Getting Into the Act... Actuaries Address Tax Issues Head-On

Getting Into the Act...

Actuaries Address Tax Issues Head On

Actuaries are making their presence known by assuring that tax issues are properly and correctly addressed.

By Jim Reiskytl

Much of life insurance product development or company income tax is actuarial in nature and thus tax is a professional actuarial concern. We believe it is important that more actuaries become aware of the potential tax issues and be concerned that they are appropriately addressed by both Congressional/Treasury and Academy of Actuaries or other Life Insurance Industry Committees creating proposals.

Issues Monitored

U.S. Life Insurance Federal Income product and company tax issues that have arisen in 2005 or may arise in the future are monitored. These issues were selected since:


  • They may determine future product designs required to receive favorable tax treatment (or affect products previously sold).
  • Federal income taxes are one of the largest expenses of the company.
  • Many actions/proposals can affect either the product and/or this expense.

Sources Scanned

Emerging issues may arise from a variety of sources including: the President's proposals, Congressional proposals, Treasury or Internal Revenue Service proposals or possible regulations; formal efforts to provide tax reform or tax simplification; AAA task forces, committees and sections; AAA product, nonforfeiture, reserve or other proposals; comparable SOA actions to those described in the AAA; ACLI comments and proposals; and the NAIC Life Health Actuarial Task Force (LHATF) and other committees.

Other sources scanned included: Wall Street Journal articles, various tax services that report regularly on activities affecting life insurance including those from public accounting firms and law firms; ALCI tax and actuarial committees/task forces; and international accounting and tax developments/actions.

Why is This Important to Life Practicing Actuaries?

As mentioned earlier, much of life insurance product development or company income tax is actuarial in nature making the subject of taxes a concern that most actuaries share. Simply put, it affects what your company can sell and what it will pay in income taxes every year.

For example, taxes affect the relative competitiveness of asset accumulation products sold by life insurers versus other investment alternatives available to the public.

Results of the Scanning Process

Current emerging company and product tax issues include:

Issues Arising from President's Advisory Tax Reform Panel Recommendations to Treasury. The President's Advisory Panel on Federal Tax Reform issued its recommendations to the Treasury Department on November 1, 2005. The Treasury may modify these recommendations before sending any tax reform proposals to the White House. The President may, in turn, modify the Treasury recommendations and could submit tax reform proposals to Congress for its consideration either in 2006, or more likely, at a later point in time. These proposals could also become a source of options for Congress and the President for future implementation.

The most significant issue for the life insurance industry is the tax reform panel's recommendation to effectively repeal the inside build–up tax deferral for life insurance and annuities. Specifically, the President's Advisory Panel recommends tax deferred treatment of inside build–up on life insurance and annuities to be eliminated outside of the Save for Retirement and Save for Family Accounts. Therefore, the increase in value would be treated as current income and subject to tax on an annual basis, similar to a savings account. There are exceptions from the inside build–up tax for level annuities payable for life and life insurance that cannot be cashed out.

Among many other recommendations significantly affecting life insurance consumers is the Save for Retirement and Save for Family Accounts Proposals which set an annual contribution limit of $10,000 per taxpayer for each account for all savings. Currently there are no annual limits on the increases in the cash value of life insurance and annuities.

Life insurance and annuities can be purchased and maintained in the Save for Retirement and Save for Family Accounts. The panel recommends that these policies and contracts be treated like any other investments. The tax deferral for non–qualified retirement plans would also be eliminated, except as part of the Save for Retirement and Save for Family Accounts.

The panel recommendations include two different tax plans:

  1. Simplified Income Tax Plan. Highlights under this plan include the following: 100 percent of dividends attributed to U.S. income of U.S. corporations would be excluded; 75 percent of capital gains in U.S. corporate stock would be excluded; and the plan does not specifically state whether the tax reserve deduction will be retained.
  2. Growth and Investment Tax Plan. Highlights under this plan include: a 15 percent tax rate on received interest, dividends and capital gains. The Growth and Investment Tax Plan deviates from a traditional consumption tax by imposing a low–rate tax on all household capital income, while also retaining a system of tax–exempt savings accounts that would enable many households to avoid taxation altogether on returns to savings.

Tax Issues that Could Arise from Proposed Principles–Based Statutory Reserves.

Since taxes for most life insurance companies are the largest, or one of the largest, single categories of expense, the tax consequences of any proposed changes to reserves is most important.

Subcommittees and work groups of the Academy of Actuaries' Life Practice Council are developing proposed, more refined methods of determining reserves for financial reporting purposes. In particular, this effort would move statutory reserving from its present rule–based formulaic minimum, individual policy basis, with required additional reserves based on actuarial judgment, to a principles–based aggregate policy approach based on actuarial judgment, company experience and stochastic modeling of the interest and equity assumptions, with a new deterministic per policy minimum. This new minimum is based on a gross premium valuation methodology.

It is highly desirable that the new statutory aggregate reserve requirements include an individual per policy structure that provides the basis for reserves that comply with the current tax code. Such a structure would appropriately permit tax deductions for more of the actual reserves held above the guaranteed cash values.

Section 807 of the Internal Revenue Code defines the reserve amounts life insurance companies are allowed to claim as deductions offsetting premium and investment income in computing their taxable income. The rules are quite detailed. The tax reserve method is the CRVM or CARVM applicable to the contract at issue (or, for noncancellable accident and health contracts, two–year preliminary term), with prescribed interest assumptions and CSO Mortality Tables or Morbidity Tables. Reserves must be determined on a contract–by–contract basis, with the contract net surrender value as a minimum amount, and the statutory reserve as a maximum amount. Often the deductible amount is less than the statutory reserve, and this difference can be significant.

