supporting actuarial memoranda in accordance with Section 3 of the SVL (collectively referred to as Actuarial Opinion and Memorandum (“AOM”) requirements).⁷ The actuarial opinion is the opinion regarding the adequacy of reserves and related actuarial items pursuant to these AOM requirements.

Section 2.B. of VM-30 provides the standards for asset adequacy analysis. Section 2.C.1. provides that the actuarial opinion applies to all in-force business on the annual statement date, whether directly issued or assumed, regardless of when or where issued. Pursuant to Section 2.C.2., if it is determined as a result of the asset adequacy analysis that a reserve should be held in addition to the aggregate reserve held by the company and calculated in accordance with the requirements set forth in the VM, the company shall establish the additional reserve. Any additional reserve established under section 2.C.2. is an AAR and must be shown as such in the table required by Section 3.A.5. of VM-30.

Thus, the distinguishing factor of an AAR is that it is a reserve in addition to the reserve otherwise established by the company at the reserve valuation date calculated in accordance with the requirements set forth in the VM, such as the CRVM for contracts covered by the CRVM and the CARVM for contracts covered by the CARVM.

The suggested language in Appendix A would make the following changes to the proposed regulation:

• Lead with a new § 1.807-1(a) that briefly lays out how life insurance reserves are determined under section 807(d) as a general matter, before prescribing a rule for AAR. The regulation will provide clearer guidance if it first addresses how life insurance reserves are determined before stating that such reserves exclude AAR.

• Retain as § 1.807-1(b) the substance of the proposed regulation with three changes:

  • Replace "includes" with "is," for clarity since we recommend the regulation address what is excluded from AAR rather than merely what is included

  • Eliminate the reference to "a particular contract" for the reasons explained above

  • Explain that an AAR is "in addition to," other reserves required by the VM, such as CRVM and CARVM reserves

• Provide an example to illustrate that CRVM reserves do not include an AAR component even if they are determined using a principle-based method (as Congress clearly intended), and that additional reserves determined under VM-30 are included in AAR.

We believe that these changes will lead to more consistent application of the regulation and reduce or eliminate unnecessary and unwarranted controversy.

Separately, ACLI agrees that the substantive rules in current § 1.807-1 do not apply for post-2017 taxable years and therefore are properly excluded from Prop. § 1.807-1.

B. Reporting of Reserves — Proposed Regulation § 1.807-3

The TCJA added section 807(e)(6) to provide that the IRS shall require reporting with respect to the opening balance and the closing balance of reserves and with respect to the method of computing reserves for purposes of determining income. To implement this provision, Prop. § 1.807-3 provides that the IRS may require such reporting with respect to section 807(c) reserves. The proposed regulation further states that such reporting may provide for the manner in which separate account items are reported. The reference to separate account reporting is consistent with the explanation of the provision in the legislative history. See Conference Report at 478; see also Blue Book at 236.

The preamble to the proposed regulations explains that “[p]roviding this information is necessary to allow the IRS to better examine an insurance company's Federal income tax return.” The preamble further indicates that the burden for the collection of information associated with Prop. § 1.807-3 will be reflected in the burden on the Form 1120-L when the burden is revised to reflect collection of that information.

ACLI believes that the reserve reporting required by section 807(e)(6) and Prop. § 1.807-3 should properly balance the reporting burden on life insurance companies with the utility of the information provided to the Government. The proposed regulation itself does not describe the potential scope of the reporting requirements. It also is unclear whether the requirements will be implemented through Forms and Instructions or through additional proposed regulations that will be subject to regular notice and comment procedures. In either case, ACLI requests that the IRS and Treasury consult with taxpayers before putting further reserve reporting requirements into effect.

It is impossible to judge whether the information to be required would "allow the IRS to better examine an insurance company's Federal income tax return" without knowing what the reserve reporting requirements will actually entail. In IRS examinations of life insurance company tax returns, one of the earliest Information Document Requests generally asks for very detailed, product-by-product tax reserve information that far exceeds the information that could be reported on the tax return itself or in its supporting schedules. Additionally, it is impossible to know how the burden of reserve reporting would be estimated without knowledge of the actual reporting requirements or how that information would be gathered by each company.

Nevertheless, ACLI has given substantial consideration to the manner in which the reporting requirements of the proposed regulation could be addressed. Appendix B of this letter presents detailed further thoughts and discussion on how (1) information regarding opening and closing reserve balances and (2) separate account operations, might be reported on Form 1120-L.

C. Change in Basis of Computing Reserves — Proposed Regulation § 1.807-4

The TCJA amended section 807(f) to eliminate the 10-year spread for adjustments resulting from a change in basis for computing reserves. As amended, section 807(f) provides that, for contracts issued before the year of change, the difference between the amount of the reserves computed on the new basis, and the amount computed on the old basis, at the close of the year of change is "taken into account under section 481 as an adjustment attributable to a change in method of accounting initiated by the taxpayer and made with the consent of the Secretary." Prop. § 1.807-4 would apply to such changes in basis of computing reserves.

Under prior law, the interests of taxpayers and the IRS were often at odds as to whether a change in reserves constituted a change in basis under section 807(f). Because section 807(f) provided a 10-year spread for either a positive or negative adjustment resulting from a change in basis, whereas a correction of an error would be recognized in one year, the incentives of each of the parties to apply section 807(f) could vary. In that environment, the IRS issued administrative guidance over a period of five decades on what constituted a change in basis.⁸

The TCJA amendments more closely align the interests of both taxpayers and the IRS to treat a change in reserves as a change in basis to which administrative procedures would apply. For taxpayers, the availability of audit protection and a 4-year spread of positive section 481 adjustments are an incentive to treat a change as a change in basis. Likewise, for the IRS, the enhanced notification and reporting of reserve basis changes and incentives for taxpayers to correct erroneous reserve methods are beneficial.

With this background, ACLI's comments on Prop. § 1.807-4 incorporate the following broad precepts:

• ACLI acknowledges the application of IRS administrative procedures to a section 807(f) change in basis of computing reserves, including the filing of Form 3115 in a manner consistent with automatic accounting method change procedures that apply to other taxpayers.

• The TCJA's amendments to section 807(f), however, do not affect the application of section 811(a) to life insurance accounting methods generally, including with respect to reserve methods of accounting. Congress has established, through sections 811(a) and section 807(d), how tax reserves are determined to clearly reflect life insurance company taxable income.

• The TCJA's amendments to section 807(f) changed the manner in which an adjustment attributable to a change in basis in reserves is taken into account but did not change the standard for what constitutes a change in basis. In light of (1) the continued need for clear guidance on what constitutes a change in basis, and (2) the proposed obsolescence of existing guidance on changes in basis dating back to 1965:

  • Examples 1 and 2 of the proposed regulations should be clarified.

  • Further detailed guidance as to what constitutes a change in basis is needed based on the current definition of tax reserve methods and current NAIC reserving methodologies, including PBR.

  • The additional examples should incorporate principles from the obsoleted rulings that continue to apply under current law.

The Proposed Regulation — § 1.807-4

(a) Requirement to follow administrative procedures. The proposed regulation provides that a change in basis of computing a section 807(c) reserve is a change in method of accounting under § 1.446-1(e), except as otherwise provided in that regulation. It then states that a life insurance company must obtain IRS consent, pursuant to prescribed administrative procedures, to use the new method. A company taxed as a nonlife insurance company that changes its basis of computing life insurance reserves similarly must obtain consent for the change.

ACLI believes that Prop. § 1.807-4(a) would provide clearer guidance if it states at the outset that section 807(f) treats a change in basis of computing reserves as a change in method of accounting, thereby establishing why the regulation provides that § 1.446-1(e) applies. Rev. Rul. 94-74 made clear that the standard for determining whether a change is a change in basis is the same as that for determining whether a change is a change in method of accounting.⁹ In view of the proposed obsolescence of Rev. Rul. 94-74, this principle should be retained by inclusion in the regulation. This clarification also would conform the regulation to the TCJA amendments to section 807(f), which now explicitly incorporates the words “change in method of accounting.”

