2012 VSCAC INDUSTRY SUMMIT New Developments in Reinsurance by Greg Petrowski GPW and Associates, Inc. September 11, 2012

Overview of Presentation Product and Structure Updates for Reinsurance Programs Current and Pending Tax Changes and Impact on Dealer Owned Reinsurance Structures and NCFC Programs Changes to Shareholder Taxation Q & A

Product and Structure Updates for Reinsurance Programs Most F&I reinsurance programs are centered around reinsurance of extended service contracts. The recent trend has been to add ancillary F&I products to “fill up” reinsurance program GAP Tire and Wheel Etch/Theft Products Chemical/Paint and Fabric Products Lifetime Products Key Replacement

Product and Structure Updates for Reinsurance Programs The primary advantages of this strategy is to provide the ability to participate in underwriting profit of ancillary products. Administrators/insurers do not generally offer bonus or retro programs for many of these products

Product and Structure Updates for Reinsurance Programs There are also potential disadvantages when adding ancillary products to the reinsurance program: Exposure to underwriting losses  While there is segregation of trust accounts, losses from one product will offset profits from others within the same reinsurance company  Segregation of underwriting can be achieved through use of a separate reinsurance company or alternative participation program Potential of adding premium that could push combined premium over the $1.2 million annual IRC Section 831(b) threshold

Product and Structure Updates for Reinsurance Programs Recent loss experience tends to favor many F&I products for reinsurance program, assuming premium reserve provides enough margin for profit VSC Limited Warranty GAP (although currently trending upward) Etch Paint and Fabric

Product and Structure Updates for Reinsurance Programs Key Point: All ancillary products considered for reinsurance should be reviewed for potential underwriting risk and expected annual premium volume

Product and Structure Updates for Reinsurance Programs Strong vehicle sales in fourth quarter, 2011 and first and second quarters of 2012 have translated into increased F&I product sales

Product and Structure Updates for Reinsurance Programs Key Point: For Dealers in existing reinsurance programs, reinsurance premium volumes have likely increased and should be periodically reviewed for potential impact on IRC Section 831(b) premium thresholds and tax planning

Product and Structure Updates for Reinsurance Programs There may be opportunities to change the existing dealer participation program to include one or more of the following:  Multiple reinsurance company structures Opportunity to segregate business/products Opportunity to change shareholders Estate planning tool Minority shareholders/Key employees  Hybrid participation program structures NCFC Retro

Product and Structure Updates for Reinsurance Programs Key Point: For Dealers not previously in reinsurance programs, reinsurance may now be a viable option by bundling multiple products/administrators to put into a single reinsurance program New reinsurance company participation Participation in multiple stock class reinsurance company or NCFC

Reinsurance Update Tax Law Changes Hiring Incentives to Restore Employment (HIRE) Act  Section 6038D Information with Respect to Foreign Financial Assets  Foreign Account Tax Compliance Act (FATCA) Sections Proposed Regulation

Reinsurance Update Tax Law Changes Section 6038D Created by HIRE Act Requires US persons to file a disclosure statement with their personal tax returns if they hold any interest in a specified foreign financial asset(s) whose aggregate value exceeds the threshold for their filing status (Form 8938) Effective for 2011 and all tax years thereafter Penalties for underpayments related to undisclosed foreign financial assets and extension of statue of limitations

Reinsurance Update Tax Law Changes Specified Foreign Financial Assets (SFFA) any financial account maintained by a foreign financial institution any of the following assets which are not held in an account maintained by a financial institution  any stock or security issued by a person other than a United States person  any financial instrument or contract held for investment that has an issuer or counterparty which is other than a United States person  any interest in a foreign entity

Reinsurance Update Tax Law Changes Filing StatusLivingValue on 12/31Maximum Value SingleIn US$50,000$75,000 Married Filing JointlyIn US$100,000$150,000 Married Filing SeparatelyIn US$50,000$75,000 SingleAbroad^$200,000$300,000 Married Filing JointlyAbroad^$400,000$600,000 Married Filing SeparatelyAbroad^$200,000$300,000 ^ Must be bona fide resident of a foreign country(ies)

Reinsurance Update Tax Law Changes What is value? Value is determined on a per asset/investment basis Instructions to the Form 8938 provide guidance for the determination of value  Typically fair market value  Negative values are treated as zero from maximum value and aggregation  Assets denominated in a foreign currency must have their value converted to US dollars using the end of year exchange rate from May need to provide proof if the value is less than the threshold

Reinsurance Update Tax Law Changes Sources of fair market value  Periodic account statements for financial accounts  Reported stock price for publically traded foreign securities with daily price information available  Based on distributions received from foreign trusts Third party appraisal is not necessary In most cases, you may use the value as of the last day of the tax year unless you have reason to know that the value does not reflect a reasonable estimate of the maximum value during the tax year

Reinsurance Update Tax Law Changes Disclosure requirements Form 8938 For accounts, the name and address of the financial institution where the account is maintained and the account number For any stock or security, the name and address of the issuer and information necessary to identify the class or issue of the stock or security

Reinsurance Update Tax Law Changes Disclosure requirements (continued) For any other instrument, contract, or interest  information necessary to identify such instrument, contract, or interest, and  the names and addresses of all issuers and counterparties with respect to such instrument, contract, or interest The maximum value for each of the asset owned during the taxable year