Some of the possible emerging tax issues that may arise, assuming no change to the current tax code, are:

  1. Will the new requirements (assumptions other than interest rates and mortality/morbidity tables) affect the basis for determining tax deductible reserves?
  2. Is a contract–by–contract basis reserve part of the proposed valuation structure?
  3. Since aggregate stochastic reserves are not likely to meet current tax code requirements, what can be done to increase the deductible amount of the actual reserves held? To the gross premium valuation?
  4. What does this reserve change suggest for the deferred acquisition tax (DAC)?
  5. Careful construction of the possible new Multiple CSO Mortality Tables (as was previously done for smoker/nonsmoker tables) is required to avoid creating possibleemerging tax reserve and product definitional issues.
  6. Impact of year–of–valuation statutory assumptions for reserves versus the tax rules requiring year–of–issue assumptions.

The Internal Revenue Code might be changed to accommodate this new proposal, but this is a very lengthy process (five to 15 years). Moreover, since this is a political process, once begun, there is no assurance the end result will be as originally hoped for or even marginally acceptable.

Other Potential Emerging Issues Affecting Company Taxation.

  1. International accounting changes over the next five to 10 years, if adopted in the United States, could become an emerging issue.
  2. Consolidated Returns. The life insurance industry has one of the most complex sets of rules regulating consolidation of tax returns with corporations that are not life insurers. Since the 1980s tax reform has rendered the original concerns about possible abuse bsolete, will they be changed? At what price?
  3. Proration of stockholder dividends and tax exempt interest rules differ significantly between Property Casualty and Life Insurance Company taxpayers. Will this be changed?
  4. The ability to treat insurer and reinsurer differently under Section 845 might create unexpected tax results for reinsurance. To our knowledge, this treatment has not occurred on audit.

Other Potential Emerging Issues Affecting Product Taxation. Definition of life insurance. The definition of life insurance for purposes of federal taxation (Section 7702) is more than 20 years old. There have only been a few IRS published rulings and no adopted regulations.

Possible emerging issues include:

  1. What standards apply in doing definitional computations for classified/substandard business? Is age rating allowed? What are the rules for simplified/guaranteed issue?
  2. What standards apply in doing definitional computations for joint life and second–to–die products? Methods (Frasier or tradi–tional for second–to–die)? Assumptions (how to create multiple life tables)?1
  3. Section 7702 presumes the contract matures between insured ages 95 and 100 and the 2001 CSO Tables go to age 121.
  4. In the cash value test, what are the future benefits at age 101, when, for computation purposes, the contract is deemed to have already matured?
  5. If multiple mortality tables (adding preferred risk tables) are introduced and become prevailing, what definitional standards will apply for each segment of business?

Lack of guidance may become an emerging issue on audit or via possible future regulations:

Tax Ramifications of Changes in Nonforfeiture Value Requirements.Significant liberalization of the nonforfeiture and guaranteed cash values rules (being considered by an Academy Committee) could become an emerging tax issue, if the changes do not carefully consider the tax ramifications. For example, if the liberalizations undermine the social good rationale that life insurers use to support inside interest build–up.

Minimum Required Annuity Distributions in Qualified Trusts Regulation. Starting in 2006, new regulations under IRC section 401(a)(9) require the following: where annuity contracts are held in qualified trusts, the required minimum distributions that must start the year after the employee attains age 70 1/2 must be based on the cash value of the annuity plus the actuarial present value of any additional benefits in the contract. This applies to both death benefits (e.g., a death benefit of the greater of the account value or the highest the account value has ever attained less any later distributions) and living benefits (e.g., guaranteed minimum account values). The Society of Actuaries' Taxation Section has addressed how the valuations might be done. (Note: the present value of the benefit is accurate where the benefit is fully paid up, but should be reduced by the present value of future consideration for the benefits paid for by annual charges.)

Determining the appropriate actuarial present value of additional benefits might become an emerging tax issue if the Society's suggestions are not adopted or are adversely modified.


Our challenges include the following:

  • To educate.
  • To review proposals to determine whether they are likely to meet current code requirements.
  • To provide, whenever possible, alternatives for consideration that effectively meet other objectives for change which are relatively tax–friendly.
  • To assess/illustrate alternatives so that others making decisions or recommendations may make informed choices.
  • To create proposed tax changes that will strengthen our products' positions and their ability to meet consumers' needs, such as that developed by the ACLI for payout annuities.

Tax relief provided to non–life insurance competitors or corporate or individual taxpayers may reduce the attractiveness of life insurance or annuities. For example, lower taxes on capital gains and dividends, at least temporarily, and proposed tax advantaged savings vehicles (e.g., Lifetime Savings Accounts) and other changes described earlier proposed by the President's Advisory Tax Reform Panel, could, if adopted, reduce the advantages that currently exist—particularly for annuities.

Need to Continue Scanning

Federal income taxes will undoubtedly continue to be an emerging issue. The memory of Congressional tax writing committees/ staff is excellent. Specific proposals to raise taxes resurface regularly after not being enacted in earlier attempts. Many well–intentioned actuarial, accounting or other professional constituencies may create tax issues due to insufficient knowledge or in some cases belief that their effort does not need to consider the tax affect of the proposed changes.

Author's note: Special thanks to Doug Hertz for his much appreciated assistance with the first draft of many of the issues included in this report.

Jim Reiskytl is retired. He can be contacted at