ACLI requests this clarification because neither the TCJA's statutory changes to section 807(f), nor its legislative history,¹⁰ makes explicit reference to section 446. On the other hand, before the TCJA, it was clear that changes in basis under section 807(f) and its 1959 Act predecessor, section 810(d), were not subject to section 446(e).¹¹ To promote consistent treatment and to reduce controversy, the preamble to the final regulations should note that the TCJA amendments to section 807(f) led to the requirement in § 1.807-4(a) that changes in basis follow the same administrative procedures as other changes in accounting method, and that, as a result, the existing guidance in § 1.806-4 and Rev. Rul. 94-74 that changes in basis under section 807(f) are not changes requiring consent under section 446(e) is being removed.¹²

The preamble to the proposed regulations also states that “[s]ection 811(a) does not affect the application of section 446(e), which generally requires a taxpayer to secure the consent of the Secretary before changing the method of computing the taxpayer's taxable income. See also § 1.446-1(e).”¹³ Under section 811(a), computations of the tax imposed on life insurance company taxable income are made using an accrual method of accounting and, to the extent not inconsistent with accrual accounting or Part I of subchapter L, in the manner required for the annual statement approved by the NAIC. Section 811(a) reflects a determination by Congress that NAIC-prescribed accounting methods clearly reflect income for life insurance companies, if not inconsistent with rules otherwise prescribed. As applied to life insurance reserves, this principle means starting with NAIC reserves and modifying them as required by Subchapter L (primarily section 807). The tax reserve method mandated by section 807(d)(2) and defined in section 807(d)(3) requires that NAIC-prescribed methods be used to compute life insurance reserves. If section 807(d) does not provide a specific rule or assumption for the computation, section 811(a) requires that the computation be made in a manner consistent with a company's NAIC annual statement. In other words, Congress has determined — through the provisions of sections 811(a) and 807 — how reserves should be determined to clearly reflect life insurance company taxable income.

In keeping with the above discussion, ACLI requests that the preamble to the final regulations expand on the reference to section 811(a) to acknowledge that application of the consent provisions of section 446(e) and § 1.446-1(e) does not — with respect to the determination of section 807(c) reserves — affect the more specific life insurance company reserve accounting method provisions of sections 811(a) and 807(d), which as more specific provisions trump the general rule of section 446. ACLI believes that such a clarification would promote consistent treatment among taxpayers and reduce the potential for controversy.

(b) Section 481 adjustment.

ACLI has no comments on this paragraph.

(c) Effect on determining increase or decrease in reserves. ACLI has no comments on this paragraph.

(d) Examples. Proposed § 1.807-4 includes four examples to illustrate the principles of paragraphs (a) through (c). ACLI recommends that Examples 1 and 2 be clarified, and that additional substantive examples be included in the regulation or other administrative guidance to explain what is a change in basis in situations that will commonly arise under current NAIC reserving standards.¹⁴

In Example 1, IC discovers in 2021 that it had computed the life insurance reserves for its 2019 and 2020 taxable years by using a mortality table not permitted by the tax reserve method as defined in section 807(d)(3). The proposed regulations state that to comply with section 807(d), IC must use the appropriate mortality table to compute its life insurance reserves for the 2021 taxable year and must obtain IRS consent to change its basis by following the prescribed administrative procedures for accounting method changes. Three clarifications would make this example more useful to taxpayers:

• The example appears to assume that IC used a non-permitted mortality table in computing its NAIC-prescribed statutory reserves in its 2019 and 2020 NAIC Annual Statement, as well as for tax purposes. If this is the case, the example should state this directly. (The example actually seems more suited to prior law when the Code prescribed the mortality tables that were required in determining tax reserves.)

• The example also appears to assume that the error was discovered after the tax return for 2020 had been filed, as an improper accounting method is established for tax purposes only after having been used for two taxable years. If the discovery had been made before the 2020 tax return was filed, IC could have made the correction on the 2020 tax return and amended the 2019 tax return accordingly. Again, the example would be more useful if this fact were made explicit.

• Lastly, the example does not explain why only the 2019 and 2020 taxable years were affected. Did IC only begin issuing contracts subject to this requirement in 2019? Did the mortality table apply only to contracts issued in 2019 and subsequent years? Did IC issue similar contracts before 2019 for which reserves were properly computed so that the change in 2019 was made without the consent of the Commissioner? The reader would better understand the import of the example if these facts were provided.

In Example 2, IC issues variable annuity contracts with guaranteed minimum benefits. In Year 1, the NAIC changes CARVM for such contracts, effective December 31, Year 1 for contracts issued on or prior to that date. To comply with section 807(d), the proposed regulations state that IC must compute its reserves for variable annuities with guaranteed minimum benefits for the Year 1 taxable year using the new computational requirement and that this is a change in basis of computing life insurance reserves for contracts issued prior to Year 1 and a change in method of accounting. Accordingly, IC is required to obtain IRS consent to change its basis of computing reserves by following the prescribed IRS administrative procedures.

This example also could be clarified as it implies that all tax reserves for variable annuity contracts with guaranteed minimum benefits would be determined under the new method of CARVM as of the close of Year 1, whereas that would be the case only for contracts issued in Year 1. Reserves for contracts issued prior to Year 1 would continue to be computed on the old CARVM basis at December 31, Year 1, and would be reflected on the new basis as of January 1, Year 2.

ACLI has no comments on Examples 3 and 4, except to note that like Examples 1 and 2 they provide little substantive guidance on how the standard for what constitutes a change in basis of computing reserves applies to frequently-encountered fact patterns involving life insurance reserves, such as under PBR. ACLI believes that detailed guidance on specific insurance reserving fact situations would benefit both taxpayers and the IRS, and that without such guidance controversy and inconsistent treatment among taxpayers is likely.¹⁵ Specifically, ACLI believes that the additional examples set forth in Appendix C of this letter would provide realistic and helpful guidance to taxpayers and IRS examiners as to what is and what is not a change in basis in situations that are likely to arise under current NAIC-prescribed reserving methods and current tax law. We urge that the situations in these examples be addressed in final regulations:

• Additional Example 1: This example would recognize the TCJA's amendment to section 807(d)(3) and illustrate that a change from incorrectly applying the 92.81% factor set forth in section 807(d)(1)(A)(ii) and (B)(ii) is a change in basis.

• Additional Example 2: This example would illustrate that a computational change in the NAIC Valuation Manual that applies to previously issued contracts is a change in basis.¹⁶

• Additional Example 3: This example would illustrate that a change in an Actuarial Guideline is a change in basis.

• Additional Example 4: This example would illustrate that a change in NAIC-prescribed mortality tables is a change in basis.

• Additional Example 5: This example would illustrate that a change in which reserve dominates (i.e., the net premium reserve, the deterministic reserve, or the stochastic reserve) for statutory reserve purposes pursuant to the terms of part 20 of the VM is not a change in basis.

• Additional Example 6: This example would illustrate that a routine update of company mortality rates in accordance with the NAIC-prescribed method is not a change in basis.

• Additional Example 7: This example would illustrate that no change in basis results from the NSV floor of section 807(d) applying in one year but not another.

• Additional Example 8: This example would provide the same conclusion as Situation 4 of Rev. Rul. 94-74, which the notice of proposed rulemaking indicates will be made obsolete. It would illustrate that correcting the omission of a policy grouping or cell for one year is a correction of an error, not a change in reserve basis. The example remains relevant.¹⁷

• Additional Example 9: This example would draw from Rev. Rul. 69-444, which the proposed rulemaking package intends to make obsolete even though the principle continues to apply under current law.

Effect on Other Documents

The preamble to the proposed regulations states that certain revenue rulings are inconsistent with section 807(f) as amended by the TCJA and, accordingly, proposes those rulings be obsoleted for taxable years beginning on or after the date final regulations are published in the Federal Register. These fourteen revenue rulings are: 2002-6, 94-74, 80-117, 80-116, 78-354, 77-198, 75-308, 74-57, 70-568, 70-192, 69-444, 65-240, 65-233, and 65-143. Also, the notice of proposed rulemaking proposes that Notice 2010-29 be obsoleted for taxable years beginning after December 31, 2017. The notice of proposed rulemaking requests comments regarding whether there are principles contained within these revenue rulings that are consistent with current section 807(f) and for which additional guidance is needed if these rulings are obsoleted.

