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Jean Baxley – Moderator Jeff Webb - S p e a k er Shawn Abrams - S p e a k er November 2, 2017

42 nd Annual Insu r an c e T a x Co n f e r e n c e. Introduction to the Life Annual Statement. Jean Baxley – Moderator Jeff Webb - S p e a k er Shawn Abrams - S p e a k er November 2, 2017. A g enda. Financial Statements: Source Document. A ss e t s – P a g e 2. 10.

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Jean Baxley – Moderator Jeff Webb - S p e a k er Shawn Abrams - S p e a k er November 2, 2017

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  1. 42ndAnnualInsuranceTaxConference Introduction to the Life Annual Statement Jean Baxley – Moderator Jeff Webb -Speaker Shawn Abrams -Speaker November 2, 2017

  2. Agenda 42nd Annual Insurance Tax Conference

  3. Financial Statements: Source Document 42nd Annual Insurance Tax Conference

  4. Assets–Page2 42nd Annual Insurance Tax Conference 10

  5. Liabilities,Surplus,Other Funds–Page3 42nd Annual Insurance Tax Conference 10

  6. SummaryofOperations–Page4 42nd Annual Insurance Tax Conference 10

  7. CashFlows – Page5 42nd Annual Insurance Tax Conference 10

  8. Introduction to the Annual Statement 42nd Annual Insurance Tax Conference

  9. Summary:Statutory Net Income 42nd Annual Insurance Tax Conference

  10. Financial Reporting – STAT Accounting • Statutory Accounting Principles (SAP) form the foundation for amounts reported in the statutory annual statement. • The basic concern of SAP is solvency. If the insurance company were liquidated, what assets would likely be available to pay policyholder claims? • The concern over solvency is also demonstrated on the income statement: policy acquisition expenses are immediately expensed, rather than capitalized, as they are for GAAP purposes • SAP generally requires the recognition of current and deferred taxes similar to GAAP, with several modifications based on the primary concerns and operations of an insurance company • The primary difference in accounting for deferred income taxes for Statutory Accounting in comparison to GAAP is that Statutory Accounting employs an admissibility test with respect to DTAs through the admissibility test in Statements on Statutory Accounting Principles (“SSAP”) 101 42nd Annual Insurance Tax Conference

  11. Life Introduction: Qualification as a Life Insurance Company • Defined by the Internal Revenue Code under Section 816(a) and must meet the following requirements to be considered a life insurance company: • Company is an insurance company • Company is in the business of writing life insurance, annuity or non-cancellable health insurance policies • more than 50% of its total reserves are life insurance reserves or unearned premiums/unpaid losses on non-cancellable life, accident or health insurance policies • Determination of a company’s “life insurance company” status is made on an annual basis • Requirements defined in Section 816(a) must be met each year for a company to classify as a life insurance company 42nd Annual Insurance Tax Conference

  12. LifeInsuranceCompanyQualificationTest 42nd Annual Insurance Tax Conference

  13. Life Taxation Basics: STAT to Tax • GAAP to statutory differences include: • Loss Reserves • Non-Admitted Assets • Securities/Investments • Cash Basis Dividends • Realized Gains & Losses/Interest Maintenance Reserve (IMR) and Asset Valuation Reserve (AVR) • Other Than Temporary Impairments (OTTI) • Partnership Investments • Pensions • Deferred Acquisition Costs • Transfer to IMR • Change in Loading • Statutory to tax differences include: • Policyholder Reserves • Deferred Acquisition Costs • Tax Exempt Interest • Dividends Received • Change in Accrued Dividends • Deferred Compensation • Other Than Temporary Impairments (OTTI) • Capital Gains – Unrealized and IMR • Accrual of Market Discount Statutory accounting - Regulatory U.S. Federal Tax U.S. GAAP - 10-K Section 811(a) indicates that computations in determining income taxes for insurance companies shall be made in a manner consistent with the manner required for purposes of the annual statement approved by the National Association of Commissioners (NAIC). 42nd Annual Insurance Tax Conference

  14. Items that Create Deferred Tax Assets (DTAs) or Deferred Tax Liabilities (DTLs) 42nd Annual Insurance Tax Conference 19 10

  15. Items that Create Deferred Tax Assets (DTAs) or Deferred Tax Liabilities (DTLs) (cont.) 42nd Annual Insurance Tax Conference 19 10

  16. Premiums 42nd Annual Insurance Tax Conference

  17. Premiums • Premiums are amounts collected by an insurer from a policyholder to provide coverage under a given insurance plan for a defined period of time • Earned premiums: portion of premium related to expiration of the contract’s risk period. Earned premiums are recognized currently in income • Unearned premiums: portion of gross written premium allocable to the unexpired term of the insurance contract. Instead of recognizing the unearned portion of premium income through P&L, a liability is established for the unearned premium reserve (UPR) • As terms of a contract expires, the related portion of the unearned premium becomes earned. The UPR liability is reduced and the earned premiums are recognized in income 42nd Annual Insurance Tax Conference 10

