Risk Transfer – Federal Tax Perspective Casualty Actuarial Society Washington, DC September 18-19, 2008 Kevin Owens.

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Presentation transcript:

Risk Transfer – Federal Tax Perspective Casualty Actuarial Society Washington, DC September 18-19, 2008 Kevin Owens

September 18-19, 2008 Risk Transfer – Actuarial Perspective Page 2 What is an insurance contract for federal tax purposes? ► No statutory authority defining the terms “insurance” or “insurance contract” ► Helvering v. Le Gierse ► Arrangement must involve risk shifting and risk distribution to qualify as insurance for federal income tax purposes ► Terms not defined in case

September 18-19, 2008 Risk Transfer – Actuarial Perspective Page 3 What is an insurance contract for federal tax purposes? ► Factors set out by tax court ► Insurance risk ► Must have “underwriting” risk ► Investment risks, credit risk, timing risks alone are not sufficient ► Risk shifting ► Relationship of insured to insurance company (captive insurance company issues) ► Transfers some or all of the financial consequences of a loss to the insurer

September 18-19, 2008 Risk Transfer – Actuarial Perspective Page 4 What is an insurance contract for federal tax purposes? ► Factors set out by tax court ► Risk distribution ► Type of risk ► Number of insureds ► Commonly accepted notions of insurance

September 18-19, 2008 Risk Transfer – Actuarial Perspective Page 5 Risk shifting for federal tax purposes ► P&C companies ► Taxable income consists of underwriting and investment income “… computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Association of Insurance Commissioners …” Sec. 832(b)(1)(A) ► “The underwriting and investment exhibit is presumed to reflect the true net income of the company, and insofar as it is not inconsistent with the provisions of the Code will be recognized and used as a basis for that purpose.” Reg (a)(2)

September 18-19, 2008 Risk Transfer – Actuarial Perspective Page 6 Risk shifting for federal tax purposes ► Life companies ► “… all such computations [determination of taxable income] shall be made in a manner consistent with the manner required for purposes of the annual statement approved by the National Association of Insurance Commissioners.” Sec 811(a)(2)

September 18-19, 2008 Risk Transfer – Actuarial Perspective Page 7 Risk shifting for federal tax purposes ► Inference that annual statement would determine federal tax treatment of contract ► Internal Revenue Service (IRS) and courts have frequently disregarded annual statement treatment of contract

September 18-19, 2008 Risk Transfer – Actuarial Perspective Page 8 Rev. Rul ► FACTS: ► Fire results in a catastrophic loss to a hotel ► Total loss could not be ascertained but was “expected to be substantially in excess” of $130x ► Existing coverage - $30x ► Additional coverage of $100x in excess of $30x for premium of $50x ► Total coverage of $130x less than the total anticipated loss ► Treated as insurance on annual statement

September 18-19, 2008 Risk Transfer – Actuarial Perspective Page 9 Rev. Rul ► Holding – ► “it was reasonable to expect” that the premiums, tax savings and investment income would exceed the maximum anticipated liability under the insurance contract ► Timing and investment risks alone cannot create insurance for federal income tax purposes

September 18-19, 2008 Risk Transfer – Actuarial Perspective Page 10 Rev. Rul ► IRS application ► Adding tax implications to cash flow to Statement of Statutory Accounting Principles No. 62 (SSAP 62) and Financial Accounting Standard 113 (FAS 113) analysis – FSA F ► SSAP 62 and FAS 113 operate as minimum ► Other considerations ► Unique facts ► Disregard of annual statement treatment ► A “reasonable expectation” standard

September 18-19, 2008 Risk Transfer – Actuarial Perspective Page 11 Risk shifting for federal tax purposes ► What is standard to be applied to a contract to determine if there is sufficient risk of loss for the contract to be treated as insurance for federal tax purposes? ► SSAP 62 / FAS 113? ► SSAP 62 / FAS 113 as modified by IRS? ► A “reasonable expectation” of a loss?