ACLI agrees that most of this prior guidance, much of which was issued under pre-1984 law, is obsolete. However, ACLI believes three of these revenue rulings contain principles that are consistent with current section 807(f) and for which additional guidance is needed if these rulings are obsoleted:

• The principle set forth in Rev. Rul. 94-74 that the standard for determining whether a change is a change in basis of computing reserves is the same as that for determining whether a change is a change in method of accounting. See above discussion for ACLI's recommendation for inclusion of this principle in paragraph (a) of § 1.807-4.

• Guidance on what does and does not constitute a change in basis set forth in Rev. Rul. 69-444, Rev. Rul. 2002-6, and Situations 3 and 4 of Rev. Rul. 94-74. See discussion above and ACLI's recommendations for Additional Examples in Appendix C.

Procedure for Obtaining Automatic Consent

The preamble to the proposed regulations indicates that Treasury and the IRS intend to make certain revisions to section 26.04 of Rev. Proc. 2019-43, which provides the currently applicable procedures for automatic consent for a section 807(f) change in basis of reserves. Section 26.04 of Rev. Proc. 2019-43 now provides for netting of multiple changes during the same taxable year for “the same type of contract” in determining the section 481(a) adjustment. The preamble to the proposed regulations indicates that section 26.04 will be revised to require netting of the section 481(a) adjustments at the level of each item referred to in section 807(c), so that there is a single section 481(a) adjustment for each of the items referred to in section 807(c). In addition, section 26.04 will be revised to clarify the manner in which nonlife insurance companies implement changes in the basis of computing life insurance reserves.

ACLI recognizes that the rule in the proposed regulations is likely to promote consistency of treatment among taxpayers and to reduce controversy, and therefore concurs with the proposed netting rule.

With respect to the treatment of life insurance reserves held by nonlife insurance companies, ACLI agrees that the treatment should be the same as for life insurance companies.

D. Definition of Life Insurance Reserves — Proposed Regulation § 1.816-1

The TCJA modified section 807(d) to provide that the amount of life insurance reserves is determined with reference to the applicable tax reserve method, and to confirm that, for purposes of section 807(d), life insurance reserves may be determined using PBR methods.¹⁸ The preamble notes, however, that section 807(c)(1) provides that life insurance reserves are defined in section 816(b), and “[s]ection 816(b) (and its predecessor provisions) have been interpreted as describing a net premium reserve that does not take into account expenses or certain other factors.”¹⁹ This cross-reference, the preamble states, could be interpreted to preclude reserves determined under PBR methods from qualifying as life insurance reserves for purposes of section 807.

To clarify, Prop. § 1.816-1(a) provides that a reserve that meets the definition of life insurance reserves in section 816(b)(1) and (2) will not be disqualified as a life insurance reserve solely because the method used to compute the reserve takes other factors into account, provided that the method used to compute the reserve is a tax reserve method as defined in section 807(d)(3) and that the reserve is not an AAR as described in § 1.807-1(a). The preamble indicates that this definition of a life insurance reserve applies whether the reserve is held by a life insurance company or by a nonlife insurance company.

ACLI has no comments on the proposed language of § 1.816-1 itself, but seeks clearer language in the preamble to the final regulations to remove any negative inference as to the use of other permissible factors in computing reserves in periods prior to the effective date of final regulations. Although section 816(b) does not specifically provide for the use of factors other than mortality and interest to compute life insurance reserves, it does not prohibit the use of other factors. In fact, it is well recognized that in some cases factors other than mortality and interest may be taken into account in attempting to make a reserve calculation more exact. See, e.g., Mutual Benefit Life Insurance Company v. Commissioner, 488 F. 2d 1101 (3rd Cir. 1974) (factors concerning benefit elections by beneficiaries), Lincoln National Life Insurance Co. v. United States, 217 Ct. Cl. 515 (1978) (experience factors regarding term conversions), Equitable Life Insurance Co. of Iowa v. Commissioner, 73 T.C. 447 (1979) (lapse rates and election rates applied to settlement options).

Accordingly, ACLI requests that the reference in the preamble to “certain other factors” be eliminated so as to focus the clarification on the question of expense factors being taken into account and to remove any negative inference that no factors other than mortality or interest previously could be taken into account in determining life insurance reserves.

E. Electronic Filing of Annual Statements

Presently, § 1.6012-2(c) requires that an insurance company file with its tax return a copy of its NAIC annual statement, but § 1.6012-2(c)(4) provides that if an insurance company files its Federal income tax return electronically, it should not include its annual statement.²⁰ Instead, the annual statement must at all times be available for inspection by the IRS and retained for so long as such statement may be material in the administration of the tax laws.

The TCJA legislative history contemplates requiring the electronic filing of annual statements to improve reporting of insurance reserves.²¹ Accordingly, the proposed regulations would remove § 1.6012-2(c)(4). The preamble requests comments regarding potential issues that may arise in filing annual statements electronically, e.g., size limits.

ACLI has determined that for some of the largest groups of companies (in terms of assets) with multiple life insurance company members, electronic filing of the annual statements alone would likely exceed the size limits in section 2.1.2 of IRS Publication 4164, Modernized e-File (MeF) Guide to Software Developers and Transmitters, Processing Year 2020. For other groups, the combination of the annual statements and the filed return also may exceed the size limits.

One problem with submitting annual statements electronically is that they may contain hundreds of pages of schedules detailing every stock and bond holding of the life insurance company, including each acquisition and disposition that occurred during the calendar year. Detailed scheduling in the annual statement of derivative transactions also may lead to voluminous reporting. Although such information is obviously important to the determination of taxable income, it does not easily lend itself to electronic submission with the tax return.

For these reasons, ACLI recommends that § 1.6012-2(c) not be amended to require electronic filing of the complete annual statement. Instead, ACLI suggests that either:

• The regulation could continue to provide that the annual statement must at all times be available for inspection by the IRS and retained for so long as such statement may be material in the administration of the tax laws. As a matter of course, copies of annual statements are now provided to IRS examiners at the commencement of an examination, and that practice would continue; or

• The regulation could require electronic filing of a limited number of annual statement pages, with a continued requirement that the full annual statement at all times be available for inspection by the IRS and retained for so long as it may be material in the administration of the tax laws. In this regard, ACLI recommends that pages 1 through Exhibit 8 plus the notes to the financial statements from the annual statement of each life insurance company included in the tax return be electronically filed with the return.²² These pages include the current and prior years' balance sheet and income statement, summary schedules of current year investment income and expenses, capital gains and losses, and general expenses, and product line information regarding premiums and annuity consideration, policy reserves, and other insurance liabilities. The detailed investment and derivative schedules would be excluded but would of course continue to be available in physical form for IRS examiners. If even this reduced electronic filing requirement results in size limit issues, the regulation could require that a statement be attached to the return to that effect and include an acknowledgement that the record retention requirements of the regulation will be satisfied. If attaching the entire annual statement will not cause size limitation issues, the regulation could permit submission of the complete annual statement.

Even if electronic submission of annual statements pages is otherwise required, the IRS's prohibition on electronically filing Form 1120-L unless the parent company of a consolidated return group files Form 1120 means that electronic submission of annual statement data will be required for only a portion of the life insurance industry. Consolidated return groups with a mutual or stock life insurance company parent would be excluded, as would many small mutual and stock life insurance companies that file stand-alone Form 1120-L's.²³ ACLI estimates that this excluded group of companies would comprise more than 20% of life insurance industry general account assets, and approximately 15% of total life insurance industry assets.

