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ACLI Comments on Proposed Insurance Discounting Regs

DEC. 7, 2018

ACLI Comments on Proposed Insurance Discounting Regs

DATED DEC. 7, 2018
DOCUMENT ATTRIBUTES
  • Authors
    Rose, Regina
    Parsazad, Mandana
  • Institutional Authors
    American Council of Life Insurers
  • Code Sections
  • Subject Area/Tax Topics
  • Industry Groups
    Insurance
  • Jurisdictions
  • Tax Analysts Document Number
    2018-48276
  • Tax Analysts Electronic Citation
    2018 TNT 238-16

December 7, 2018

CC:PA:LPD:PR (REG-103163-18)
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044

Re: Proposed Regulations on Discounting of Unpaid Losses

Dear sir or madam:

On behalf of its member companies, the American Council of Life Insurers1 is submitting comments on the Notice of Proposed Rulemaking (REG-103163-18) (“proposed regulations”) published in the Federal Register on November 7, 2018, providing guidance on new discounting rules for unpaid losses and estimated salvage recoverable of insurance companies for federal income tax purposes.

Background on TCJA Amendment and Proposed Regulations

Section 846 of the Internal Revenue Code (“Code”) sets forth rules for discounting unpaid losses of insurance companies subject to tax under Subchapter L of the Code. Section 846 was amended in several respects by section 13523 of the law commonly referred to as the Tax Cuts and Jobs Act (“TCJA”),2 effective for tax years beginning after December 31, 2017. As it applies to life insurance companies, the key amendment to section 846 made by TCJA section 13523(a) provided a new definition of the “annual rate” to be used by insurance company taxpayers for discounting purposes. Under Code section 846(c)(1), determination of the rate of interest for section 846 discounting is “the annual rate determined by the Secretary under paragraph (2).” Code section 846(c)(2) was amended by TCJA to read as follows:

“(2) DETERMINATION OF ANNUAL RATE. — The annual rate determined by the Secretary under this paragraph for any calendar year shall be a rate determined on the basis of the corporate bond yield curve (as defined in section 430(h)(2)(D)(i) determined by substituting '60-month period' for '24-month period' therein).”3

The corporate bond yield curve is published on a monthly basis by the Treasury Department and consists of spot interest rates for each stated time to maturity. The spot rate for a given time to maturity represents the yield on a bond that gives a single payment at that maturity. For the stated yield curve, times to maturity are specified at half-year intervals from 0.5 years through 100 years. Section 846(c)(2) does not specify how the Secretary is to determine the annual rate for any calendar year based on the corporate bond yield curve.

The proposed regulations provide that the annual rate for any calendar year is the average of the corporate bond yield curve's monthly spot rates with times to maturity of not more than 17½ years, computed using the most recent 60-month period ending before the beginning of the calendar year for which the determination is made. Under the proposed regulations, a single annual rate is applicable for all lines of business. The preamble to the proposed regulations states that “the annual rate should be determined in a manner that more closely matches the investments in bonds used to fund the undiscounted losses to be incurred in the future by insurance companies.”

The preamble also states that an alternative approach would be the direct application of the corporate bond yield curve to the loss payment pattern for each line of business, “which would result in a more accurate measure of the present value of the unpaid losses for each line of business.” Although the proposed regulations do not adopt this approach, the preamble indicates that the maturity range used to determine the single rate was selected to minimize the differences in taxable income, in the aggregate, resulting from use of a single rate versus direct application of the corporate bond yield curve to the loss payment patterns. Additionally, the preamble notes that the use of two rates was considered (one for long-tail lines of business, and one for short-tail lines of business), as was the use of a different rate for each line of business, but these alternatives also were not adopted.

The Treasury Department and the IRS have requested comments on the method for determining the annual rate on the basis of the corporate bond yield curve, including comments on whether a different option than the one incorporated in the proposed regulations should be adopted in the final regulations and, if so, the legal basis for that alternative option and explanation of how that option would more clearly reflect income.

