ACLI Looks for Correction in Future Guidance on Insurance Reserves

September 6, 2019

The Honorable David Kautter
Assistant Secretary, Tax Policy
Department of the Treasury
1500 Pennsylvania Ave, NW
Washington, DC 20220

The Honorable Michael Desmond
Chief Counsel (CC)
Internal Revenue Service
1111 Constitution Ave, NW
Washington, DC 20224

Re: Comments on Future Guidance under Section 807

Dear Messrs. Kautter and Desmond:

On behalf of its members, the American Council of Life Insurers ("ACLI")¹ thanks Treasury and the IRS for the attention given to the Tax Cuts and Jobs Act (“TCJA”) provisions that directly affect life insurers. We appreciate the opportunities ACLI has had to engage with your staffs over the past several months on some of these matters.

We understand work is continuing on issues under Internal Revenue Code (“IRC”) §807. Anticipating further guidance in the area, we wish to call to your attention an omission in the background and purpose sections of two recent revenue procedures that has troubled the life insurance industry and that will cause controversy if repeated when more substantive guidance is issued. We request that future guidance correct this omission by properly taking into account the provisions of IRC §811(a) in the determination of life insurance reserves and changes in the basis of determining such reserves.

Rev. Procs. 2019-34 and 2019-10

Rev. Proc. 2019-34 grants permission for an insurance company to change its method of accounting as required under the TCJA for life insurance reserves, provided it does so as described in the revenue procedure, including the use of the spread period already prescribed by the TCJA. Because the Form 3115 filing requirement is waived by the Rev. Proc., a company that does what it already was required to do by the TCJA is treated as having permission to make the change. In this sense, the revenue procedure imposes no new burden on companies.

However, the Background section of the revenue procedure, section 2.04(1) states as follows:

“A change in the method of computing life insurance reserves . . . to comply with amendments to §807 made by the TCJA . . . is a change in method of accounting subject to §446(e) and §1.446-1.”

Similarly, the "Purpose" section of Rev. Proc. 2019-10 states that the automatic change procedures for changes in basis for computing life insurance reserves are provided "under §446 and §1.446-1(e) of the regulations,” and that Rev. Rul. 94-74 (which provided pre-TCJA guidance on changes in basis for computing life insurance reserves) was obsoleted "to the extent the holdings are inconsistent with the general rules for changing a method of accounting under §446(e) and §1.446-1."

We do not take issue with the procedural approach taken in Rev. Proc. 2019-10 and Rev. Proc. 2019-34. Whether or not permission is technically "required" for a change in basis, we understand that as a matter of tax administration the IRS may request the information required under Rev. Procs. 2019-10 and 2019-34. In fact, we engaged in constructive dialogue with the IRS leading up to the issuance of Rev. Proc. 2019-10. Likewise, if the IRS believes it must grant taxpayers permission to comply with amendments to §807(d), we appreciate the practical approach that was taken in Rev. Proc. 2019-34. As explained below, our primary concern is that references in these Rev. Procs. to §446 and §1.446-1, with no acknowledgement of §811(a), could be problematic when further substantive guidance is provided under §807.

Application of More Specific Provisions of Subchapter L

Under §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,² in the manner required for the annual statement approved by the National Association of Insurance Commissioners (“NAIC”). Section 811(a) and its predecessor have been in effect for 60 years. For many methods of accounting (but, as explained below, not with respect to the determination of life insurance reserves), subchapter L applies the same rules (and the same accounting method change rules) to life insurers as to other corporate taxpayers.

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 §807). Life insurance companies are required to use reserve methods of accounting for both NAIC accounting and Federal income tax purposes. Life insurance companies are permitted a deduction for additions to life insurance reserves, and must include decreases in such reserves in gross income. The tax reserve method mandated by §807(d)(2) and defined in §807(d)(3) requires that NAIC-prescribed methods be used to compute life insurance reserves. If §807(d) does not provide a specific rule or assumption for the computation, §811(a) requires that the computation be made in a manner consistent with a company's NAIC annual statement.

Therefore, whereas §446 provides the general rule for methods of accounting, §§811(a) and 807 provide the rules for methods of reserve accounting for a life insurance company. The clear reflection of income standard of §446(b) does not apply to life insurance reserves properly determined in accordance with the computational rules of §807 because, as more specific provisions, §§807 and 811(a) trump the general rule of §446. Stated differently, Congress has determined — through the provisions of §§811(a) and 807 — how reserves are clearly reflected in income.

Likewise, whereas §§446(e) and 481 provide the general rules for changes in method of accounting, §807(f) provides the rule for changes in basis for computing life insurance reserves. A change in basis in computing life insurance reserves has never been treated as a change in accounting method under §446(e). See Treas. Reg. §1.806-4(a). The TCJA amended §807(f) only to provide that the adjustment required as a result of a change in basis "shall be taken into account under §481 as adjustments attributable to a change in method of accounting initiated by the taxpayer and made with the consent of the Secretary."³ The statutory language itself does not support the notion that §446 has more broadly replaced §§811(a), 807(d) and 807(f) as to accounting methods for life insurance reserves. Had Congress wanted to make a life insurance reserve basis change just another accounting method change subject to §446, it would have repealed §807(f) in its entirety, but it did not do so.

Although Rev. Procs. 2019-10 and 2019-34 have made no specific assertions about the application of §446 to the proper determination of life insurance reserves, their references to §446, §446(e), and §1.446-1 are troubling to life insurance company taxpayers. The issues discussed above are fundamental to the taxation of life insurers, and any future guidance under §807 should recognize the important role of §§811(a) and 807(f), and not improperly assert the applicability of the general rules of §446. We would be pleased to discuss this matter with you in greater detail. We appreciate your consideration of these comments and would look forward to the opportunity to work with you to address these issues.

Sincerely,

Regina Rose
American Council of Life Insurers
Washington, DC

Cc:
Jeffrey Van Hove
Krishna Vallabhaneni
Angela Walitt
Ellen Martin
William Paul
Helen Hubbard
Alexis MacIvor
John Moriarty
Roy Hirshorn