F. Proposed Removal or Revision of Regulations with No Future Application

In general

The notice of proposed rulemaking proposes to remove seven elements of the existing regulations under Part I of Subchapter L on the basis that they provide guidance under law that has been repealed or substantially changed and will have no future application. These are §§ 1.801-7, 1.801-8(e), 1.806-4, 1.809-2. 1.810-3, 1.818-2(c), and 1.818-4. In addition, § 1.801-5(c) is proposed to be removed because its requirement that a taxpayer file certain information when it changes the basis of computing life insurance reserves is obviated by the requirement in the proposed regulations that a taxpayer changing the basis of reserves follow IRS administrative procedures and because section 26.04 of Rev. Proc. 2019-43 has its own information filing requirements.

The vast majority of the existing regulations under Part I of Subchapter L were promulgated under the Life Insurance Company Income Tax Act of 1959, which subjected life insurance companies to a complex three-phase system of taxation. The three-phase system was eliminated for post-1983 taxable years by the Deficit Reduction Act of 1984. Where provisions of prior law were incorporated in the 1984 Act, guidance under prior law continued to serve as interpretive guidance under the new law.²⁴ Accordingly, the regulations under Part I of Subchapter L were not amended to remove deadwood nor to renumber them to correspond to the new sections enacted in 1984. TCJA's amendments to Part I of Subchapter L created additional deadwood. Recent initiatives to reduce unnecessary regulatory guidance have resulted in relatively few reductions to these regulations.

The proposed removal of existing regulations makes only minor deletions to the deadwood regulations under Part I of Subchapter L, apparently limited to provisions dealing with reserves, changes in basis of determining reserves, or computation of required interest on reserves. Further, a number of the regulations have been misnumbered for more than 35 years. This continued state of affairs makes it problematic to determine what guidance should be considered deadwood and what guidance has continued application. In fact, it is difficult, at best, to locate the guidance in the first place. ACLI urges that the regulations under Part I of Subchapter L be updated and renumbered to reflect the law that remains in effect subsequent to the amendments made by the 1984 Act, the TCJA, and all other intervening legislation.

ACLI has the following comments and questions with respect to some of the Subchapter L regulations proposed to be removed by notice of proposed rulemaking:

• § 1.801-7

  • Parts of paragraph (a) remain relevant under section 817.

  • It is unclear why this would be "reserved."

• § 1.801-8(e) — This is deadwood, as is paragraph (d).

• § 1.806-4 — All regulations under section 806 are deadwood.

• § 1.809-2 — This is deadwood, as are most of the regulations under section 809.

• § 1.810-3 — This is deadwood, as are parts of § 1.810-2.

• § 1.818-4 — This is deadwood. It is unclear why it would be "reserved."

Reg. § 1.381(c)(22)-1

The proposed regulations would remove § 1.381(c)(22)-1(b)(6) because its requirement no longer applies.

ACLI has no comment with respect to this deletion, other than to note that most of § 1.381(c)(22)-1 is deadwood that also could be removed.

Reg. § 1.817A-1

Section 817A provides special rules for modified guaranteed contracts (“MGCs”). Under prior law, section 817A(e)(2) granted regulatory authority to determine annually the interest rates applicable under sections 807(c)(3), 807(d)(2)(B) and 812 with respect to a MGC, in a manner appropriate for MGCs. That regulatory authority was the basis for § 1.817A-1(b), which addresses the applicable interest rates for non-equity-indexed MGCs.

The TCJA repealed sections 807(d)(2)(B) and 812. Accordingly, the notice of proposed rulemaking would amend § 1.817A-1 to apply only to determinations under section 807(c)(3).²⁵ The TCJA, however, also amended the flush language of section 807(c) to provide that, for purposes of section 807(c)(3), the appropriate rate of interest is the highest rate or rates permitted to be used to discount the obligations by the NAIC as of the date the reserve is determined. Under prior law, the rate was determined at the time the obligation first did not involve life, accident, or health contingencies.

The preamble to the proposed regulations includes a request for comments on whether the current market rate of interest prescribed by § 1.817A-1 should continue to apply to reserves under section 807(c)(3) for an MGC during any temporary guarantee period.

Having considered this request, ACLI recommends that § 1.817A-1 be removed in its entirety.

Reg. § 1.338-11

ACLI has no comments on the proposed amendment to this section of the regulations.

G. Proposed Conforming Changes to Regulations

The proposed regulations also include revisions to §§ 1.801-2, 1.809-5, and 1.848-1 to correct references to Code provisions or regulations that have been changed, removed, or are proposed to be removed by the proposed regulations.

ACLI's comments are as follows:

• Section 1.801-2 apparently applies only to taxable years prior to 1984 — it is unclear why it should not be entirely removed.

• Section 1.809-5(a)(5)(iii) makes a change to a section of the regulations that has been deadwood since the 1984 Act — again, it is unclear why it should not be entirely removed.

Other Requests for Comments

The preamble to the proposed regulations states that the IRS and Treasury received a request to promulgate regulations under section 807 that generally would provide, for purposes of Subchapter L, that the determination of whether a contract issued by a non-US insurance company and reinsured by a US insurance company is a life insurance or annuity contract is made without regard to certain statutory requirements (sections 7702, 101(f), 72(s), 817(h)), provided that (i) no policyholder, insured, annuitant or beneficiary with respect to the contract is a US person and (ii) the contract is regulated as a life insurance or annuity contract by a foreign regulator. The preamble states that Treasury and the IRS are evaluating this request, including whether to address it as part of this regulation project. Comments are requested generally in respect of the requested change, including on potential withholding tax and administrability issues.

ACLI endorses the request that Treasury and the IRS promulgate a regulation under section 807, presented in the May 27, 2020 letter written by EY on behalf of ACLI member companies MetLife, Inc., Pan-American Life Mutual Holding Company, Prudential Financial Inc., and Reinsurance Group of America, Incorporated, which would specifically provide that the phrase "life insurance reserves (as defined in section 816(b))" includes reserves assumed by a domestic insurance company in connection with the reinsurance of a foreign-issued life insurance or annuity contract, without regard to sections 7702 and 72(s).

Lastly, comments are requested on the collection of information required by §§ 1.6012-2 and 1.807-3 of the proposed regulations. ACLI comments on these matters have been included in this letter and in a separate submission to the Office of Management and Budget and the IRS Reports Clearance Officer as per instructions in the notice of proposed rulemaking by letter dated June 1, 2020.

Sincerely,

Regina Y. Rose

Mandana Parsazad

American Council of Life Insurers
Washington, DC

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Appendix A

ACLI Recommended Changes to Prop. § 1.807-1

[Note: Language of Prop. § 1.807-1 included in Notice of Proposed Rulemaking shown in bold]

§ 1.807-1 Computation of life insurance reserves.

(a) In general. — Section 807(d)(2) provides that the amount of the life insurance reserve determined for a contract under section 807(d) is determined using the tax reserve method applicable to the contract which is defined in section 807(d)(3). Under section 807(d)(3), the tax reserve method is the CRVM, the CARVM, or other NAIC-prescribed reserve method that applies to the contract as of the date the reserve is determined. If the NAIC has not prescribed a reserve method that covers the contract, a reserve method that is consistent with the CRVM, the CARVM, or other NAIC-prescribed method as of the date the reserve is determined (whichever is most appropriate) must be used.

(b) No asset adequacy reserve. The life insurance reserve determined under section 807(d)(1) does not include any asset adequacy reserve. An asset adequacy reserve includes is any reserve that is established as an additional reserve based upon an analysis of the adequacy of reserves that would otherwise be established in accordance with the requirements set forth in the NAIC Valuation Manual, such as the CRVM or CARVM as applicable or any reserve that is not held with respect to a particular contract. In determining whether a reserve is a life insurance reserve, the label placed on such reserve is not determinative, provided, however, any reserve or portion of a reserve that would have been established pursuant to an asset adequacy analysis required by the National Association of Insurance Commissioners' Valuation Manual 30 as it existed on December 22, 2017, the date of enactment of Public Law 115-97, is an asset adequacy reserve.

(c) Example. (1) Facts. — At December 31, 20XX, IC is an insurance company that issues only life insurance contracts subject to the requirements of part 20 of the NAIC Valuation Manual (VM-20).

The VM sets forth the reserve standards and related requirements for jurisdictions where the Standard Valuation Law (or legislation including substantially similar terms and provisions) has been enacted.

