AICP E Day The 2017 Tax Act – Much Change, but Little Reform Lower Rates & Changes to special insurance provisions: What does it mean for Insurers? June 6, 2018 Sturbridge, MA Walter C. Welsh University of Connecticut School of Law Walter C. Welsh University of Connecticut School of Law

2017 Tax Act or Tax Cut & Jobs Act Goals of Tax Reform Lower Rates Simplification Additional Revenue Elimination or Reduction of Tax Expenditures or deductions Closing loopholes Walter C. Welsh University of Connecticut School of Law

Joint Tax Committee -Tax Expenditures - Examples Tax Expenditure Estimated Cost (billions) 1. Health Care Exclusion $ 659 2. Home Mortgage Deduction $ 484 3. State & local sales & Property Tax Deduction $ 237 4. Exclusion of invest. Inc. on life & annuity contracts $ 149 5. Special treatment of life insurance reserves $ 12.2 6. Proration for property & casualty tax exempts $ 1.8 7. Discounting Property & casualty reserves $ 34 Joint Committee on Taxation “Estimates of Federal Tax Expenditures for Fiscal Years 2010-2014,” December 15, 2010 Walter C. Welsh University of Connecticut School of Law

Tax reform: focus on expenditures = focus on Insurers Special Code provisions for Insurance companies identified as expenditures Tax treatment of insurance contracts called expenditures Walter C. Welsh University of Connecticut School of Law

Contracts and Tax Treatment Contracts, Life Insurance, Annuity, Disability Income Insurance, Long-Term Care, Health Unique Features – protection against risk Tax treatment/consequences depends on nature of the contract Walter C. Welsh University of Connecticut School of Law

Contracts and Tax Treatment No income and no tax until owner sells or exchanges the contract OR Upon distribution from the insurance contract There are special tax rules for disability income insurance and long term care insurance Walter C. Welsh University of Connecticut School of Law

2017 Tax Act- No Change to the Tax Treatment of Contracts & Retirement Plans The Act did not change the tax treatment for the owners, individuals and corporations, of insurance and annuity contracts These contracts include: life insurance, annuities, disability income insurance and long term care insurance The Act also did not change the tax treatment of retirement plans Walter C. Welsh University of Connecticut School of Law

2017 Tax Act Lower Rates and Revised Deductions & Exclusions Corporate Tax Changes Individual Tax Changes Rate 35% 21% Permanent Rates 10% to 39.6% 10% to 37% 2018 to 2025 Deductions – examples Interest deduction limit Insurance Cos new limits Reserves Dividends Rec’d., T.E.I. Acquisition expenses Deductions - examples State & Local Taxes Cap at 10,000 Mortgage interest on debt up to 750,000 No Misc. Deductions Walter C. Welsh University of Connecticut School of Law

2017 Tax Act Lower Rates and Revised Deductions & Exclusions Corporate Tax Changes Individual Tax Changes Rate 35% 21% Permanent Rates 10% to 39.6% 10% to 37% 2018 to 2025 Deductions – examples Interest deduction limit Insurance Cos new limits Reserves Dividends Rec’d., T.E.I. Acquisition expenses Pers. exem. 4,050 to 0 Std. Ded. 6,500 to 12,000 Walter C. Welsh University of Connecticut School of Law

Lower Rates, Revised Deductions & Exclusions for Individuals Example H&W Approx. Pre 2018. 2018 2018 w/ std ded Gr. Inc. $150,000 150,000 150,000 Less Per ex 8,100 0 0 St & loc. 25,000. 10,000. 0 Other 5,000 5,000 0 STD ded. 0 0 24,000 Tax. Inc. 111,900 135,000. 126,000 Marginal rate 25% 22% 22% Walter C. Welsh University of Connecticut School of Law

Estate Tax Exclusions Estate tax Exclusion per Individual 5,490,000 11,180,000 - 2025 Indexed for inflation 2026 5,490,000 Indexed Walter C. Welsh University of Connecticut School of Law

Lower Rates, Revised Deductions & Exclusions for Corporations 2017 Tax Act Rate – 21%, No Alternative Min. Tax Limit on Interest expense deduction Sum of business interest + 30% of adjusted taxable income Limits on deductions for Meals & Entertainment Entertainment – not deductible Employee meals on premises & cafeteria subsidies 50 % deductible Transit subsidies (Pre tax) not deductible Walter C. Welsh University of Connecticut School of Law

Lower Rates, Revised Deductions & Exclusions for Corporations 2017 Tax Act Executive Compensation Limit of $1K on deduction for Executive Comp. Performance-based exception repealed, includes CFO Full immediate deduction for cost of certain business assets. The 100% deduction is gradually eliminated from 2022 to 2026 Walter C. Welsh University of Connecticut School of Law

Insurance Company Income NAIC Annual Statement LIFE Property Casualty Health Walter C. Welsh University of Connecticut School of Law

Insurance Company Income NAIC Annual Statement + Premiums + Investment Income - Commissions – Acquisition Expenses Losses Paid Change in reserves = Income Internal Rev. Code starts with NAIC Annual statement Walter C. Welsh University of Connecticut School of Law

Insurance Company Taxation Special Provisions Reserves Acquisition Expenses Proration Walter C. Welsh University of Connecticut School of Law