Reinsurance Update Tax Law Changes

Planning considerations Does not apply to offshore companies with valid IRC Section 953(d) election Applies to typical NCFC structures For NCFC ownership, aggregate all SFFA interests and discuss disclosure to avoid penalties May require additional time and costs to calculate fair market values for each shareholder

Reinsurance Update Tax Law Changes Key Point: Instructions for Form 8938 Statement of Specified Foreign Assets (Disclosure Form) require filing for individuals only. If assets are owned by corporation, partnership or other entity, the disclosure form does not appear to be required, although actual regulations appear to apply to these entities

Reinsurance Update Tax Law Changes FATCA Created by HIRE Act Creates Chapter 4 of the Internal Revenue Code, Sections New law takes effect in 2013 IRS states the purpose is to combat tax evasion by US persons holding investments in offshore accounts Generally does not effect reinsurance companies

Reinsurance Update Tax Law Changes FATCA Requires US taxpayers holding financial assets outside the United States to report those assets Requests that Foreign Financial Institutions enter into an agreement with the IRS  To test for US accounts  To report directly to IRS about financial accounts held by US taxpayers  To act as withholding agent

Reinsurance Update Tax Law Changes Proposed Reg Issued September 13, 2010 Proposes treating each series of a series organization as a separate entity for federal tax purposes Applies to all domestic series and all foreign series that engage in an insurance or reinsurance business May remove the tax benefits of multiple stock class domestic and NCFC insurance and reinsurance structures

Reinsurance Update Tax Law Changes Each series is treated as created or organized under the laws of the same jurisdiction in which the series is established Ownership of a series is determined by who has the beneficial rights of ownership Entity type for federal tax purposes would be determined by existing regulations  An insurance company series would always be a stand alone C-corporation

Reinsurance Update Tax Law Changes Series need not possess all attributes of separate legal entities (ex. ability to sue, be sued, enter into contracts, hold property in its own name) since liability shields (stop loss, risk fees, etc.) of series often have the same effect Series, treated as separate entities for federal tax purposes, may make any federal tax elections independently

Reinsurance Update Tax Law Changes Grandfathering provisions for existing series  Established prior to regulation date  Conduct business or investment activity, or more than half the business of the foreign series is insurance  Foreign series has correct entity classification and more than half the business is insurance  Not treated as a separate entity for filing any federal income tax returns, information returns, or withholding documents for any taxable year

Reinsurance Update Tax Law Changes Grandfathering provisions for existing series (continued)  Has a reasonable basis for their claimed classification; and  Series classification was not under examination when the regulation is made law, if so the classification is determine by the examination Must maintain same series ownership as prior to effective date of regulation

Reinsurance Update Tax Law Changes Planning Considerations Still pending finalization by the Treasury Actual regulation may not be issued in same form as proposed The regulation is with the Treasury for consideration/finalization, but has been hung up at this point for over a year Grandfathering may be impacted by examinations of NCFC structures as a result of Form 8938 disclosures

Reinsurance Update Tax Law Changes Planning Considerations (continued) Typical NCFC structure may not provide the same tax benefits  Make sure existing NCFCs meet grandfathering requirements  For new and non-grandfathered NCFCs, consider making IRC Section 953(d) elections for each series and filing as a stand alone insurance company, or  Make sure each series within the NCFC would qualify as an NCFC on its own

Reinsurance Update Shareholder Taxation Select pending Federal income tax law changes that impact Individuals and Corporations Over 40 tax provisions are set to expire December 31, 2012 Personal Income Taxes  Tax Rates and Brackets  Capital Gains and Qualified Dividends  Alternative Minimum Tax Business Taxes  Depreciation, Special Depreciation, and Section 179 New Taxes for 2013

Reinsurance Update Shareholder Taxation 2012 Rate10%15%25%28%33%35% 2013 Rate15% 28%31%36%39.6% Marginal tax rates increase 10% bracket is eliminated “Marriage penalty” returns for 15% bracket; married filing jointly (MFJ) bracket limit will no longer be required to be twice of single bracket limit The MFJ standard deduction will no longer be twice the single standard deduction Employees 2% FICA tax break is eliminated (Back to 6.2% social security tax and 1.45% Medicare tax) on first $110,100 of taxable income

Reinsurance Update Shareholder Taxation Capital Gains and Qualified Dividends After December 31, 2012  Capital gains tax rates go up to 20% for most taxpayers; 10% for taxpayers in the 15% marginal tax bracket  Qualified dividends will be taxed at ordinary income rates instead of at capital gains rates unless the current provisions are extended again

Reinsurance Update Shareholder Taxation AMT exemption is reduced by 25% of AMTI over the threshold AMT “patch” has not been passed for 2012 or future years AMT: Married Filing Jointly/Qualifying Window(er) Married Filing Separately 2011 AMT Exemption$74,450$37, AMT Exemption$45,000$22,500 Income Threshold$150,000$75,000

Reinsurance Update Shareholder Taxation New Taxes and Removed Benefits Effective for % additional tax on capital gains for individuals in the 36% and 39.6% marginal tax brackets enacted in Affordable Health Care for America Act (aka Obama Care) Floor on Medical Expense raised to 10% from 7.5% of AGI FSA limit becomes $2,500 per year Maximum Estate Tax Rate increases from 35% to 55%

Reinsurance Update Shareholder Taxation Key Point: With the scheduled expiration of the qualified dividend treatment for shareholder distributions AND the scheduled increase in the long term capital gains tax rate, expect a run on available reinsurance trust and funds held account balances and plan accordingly.

Reinsurance Update Questions and General Discussion