The VM defines the "Commissioners' Reserve Valuation Method,” and VM-20 sets forth the specific rules for principle-based reserves. More specifically, VM-20 establishes the reserve valuation standard for individual life insurance policies issued on or after the operative date of the VM and subject under the SVL to a principle-based valuation with a Net Premium Reserve (NPR) floor. Under VM-20, if life insurance policies do not pass the Deterministic and Stochastic Reserve exclusion tests as defined, the reserves for the policies equal the sum of the policy Net Premium Reserves ("NPRs") for the policies plus the excess, if any, of the greater of the Deterministic Reserve for those policies and the Stochastic Reserve for those policies over the sum of the policy NPRs for the policies (less any due and deferred premium asset held on account of the policies). Although the Stochastic Reserve and Deterministic Reserve may not be determined on a seriatim basis, the VM requires that the excess be apportioned among the contracts.

VM-30 provides guidance on the Actuarial Opinion and Memorandum Requirements, including the computing and reporting of asset adequacy reserves. In particular, VM-30 provides that if it is determined as the result of asset adequacy analysis that an additional reserve (an asset adequacy reserve) should be held in addition to the aggregate reserve held by the company and calculated in accordance with the requirements otherwise set forth in the Valuation Manual, the company shall establish the additional reserve.

Applying VM-20, IC determined at December 31, 20XX that the contracts did not pass the Deterministic and Stochastic Exclusion Tests of VM-20. Because the Stochastic Reserve with regard to the contracts exceeded both the NPR and the DR, the reserve with regard to the contracts was equal to the SR, and the excess of the SR over the sum of the policy NPRs was apportioned under the terms of VM-20 among the contracts held by the company.

Applying VM-30, IC determined as the result of asset adequacy analysis at December 31, 20XX that a reserve should be held in addition to the reserves held by the company at December 31, 20XX and calculated in accordance with the requirements otherwise set forth in the VM (including the entire VM-20 reserve).

(2) Analysis. —

(i) By its terms, VM-20 constitutes CRVM and thus under section 807(d)(3) is the tax reserve method with regard to the contracts. The VM-20 reserves, including the excess of the Stochastic reserve over the sum of the NPRs, are life insurance reserves under section 807(d)(1) and do not include any asset adequacy component.

(ii) The reserve required by VM-30 established in addition to the company's VM-20 reserves held at December 31, 20XX, and based upon the adequacy of reserves that would otherwise be established, is an asset adequacy reserve and therefore not part of the life insurance reserve determined under section 807(d).

(d) (b) Applicability date. The rules of this section apply to taxable years beginning on or after [DATE FINAL REGULATIONS ARE PUBLISHED IN THE FEDERAL REGISTER].

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Appendix B

Reserve Reporting — Prop. § 1.807-3

Reserve Reporting Generally

Form 1120-L, U.S. Life Insurance Company Income Tax Return, already includes substantial reporting requirements with respect to reserves. Schedule F of Form 1120-L requires information for determining the section 807(a) decrease or section 807(b) increase in reserves for the taxable year. On Schedule F, companies report beginning and end of taxable year balances for each of the six types of reserves specified in section 807(c)(1)-(6), to arrive at the decrease or increase for the taxable year. After further adjustments required by sections 805(a)(4)(F) and 807(a)(2)(B) or 807(b)(1)(B), the net decrease or decrease is carried from line 12 of Schedule F to line 3a or 11a of page 1 of Form 1120-L, as appropriate.

Schedule L, Part II of Form 1120-L also requires reporting of beginning and end of taxable year amounts for insurance liabilities, including reserves. This information is collected for purposes of determining under section 842(b) the minimum effectively connected net investment income of foreign companies carrying on an insurance companies doing business in the US, but is required to be completed by each company that files Form 1120-L. A note to Part II of Schedule L states: “The information provided in Part II shall conform with the 'Assets' and 'Liabilities, Surplus, and Other Funds' sections of the NAIC Annual Statement.” Information must be included both for general accounts and separate accounts (if any).

Lastly, Schedule M of Form 1120-L also requests certain information relating to reserves. See, for example, Questions 9 and 10.

One way to address the reserve reporting requirements of section 807(e)(6) would be to add a new schedule to Form 1120-L (or add to Schedule F or Schedule L) that would reconcile NAIC Annual Statement insurance liabilities reported on Schedule L to deductible tax reserves reported on Schedule F. This reconciliation, which could be done either for end of year or both beginning or end of year reserves could take the following form:

• Begin with total insurance liabilities per line 14 of Schedule L;

• Reduce Schedule L annual statement insurance liabilities by those amounts not corresponding to tax reserves described in section 807(c)(1)-(6) (for example, amounts treated as accrued liabilities or as indebtedness for tax purposes);

• Separate the remaining Schedule L annual statement insurance liabilities into the categories described in section 807(c)(1)-(6);

• For each category of section 807(c)(1)-(6) tax reserves, show a single amount for the adjustments required by sections 807 and 811 between annual statement insurance reserves and tax reserves; and

• Confirm the remaining balance equals section 807(c)(1)-(6) tax reserves per Schedule F.

If Schedule F tax reserves include separate account reserves, this reconciliation could be done separately for general account, separate account, and total reserves.

ACLI believes that, when combined with the requirement of filing the NAIC annual statement with Form 1120-L,²⁶ a reconciliation of this type would satisfy the reserve reporting requirements of section 807(e)(6) with respect to opening and closing balances of reserves and the method of computing reserves for purposes of determining income, without imposing an undue reporting burden on life insurance companies. It would also provide information — such as that necessary to compute tax to statutory reserve ratios for each type of section 807(c)(1)-(6) reserve — that would be useful to the IRS. Of course, more detailed reserve information would continue to be available through Information Document Requests in connection with IRS examinations.

Separate Account Reporting

For companies with separate accounts, there are two reporting issues. First, with regard to reporting of opening and closing balances of reserves, the reconciliation of annual statement to tax reserves described above could be done in three-column format so that general account, separate account, and total reserves are separately shown. Second, with respect to reporting of separate account operations on Form 1120-L, ACLI believes that two alternative approaches may be feasible. For convenience, we refer to these alternatives as a “balance sheet approach” and an “income statement approach.” Before describing these two approaches, it is necessary to describe 1) how separate account operations are reported for NAIC regulatory accounting purposes, and 2) the Federal income tax treatment of variable contracts.

Annual Statement Reporting. The NAIC life insurance company annual statement (often referred to as the “blue blank”) filed with state insurance regulators includes all operations of the company — both in general and separate accounts. However, it is not a true consolidation:

• Premiums and policyholder benefits related to separate accounts generally are reflected in both the blue blank and the separate account annual statement (“green blank”).

• Fees charged to separate accounts and retained by the general account are not eliminated, but are shown separately as income in the blue blank and expense in the green blank.

• Much other activity is “one-lined” through the income statement line Transfers to/from separate account.

As a result, true combined reporting of general and separate accounts on Form 1120-L (the “income statement” approach described below) would require substantial manual adjustments (manual because tax return software packages could not accommodate the adjustments), and the burden required would have to be weighed against utility of the information provided.

Separate accounts are established under state law and are used to fund variable contracts and other contracts where assets are segregated from general account assets (i.e., not subject to general account creditors), including:

• Variable life insurance and annuity contracts (section 817)

• Modified guaranteed contracts (section 817A)

• Non-variable group deposits and other contracts

Most major life insurance companies have dozens of separate accounts. At the end of 2018, separate accounts represented more than 1/3 of life insurance industry assets and roughly 40 percent of life insurance industry reserves.

Each life insurance company files one blue blank and (if applicable) one green blank.²⁷ The blue blank includes all operations of the company, both general account and separate account, but, as noted above, the separate account business is included in summary form, not in a true consolidated statement. The green blank is a supplement to the blue blank and reports only the combined operations of the separate accounts. Activities such as sales, underwriting, and contract administration are reflected in the blue blank.