Deferred Acquisition Cost (“DAC”) Tax – Life Companies Pre 2018 Law: Deduction of actual expenses incurred Capitalization - proxy amount of expenses: 1.75% of net premiums – annuity 2.05% of net premiums on group life 7.7% of net premiums on all other types Pension plan contracts excluded Amortized for 120 months – 10 years 2017 Tax Act: 2.1% of net premiums – annuity 2.46% of net premiums on group life 9.24% of net premiums on all other types Amortized for 180 months – 15 years Walter C. Welsh University of Connecticut School of Law

Acquisition Costs Non– Life Companies Pre– 2018 Law: Deduction of actual acquisition expenses incurred Deduction of only 80% of the increase in the unearned premium reserve UPR 2017 Tax Act: No Change Deduction of acquisition expenses incurred Deduction of 80% of the change in UPR Walter C. Welsh University of Connecticut School of Law

Life Co. Reserve Computations Pre - 2018 Law: Life insurance companies deduct increases in life insurance reserves Reserves determined by interest rates and mortality assumptions or by principles – PBR The greater of net surrender value and the reserve determined by NAIC method Using as the interest rate, the greater of the applicable Federal interest rate or the prevailing State assumed interest rate  No higher than NAIC (statutory) reserve Walter C. Welsh University of Connecticut School of Law

Life Reserve Computations 2017 Tax Act: The tax reserve is the greater of Net surrender value or 92.81% of the NAIC reserve Cannot exceed NAIC reserve Transition Rule. For 2018, compute year-end 2017 reserves under 2018 rules and spread the difference over 8 years Walter C. Welsh University of Connecticut School of Law

Non-Life Company Reserves Pre - 2018 Law: Non- Life insurance companies deduct increases in discounted unpaid losses The discount rate is the applicable Federal mid - term rate The loss payment pattern is a pattern determined by the Treasury or, By election, the company can choose its own historical pattern For certain long tail line the payout period is 10 years Walter C. Welsh University of Connecticut School of Law

Non-Life Company Reserves 2017 Tax Act: Deduction of increases in discounted unpaid losses The discount rate is based on the corporate bond yield curve – generally higher than the risk – free Federal rate. Maturity level not yet defined The loss payment pattern is a pattern determined by the Treasury and , The company may not use its own historical pattern For certain long tail lines the payout period is extended from 10 to 24 years Transition Rule. 8 years – same as for life Cos Walter C. Welsh University of Connecticut School of Law

DRD & Tax Exempt Interest – Proration - Life Companies Pre 2018 Law: Corporations can deduct some portion of the dividends they receive on stock they own in other corporations – generally 70% Corporations can generally exclude tax exempt interest For life insurance companies, only the “company’s share” (and not the “policyholders’ share”) of dividends received is deductible and only the company’s share of tax exempt income is excludable The company’s share is determined under complex “proration” rules Walter C. Welsh University of Connecticut School of Law

DRD & Tax Exempt Interest – Proration - Life Companies 2017 Tax Act: Corporations can deduct some portion of the dividends they receive on stock they own in other corporations– under new law generally 50% Corporations can generally exclude tax exempt interest For life insurance companies, the Company Share is a fixed percentage at 70% DRD is essentially 35% Walter C. Welsh University of Connecticut School of Law

DRD & Tax Exempt Interest – Proration – Non - Life Companies Pre 2018 Law: Corporations can deduct some portion of the dividends they receive on stock they own in other corporations – generally 70% Corporations can generally exclude tax exempt interest For other insurance companies (non– life) only the deduction for losses incurred is reduced by 15% of tax-exempt income and by 15% of the dividends received deduction Walter C. Welsh University of Connecticut School of Law

DRD & Tax Exempt Interest – Proration – Non - Life Companies 2017 Tax Act: For other insurance companies (non– life), the deduction for losses incurred is reduced by 25% of tax-exempt income and 25% of the dividends received deduction. The increase from 15% to 25% offsets the some of the benefit of the reduction in the corporate tax rate from 35% to 21%. (.35 x 15 = 5.25, .21 x 25 = 5.25) Walter C. Welsh University of Connecticut School of Law

Change in Method of Computing Reserves - Life Companies Pre– 2018 Law: Changes in reserves due to strengthening or weakening taken into account over a 10 year period 2017 Tax Act: Changes in method or basis of computing reserves treated as a change in method of accounting 4 year period for additions to income 1 year period for deductions from income Walter C. Welsh University of Connecticut School of Law

Net Operating Losses Pre– 2018 Law: NOLs could be carried back 2 years and forward 20 years and offset 100% of taxable income Life Insurance Companies subject to special rule carry back 3 and forward 15 2017 Tax Act: NOLs for cannot be carried back and can be carried forward indefinitely NOLs can only offset 80% of taxable income Non–Life Companies carried back 2 and forward 20 and offset 100% of taxable income Walter C. Welsh University of Connecticut School of Law

Special Deduction for Small life Insurance Companies Pre– 2018 Law: Life companies with assets of < $500,000 entitled to deduct up tp 60% of the first $3,000,000 of taxable income 2017 Tax Act: The small life company deduction is repealed Walter C. Welsh University of Connecticut School of Law

International Tax Provisions Pre–2018 Law US taxed world-wide income of a business Income of US-owned foreign subsidiary Not taxed, however, Subpart F could apply to impose tax on some portion of income foreign corporation owned by US shareholder Walter C. Welsh University of Connecticut School of Law

2017 Tax Act - International US imposes income tax on a territorial basis – on income earned in the US Special provisions have world-wide affect GILTI Global Intangible Low-Taxed Income FDII foreign derived intangible income BEAT base erosion and anti abuse tax Walter C. Welsh University of Connecticut School of Law