Application to Life Insurance Companies

For life insurance companies subject to tax under Part I of Subchapter L, section 846 applies to certain unpaid losses by reason of the last sentence of the flush language of Code section 807(c) which provides as follows:

“For purpose of paragraph (2) and section 805(a)(1), the amount of unpaid losses (other than losses on life insurance contracts) shall be the amount of the discounted unpaid losses as defined in section 846.”

The rate specified in section 846(c)(2) is relevant to life insurers for discounting of unpaid losses for certain accident and health (“A&H”) lines of business, as set forth in Code section 846(e)(6). As amended by TCJA, section 846(e)(6) provides as follows:

“(6) SPECIAL RULE FOR CERTAIN ACCIDENT AND HEALTH INSURANCE LINES OF BUSINESS. — Any determination under subsection (a) with respect to unpaid losses relating to accident and health insurance lines of businesses (other than credit disability insurance) shall be made —

(A) in the case of unpaid losses relating to disability income, by using the general rules prescribed under section 807(d) applicable to noncancelable accident and health insurance contracts and using a mortality or morbidity table reflecting the taxpayer's experience; except that the limitation of subsection (a)(3) shall apply, and

(B) in all other cases, by using an assumption (in lieu of a loss payment pattern) that unpaid losses are paid in the middle of the year following the accident year.”

Thus, for life insurance companies, the interest rate determined under section 846(c)(2) is relevant in discounting 1) unpaid losses on credit disability insurance, and 2) unpaid losses on A&H business (e.g., cancelable A&H insurance) that is not —

  • credit disability insurance,

  • disability insurance (other than credit disability) subject to the general rules prescribed under section 807(d), or

  • noncancelable or guaranteed renewable A&H insurance.

Credit disability insurance is a so-called short-tail line of business, with an assumed three-year loss payment pattern, as set forth in Code section 846(d)(3)(A)(i). Unpaid losses for the second category of contracts generally are paid within a few months and, under Code section 846(e)(6), are explicitly subject to a half year discount. In either case, the assets held for payment of such losses have a much shorter duration than the long-duration investment assets generally supporting life insurance and annuity contracts.4 Thus, even under pre-TCJA law, where the section 846 discount rate was based on U.S. government obligations with maturities of over three years but not over nine years, it is likely that the discount of unpaid losses was overstated for life insurance companies relative to investment assets being held to pay such losses. In such circumstances, it is unlikely that determination of the section 846 discount rate using spot rates from the corporate bond yield curve with maturities of up to 17.5 years will more clearly reflect income for life insurance companies. Accordingly, a single section 846 discount rate determined by reference to shorter maturities than those specified in the proposed regulations would at least go part way toward a clearer reflection of income for companies taxed as life insurers.

* * *

Thank you for the opportunity to comment on the proposed regulations. We would be happy to address this matter with you further should you wish to do so.

Very truly yours,

Regina Rose

Mandana Parsazad

American Council of Life Insurers
Washington, DC

FOOTNOTES

1The American Council of Life Insurers (ACLI) is a Washington, D.C.-based trade association with approximately 290 member companies operating in the United States and abroad. ACLI advocates in state, federal, and international forums for public policy that supports the industry marketplace and the policyholders that rely on life insurers' products for financial and retirement security. ACLI members offer life insurance, annuities, retirement plans, long-term care and disability income insurance, and reinsurance, representing 95 percent of industry assets, 93 percent of life insurance premiums, and 98 percent of annuity considerations in the United States. Learn more at www.acli.com.

2An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018, P.L. 115-97.

3Prior to TCJA, the rate determined under section 846(c)(2) was based on a rolling 60-month average of the applicable federal mid-term rate as defined in section 1274(d) (over three years but not over nine years).

4It should be noted that using a discount rate equal to an insurance company's investment earnings rate could improperly accelerate the recognition of future investment earnings.

END FOOTNOTES

DOCUMENT ATTRIBUTES
  • Authors
    Rose, Regina
    Parsazad, Mandana
  • Institutional Authors
    American Council of Life Insurers
  • Code Sections
  • Subject Area/Tax Topics
  • Industry Groups
    Insurance
  • Jurisdictions
  • Tax Analysts Document Number
    2018-48276
  • Tax Analysts Electronic Citation
    2018 TNT 238-16
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