NAIC Statement of Statutory Accounting Principles (“SSAP”) No. 56 governs the accounting and reporting for separate account activities in both the green blank and the blue blank. The green blank balance sheet includes detail of invested assets (mutual funds and/or directly held securities), investment receivables, etc., and reserves and payables. Assets and liabilities generally reflect fair market value and account value. Separate accounts generally have no surplus, unless seed money from the general account is held in the separate account.

The green blank statement of operations generally reflects no net/income loss (again, unless there is seed money in the separate account), because investment returns are reflected in policyholder account values. The statement of operations reflects transfers from the general account (premiums, deposits, and other considerations), investment income and capital gains/losses (realized and unrealized), transfers to the general account (benefits, policy loans, fees, expense allowances in reserves), and the change in reserves.

With respect to separate account operations, the blue blank includes aggregated amounts from the green blank in summary fashion. For example, total separate account assets and liabilities are each one-lined into the blue blank balance sheet. The balance sheet also includes amounts due to/from the separate accounts (including expense allowances in reserves), fixed subaccount assets and reserves (if the variable contract includes a fixed subaccount option), and reserves for guaranteed minimum benefits (if the variable contract includes such benefits). The blue blank income statement includes insurance activities (sales, underwriting, contract administration, etc.) related to separate account products and reflects premiums from policyholders, premium taxes, commissions, and other expenses, benefits to policyholders, and transfers to/from separate accounts. Footnote 34 of the blue blank includes a reconciliation of transfers to/from separate accounts and certain other separate account disclosures.

Policyholder reserves for separate account products may be split between the blue blank and the green blank. The green blank policyholder reserve often is stated at net surrender value for nonguaranteed variable benefits — including realized and unrealized appreciation/depreciation on separate account assets. Expense allowances recognized in reserves are recorded in the green blank as a liability due to the general account, and the blue blank records an offsetting contra liability. Policyholder reserves related to non-variable guaranteed benefits are recorded in the blue blank. This includes reserves for guaranteed minimum benefits, fixed subaccounts, and incidental (non-variable) insurance benefits (such as waiver of premium, accidental death, guaranteed insurability).

The following summarizes how aggregate green blank items are reported in the blue blank:

• Assets, page 2, line 27 — From separate account

• Liabilities, page 3

  • Line 13 — Transfers to separate account due or accrued (net)

  • Line 27 — From separate account

• Summary of Operations, page 4

  • Line 5 — Separate account net gain

  • Line 8.1 — Income from fees associated with investment management, administration, and contract guarantees from separate account

  • Line 26 — Net transfers to or (from) separate account net of reinsurance

• Capital and Surplus, page 4

  • Line 46 — Surplus (contributed to) withdrawn from separate account during period

  • Line 47 — Other changes in surplus from separate account statement

• Footnote 34, page 19.XX

  • Separate account activity, balances, and reconciliation of transfers to/from separate account

The following summarizes how specific green blank (“GB”) line items correlate with specific blue blank (“BB”) line items:

• Total separate account assets: GB p. 2 line 17 col. 3 = BB p.2 line 27 col.3

• Expense allowance in reserves: GB p. 3 line 10 inset = BB p. 3 line 13 inset

• Total due to/from general account/separate account: GB p. 3 line 10 col. 3 and GB p. 3 line 17 inset both = BB p. 3 line 13 col. 1

• Total separate account liabilities: GB p. 3 line 17 col. 3 = BB p. 3 line 27 col. 1

• Fees to general account from separate account: GB p. 4 line 11 col. 1 = BB p. 4 line 8.1 col. 1

• Separate account seed money unrealized gain: GB p. 4 line 17 inset = BB p. 4 lines 46 + 47 col. 1

• Separate account seed money contributions (withdrawals): GB p. 4 line 20 col. 1 = BB p. 4 line 46 col. 1

• Total separate account assets BB Note 34A2 = GB p. 2 line 27 col 1

• Risk charges from SA to GA: BB Note 34A3a included in BB p. 4 line 8.1 col. 1

• Transfers to separate account: BB Note 34C1 line 1(a) = GB p. 4 line 1.4 col. 1

• Transfers from separate account: BB Note 34C1 line 1(b) = GB p. 4 line 10 col. 1

• Net transfers: BB Note 34C3 = BB p. 4 line 26 col. 1

Tax Treatment of Variable Contracts. Under section 817(c), a life insurance company issuing variable contracts must separately account for income, deductions, assets, reserves, and other items properly attributable to such variable contracts. Section 817(a) provides that the section 807(c) reserves taken into account for variable contracts at the close of the taxable year are adjusted by (1) subtracting amounts added to the reserves during the taxable year for realized and unrealized gains, and (2) adding amounts subtracted from the reserves during the taxable year for realized and unrealized losses. The effect of these adjustments is to exclude current year realized and unrealized capital gains and losses from changes in reserves.

Similarly, section 817(b) provides that the basis of assets in a segregated asset account that relate to variable contracts is increased by any appreciation in value and decreased by any depreciation in value to the extent such appreciation or depreciation is reflected in increases and decreases in reserves. Accordingly, no capital gains or losses are recognized for separate account assets relating to variable contracts.

Balance Sheet Approach to Separate Account Reporting. Additional tax return reporting with respect to reserves held in separate accounts could be addressed through a "balance sheet” approach, which would seem to align with the authorization in section 807(e)(6) for reporting with respect to the opening and closing balances of reserves. With respect to separate account reserves, this reporting could be accomplished, for example, by:

• Expanding Schedule F of Form 1120-L, but separately from the portion of Schedule F that supports the increase/decrease in reserves that is carried to page 1 of Form 1120-L so as not to affect income statement reporting on page 1.

• Expanding the reserve reporting already required on Part II of Schedule L of Form 1120-L, for example, by requiring the statutory to tax reserve reconciliation described above.

• Adding interrogatories on Schedule M of Form 1120-L.

In whatever manner a balance sheet approach to separate account reserve reporting is addressed, consideration would have to be given to certain unique items of separate account reporting, such as:

• The section 817(a)(1) and (2) adjustments for appreciation/depreciation in value of separate account assets and how those adjustments are handled as between closing reserves for one year and opening reserves for the next.

• How to incorporate reserves that are in segregated asset accounts for legal purposes but are not held for variable contracts and therefore not subject to separate accounting under section 817.

Income Statement Approach to Separate Account Reporting. A second, more comprehensive approach would go beyond just the reporting of separate account reserves to require combined reporting of separate account and general account information on page 1, Schedule A, Schedule F, and other parts of Form 1120-L. This approach seems to go beyond section 807(e)(6)'s focus on reporting of opening and closing balances of reserves.

If full combined reporting throughout the Form 1120-L is under consideration, additional issues arise because, as discussed above, the blue blank reflects both general and separate account activity but is not a true consolidation of those activities. Rather, separate account activity is recorded in the blue blank as required by SSAP No. 56. If combined general account/separate account reporting was required for tax purposes, guidance would have to be provided as to whether and to what extent annual statement reporting would need to be modified for tax return reporting purposes. Some of the tax return reporting issues that would need to be addressed with respect to combined reporting of general and separate accounts include the following:

• Combined reporting would mean that Schedule F would have to include separate account reserves in a manner that supports the increase/decrease in reserves reported on page 1 of Form 1120-L. However, if separate account reserve increases are included on page 1 (which is a departure from how green blank results flow into the blue blank), then other corresponding modifications of annual statement reporting of separate account income and deduction items would also be required to avoid duplication or omission of items.

• Schedule A would have to accommodate both general account and separate account dividends received deductions. This was problematic under pre-TCJA law because of the different company share computations for the general account and separate accounts (and different company share percentages for each separate account). The TCJA's enactment of a 70% company share for both the general account and the separate account may fix this problem.

• Schedule G would have to be completed in a manner that does not double count premiums. Premiums for variable contracts are reported as premium income in both the blue blank and the green blank. Transfers of premiums and benefits between the general account and the separate account are handled through Transfers to/from separate account.

• If line-by-line combination of general account and separate accounts is required on page 1 of the Form 1120-L:

  • Would companies have to eliminate Transfers to/from Separate Account in making this combination?

  • What supporting schedules filed with the tax return might be necessary to effect the combination?

It is evident that numerous issues need to be addressed under either a balance sheet or an income statement approach to reporting for separate accounts, though the latter approach would be much more complex. As noted earlier, a proper balance should be struck between the burden of reporting on taxpayers and its utility to the Government, which can only be achieved through consultation with the life insurance industry.

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Appendix C

Additional Examples for Prop. § 1.807-4(d)

Facts applicable to all of the additional examples:

IC, a life insurance company within the meaning of section 816(a), issues life insurance and annuity contracts directly and also reinsures the risks on such contracts issued by other companies. IC is required to determine life insurance reserves under section 807(d) with respect to both directly written and reinsured contracts, and to take net increases or decreases in the reserves into account in computing life insurance company taxable income. IC computes the amount of the life insurance reserve for a contract in accordance with the net surrender value (NSV) floor of section 807(d)(1)(A) and (B) and the statutory cap of section 807(d)(1)(C). IC is not under examination, and in all situations that involve a change in basis of determining reserves to which section 807(f) applies, IC follows appropriate procedures for implementing changes in basis for computing reserves.

Additional Example 1

Facts: Beginning in 2019, IC issues variable annuity contracts within the meaning of section 817(d). On its Federal income tax returns for the years ended December 31, 2019 and December 31, 2020, IC correctly computed the amount of the reserve with regard to those contracts under the Commissioners' Annuities Reserve Valuation Method (CARVM), but incorrectly applied the 92.81% factor of section 807(d)(1)(B) to that entire amount, rather than only to the excess of that amount over the greater of the contract's NSV or the portion separately accounted for under section 817. For the year ended December 31, 2021, IC intends to apply the 92.81% factor specified in section 807(d)(1)(B) correctly.

Analysis: In this example, IC applied the 92.81% factor of section 807(d) incorrectly on two consecutively filed Federal income tax returns — 2019 and 2020. It therefore had adopted an incorrect basis for computing reserves under the analysis of Rev. Rul. 90-38 and Rev. Proc. 2015-13, section 2.01(2). Applying the 92.81% factor to the correct portion of the reserve determined under section 807(d)(2) for 2020 is a change in basis under section 807(f). IC must account for the difference between the tax reserve computed on the new basis as of December 31, 2021, and the tax reserve computed on the old basis as of December 31, 2021, attributable to contracts issued before 2021, as adjustments under section 481 attributable to a change in method of accounting initiated by IC and made with the consent of the Secretary.

Additional Example 2

[Note: This example is similar to Example 2 in the Proposed Regulations]

Facts: The National Association of Insurance Commissioners (NAIC) makes a change to the NAIC Valuation Manual that imposes a new computational requirement on issuers of variable annuities with guaranteed minimum benefits (VM-21 within the NAIC Valuation Manual). The requirement applies to the determination of statutory reserves as of December 31, 202y, with regard to contracts issued after December 31, 202x. IC's statutory reserves for these contracts as of December 31, 202y will be lower than they would have been had the change not been made.

Analysis: In this example, a change to VM-21 imposes a new computational requirement on issuers of variable annuities with guaranteed minimum benefits. The requirement applies to the determination of reserves as of December 31, 202y, with regard to contracts issued after December 31, 202x. Because for tax purposes section 807(d)(3)(B)(ii) requires the use of the CARVM "which is applicable to the contract and in effect as of the date the reserve is determined," the change to VM-21 is required to be taken into account for purposes of applying section 807(d). The new requirement represents a change in the methodology for satisfying the CARVM as prescribed by the NAIC. The change is therefore a change in basis under section 807(f). IC must account for the difference between the tax reserve computed on the new basis as of December 31, 202y, and the tax reserve computed on the old basis as of December 31, 202y, attributable to contracts issued after 202x and before 202y, as adjustments under section 481 attributable to a change in method of accounting initiated by IC and made with the consent of the Secretary.

Additional Example 3

Facts: The NAIC issues a new Actuarial Guideline (AG) that imposes a new computational requirement for the Commissioners' Reserve Valuation Method (CRVM) for universal life contracts issued before the effective date of the NAIC Valuation Manual. The requirement applies to the determination of statutory reserves for these contracts as of December 31, 202y. IC's statutory reserves for these contracts as of December 31, 202y will be lower than they would have been had the NAIC not issued the new AG.

Analysis: In this example, a newly-issued AG imposes a new computational requirement for CRVM on issuers of universal life contracts. The requirement applies to the determination of reserves as of December 31, 202y, with regard to contracts issued before the effective date of the NAIC Valuation Manual. Because for tax purposes section 807(d)(3)(B)(ii) requires the use of the CRVM "which is applicable to the contract and in effect as of the date the reserve is determined," the new AG is required to be taken into account for purposes of applying section 807(d). The new requirement represents a change in the methodology for satisfying the CRVM prescribed by the NAIC. The change is therefore a change in basis under section 807(f). Because all of the affected contracts were issued before the effective date of the Valuation Manual, IC must account for the difference between the tax reserve computed on the new basis as of December 31, 202y, and the tax reserve computed on the old basis as of December 31, 202y as adjustments under section 481 attributable to a change in method of accounting initiated by IC and made with the consent of the Secretary.

Additional Example 4

Facts: IC computes its reserves for a group of life insurance contracts under VM-20 of the Valuation Manual. The group of policies passes both the stochastic exclusion test and the deterministic exclusion test of VM-20, and the company elects to exclude the group from both the stochastic reserve calculation and the deterministic reserve calculation. Accordingly, the statutory reserve for the group is equal to the sum of the policy Net Premium Reserves (NPRs).

VM-20 prescribes the mortality standard to be used to compute the NPRs for the contracts. The NAIC changes the Valuation Manual to require the use of the 202y CSO mortality tables to compute the NPRs for all contracts subject to VM-20. The requirement applies to the determination of statutory reserves for these contracts as of December 31, 202z. IC's statutory reserves for the group of contracts will be lower than they would have been had the NAIC not changed the Valuation Manual to prescribe the use of the 202y CSO mortality tables.

Analysis: In this example, a group of contracts that is subject to VM-20 passes both the stochastic and deterministic exclusion tests of VM-20, and IC elects to exclude the group from both the stochastic and deterministic reserve calculations. As a result, the statutory reserve with regard to each contract is equal to the policy NPR, and the tax reserve is the greater of 92.81% of this amount or the contract's NSV. The NAIC changes the Valuation Manual to require the use of the 202y CSO mortality tables to compute the NPRs for all contracts subject to VM-20, effective for the determination of statutory reserves (and, as a result, tax reserves) as of December 31, 202z. IC's statutory reserves for the group of contracts will be lower than they would have been had there not been a change in tables. The new requirement represents a change in the methodology for satisfying the CRVM prescribed by the NAIC. The change is therefore a change in basis under section 807(f). IC must account for the difference between the tax reserve computed on the new basis as of December 31, 202z, and the tax reserve computed on the old basis as of December 31, 202z, as adjustments under section 481 attributable to a change in method of accounting initiated by IC and made with the consent of the Secretary.

Additional Example 5

Facts: IC computes its reserves for certain life insurance contracts under VM-20 of the NAIC Valuation Manual. Under VM-20, the minimum statutory reserve for the contracts is equal to the sum of the policy minimum Net Premium Reserves (NPRs) for the contracts, plus the excess, if any, of the greater of the Deterministic Reserve (DR) for the contracts and the Stochastic Reserve (SR) for the contracts. For the taxable year ended December 31, 2019, the DR exceeded both the SR and the sum of the policy NPRs for the contracts, and thus was the statutory reserve reported on the NAIC annual statement. The excess of the DR over the sum of the policy NPRs was allocated to individual contracts in the manner prescribed by VM-20. Its statutory reserves at December 31, 2020, were equal to the sum of the policy NPRs for the contracts, because this amount exceeded the DR as of that date.

Analysis: In this example, the comparison of the sum of the policy NPRs to the SR and DR is required under VM-20, which is the CRVM and the tax reserve method required to be used under section 807(d)(3). As a result, a change from using the DR to using the sum of the policy NPRs is not a change in basis but rather a function of the year-over-year change in those amounts. No section 807(f) adjustment results from the annual comparison. In Situation 5, there was no DR in 2019. The result would be the same if there had been a statutory DR in both 2019 and 2020 and under the terms of VM-20 some contracts were not allocated any DR in 2019, but were allocated a portion of the DR in 2020.

Additional Example 6

Facts: IC computes its reserves for certain life insurance contracts under VM-20 of the NAIC Valuation Manual. Under VM-20, the minimum statutory reserve for the contracts is equal to the sum of the policy minimum NPRs for the contracts, plus the excess, if any, of the greater of the DR for the contracts and the SR for the contracts. For the taxable years ended December 31, 2023, and December 31, 2024, the DR exceeded both the SR and the sum of the policy NPRs for the contracts, and thus was the statutory reserve reported on the NAIC annual statement. Pursuant to the requirements of VM-20, this excess was allocated to individual contracts. For purposes of computing the DR, section 9.c.2 of VM-20 requires that company experience mortality rates be determined for each mortality segment, and that the company experience data used to determine those rates be updated at least every three years. In accordance with that requirement, the mortality rates used for certain segments to compute the DR as of December 31, 2024 differed from those used for purposes of computing the DR as of December 31, 2023, because of the VM-20 mandated update.

Analysis: In this example, the statutory reserve was equal to the DR, and the mortality rates that IC used for purposes of computing the DR as of December 31, 2024 differed from those used for purposes of computing the DR as of December 31, 2023. The rates were different, however, by reason of a requirement of VM-20 itself that the company experience rates be determined for each mortality segment, and that experience data used to determine those rates be updated at least every three years. The update in mortality rates, therefore, was by operation of the reserve methodology of VM-20 itself, which IC used consistently in both 2023 and 2024. The change therefore was not a change in basis in computing reserves. No section 807(f) adjustment results from the annual comparison.

Additional Example 7

Facts: On its Federal income tax return for the taxable year ended December 31, 2018, IC reported tax reserves for certain fixed annuity contracts equal to 92.81% of the CARVM reserves for the contracts, because that amount for each contract exceeded the net surrender value for each contract. For the taxable year ended December 31, 2019, IC instead reported tax reserves equal to the net surrender value of those same contracts because that amount for each contract was greater than 92.81% of the CARVM reserve for each contract.

Analysis: In this example, IC reported tax reserves as of December 31, 2018 equal to 92.81% of the CARVM reserve determined under section 807(d)(2) for certain of its fixed annuity contracts, because that amount for each contract exceeded the net surrender value for each of those contracts. It reported tax reserves as of December 31, 2019, equal to the net surrender value of the contracts, because this amount for each contract exceeded 92.81% of the reserve determined under section 807(d)(2) for each contract. Just as in Situation 5, where the reserve methodology entailed a comparison of the DR and the sum of the policy NPRs, here the reserve methodology entails a comparison of two amounts, in this case prescribed by section 807(d) itself. The fact that year-over-year changes in these amounts results in different calculated amounts being taken into account does not change the principle that the comparison is inherent in the reserve methodology itself, and applying that methodology consistently cannot be a change in basis for computing reserves. No section 807(f) adjustment results from the annual comparison.

Additional Example 8

[Note: This example — taken from Rev. Rul. 94-74 which the proposed regulations would obsolete — continues to apply under current law]

Facts: For purposes of computing its life insurance reserves under section 807(d), IC organizes its life insurance contracts into policy groupings or cells, each consisting of policies which are identical as to plan of insurance, year of issue or contract duration, age of issue, and other factors. In 2020, after filing its return for the 2019 taxable year, IC discovered that due to a computer programming error, certain policy cells issued during 2019 had been omitted from the computation of IC's closing 2019 tax reserves. Had the omitted policy cells been included in IC's closing 2019 reserves, IC's life insurance reserves under section 807(d) at December 31, 2019, would have been greater than the amounts originally claimed.

Analysis: In this example, the understatement of IC's reserves at December 31, 2019, caused by the omission of certain policy groupings issued during 2019 is the result of a mathematical or posting error. Correction for IC's omission of reserves for certain contracts is not a change in basis under section 807(f) or a change in method of accounting under sections 446 and 481. Because this mathematical or posting error occurred only in 2019, IC should file an amended return for that taxable year, restating the closing reserves at December 31, 2019, to reflect the correct reserve amounts and taking these recomputed reserves into account in redetermining its life insurance company taxable income for that year.

Additional Example 9

[Note: This example — derived from Rev. Rul. 69-444 which the proposed regulations would obsolete — continues to apply under current law]

Facts: In 2020, IC announced to certain of its policyholders that their policies would, at no increase in premium, henceforth carry an additional indemnity benefit should death result from a non-occupational vehicular accident. At the end of 2020, IC established a reserve for the present value of this future unaccrued obligation.

Analysis: Because the new life insurance benefit did not exist before the company became contractually liable therefor in 2020, there was no reserve attributable to the benefit at the close of 2019. In this respect, the new reserve is similar to a reserve established at the end of 2020 for any new business coming on the books during 2020. A life insurance reserve at the end of the taxable year attributable to new policies sold during the taxable year has no effect on mortality tables, rates of interest, or actuarial assumptions upon which life insurance reserves at the end of the preceding taxable year were based, and therefore does not constitute a change in basis with respect to reserves. Similarly, a new life insurance reserve attributable to new life benefits for which the company was not contractually liable at the end of the preceding taxable year does not constitute a change in basis since it does not affect actuarial assumptions on which life insurance reserves attributable to existing policies were predicated at the end of the preceding taxable year. Accordingly, the increase in reserves to provide solely for the additional contractual obligation of IC pursuant to the additional benefits provided during 2020 under existing policies is not attributable to a change in basis in computing reserves within the meaning of section 807(f) of the Code.

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Appendix D

Suggested Annual Statement Attachments for Electronically Filed Tax Returns

Life Insurance Company Annual Statement

• Jurat Page

• Assets

• Liabilities, Surplus and Other Funds

• Summary of Operations and Capital and Surplus Account

• Cash Flow

• Analysis of Operations by Lines of Business

• Analysis of Increase in Reserves During the Year

• Exhibit of Net Investment Income

• Exhibit of Capital Gains (Losses)

• Exhibit 1 — Premiums and Annuity Considerations for Life and Accident and Health Contracts

• Exhibit 2 — General Expenses

• Exhibit 3 — Taxes, Licenses and Fees (Excluding Federal Income Taxes)

• Exhibit 4 — Dividends or Refunds

• Exhibit 5 — Aggregate Reserve for Life Contracts

• Exhibit 5A — Changes in Bases of Valuation During the Year

• Exhibit 6 — Aggregate Reserve for Accident and Health Contracts

• Exhibit 7 — Deposit-Type Contracts

• Exhibit 8 — Claims for Life and Accident and Health Contracts

• Notes to Financial Statements

Separate Account Annual Statement

• Jurat Page

• Assets

• Liabilities and Surplus

• Summary of Operations

• Analysis of Operations by Lines of Business

• Analysis of Increase in Reserves During the Year

• Exhibit of Net Investment Income

• Exhibit of Capital Gains (Losses)

• Exhibit 1 — Investment Expenses

• Exhibit 2 — Investment Taxes, Licenses and Fees

• Exhibit 3 — Aggregate Reserve for Life, Annuity, and Accident and Health Contracts

• Exhibit 3A — Changes in Basis of Valuation During the Year

• Exhibit 4 — Deposit-Type Contracts

• Exhibit 5 — Reconciliation of Cash and Invested Assets

• Exhibit 6 Guaranteed Insurance and Annuity Products

Property/Casualty Annual Statement

• Jurat Page

• Assets

• Liabilities, Surplus and Other Funds

• Statement of Income

• Cash Flow

• Underwriting and Investment Exhibit — all parts

• Exhibit of Net Investment Income

• Exhibit of Capital Gains (Losses)

• Schedule H — Accident and Health Exhibit — all parts

• Schedule P — all parts

• Notes to Financial Statements