  18. Taxable Premium Income - Section 803(a) 42nd Annual Insurance Tax Conference 10

  19. Taxable Premium Income - Section 803(a) (cont.) 42nd Annual Insurance Tax Conference 10

  20. Investments 42nd Annual Insurance Tax Conference

  21. Interest • Investment income: Composed of the gross amount of income earned during the taxable year from interest, dividends, rents, and royalties. • Included in life insurance gross income under Section 803(a) • Annual Statement pg. 4, Line 3 & Exhibit of Net Investment Income • 1120-L, pg. 1, Line 4 42nd Annual Insurance Tax Conference 10

  22. Taxable Interestand DividendIncome 42nd Annual Insurance Tax Conference 10

  23. Taxable Investment Income 42nd Annual Insurance Tax Conference 10

  24. Investments • Basis for investments typically held by insurance companies: 42nd Annual Insurance Tax Conference 10

  25. Investment Income: Tax Return • Income earned on investments held by life insurance companies is typically treated as ordinary income for tax purposes under Section 803 • Interest, dividends, rents and royalties are taxed as ordinary income, similar to P&C companies, with the primary difference being the computation of proration percentages applied to dividends and tax-exempt interest • For life insurance companies, proration is calculated on tax-exempt interest and dividends received based on the percentage of overall investment income the company retains (company share percentage) • Differs from P&C companies which calculate proration of dividends and tax-exempt interest at a flat rate of 15% 42nd Annual Insurance Tax Conference 10

  26. Investment Income: Tax Return (cont.) • Investment Income – 1120-L, Schedule B, Line 13 • Investment Income – 1120-L, Schedule F, Line 9 42nd Annual Insurance Tax Conference 10

  27. DRD and Proration 42nd Annual Insurance Tax Conference

  28. Proration: Overview • Proration: Based on the theory that a portion of each type of investment income will ultimately fund obligations to policyholders with the remainder available to the company • Proration adjustment: Designed to prevent a life insurance company from receiving a double tax benefit by excluding TEI and the deductible portion of dividends from income while simultaneously receiving a deduction for an increase in reserves that is partially funded by receipt of tax advantaged investment income • Policyholder’s share of TEI is treated as a reduction of the deduction for “Increase in Reserves” or as an increase of the income for “Decrease in Reserves” as computed on Schedule F, Form 1120-L • DRD allowed to the extent of the company’s share of the otherwise allowable DRD as computed on Schedule A, Form 1120-L • Life insurance companies consider proration in making investment decisions since it impacts the after-tax yield of the investment 42nd Annual Insurance Tax Conference 10

  29. Proration: Dividends • Dividends: Distributions of a company’s earnings to its shareholders and are earned by insurance companies from equity investments held in its investment portfolio. • Dividends collected and earned during the year may be found in the Annual Statement Exhibit of Net Investment Income (taxed on collected) • Detailed investment portfolio on which an insurance company receives dividends may be found in the various sections of the Annual Statement Schedule D • Rev. Rul. 78-117 provides that accrued dividends do not have to be recognized as income because they are not actually or constructively received 42nd Annual Insurance Tax Conference 10

  30. Proration: Dividends 42nd Annual Insurance Tax Conference 10

  31. Proration: Life vs. P&C Tax • Deduction for dividends under section 805(a)(4) is allowed: • “For the life insurance company’s share of dividends,” and • “For 100 percent dividends received” • For purposes of proration, a percentage is developed for the portion of investment income that remains with the insurance company, “company share percentage,” and the portion that is distributed to policyholders, “policyholder share percentage” • As opposed to the flat P&C proration percentage of 15%, proration for life insurance companies considers the “policyholder share percentage” or percentage of investment income that will be distributed to policyholders 42nd Annual Insurance Tax Conference 10

  32. DRD and Proration: Current Tax • Step 1: Obtain gross dividend amounts for the Annual Statement Exhibit of Net Investment Income and record on Schedule C, Lines 1-9 • Step 2: Calculate DRD by multiplying gross amounts by DRD exemption amounts on Schedule A, Lines 1-9 • Step 3: Enter the company share percentage on Sch. A, Line 11 and prorate the dividends received deduction by the company share percentage (obtain from Sch. F, Line 32) • Step 4: Report total dividends received deduction amount from Schedule A, Line 16 column (c) on Page 1, Line 21 (a) and Sch. J, Line 2c 42nd Annual Insurance Tax Conference

  33. DRD and Proration: Current Tax Schedule A 2) Calculate DRD Step 1 Step 2 1) Obtain Gross Dividends from A/S Step 3 3) Prorate DRD by the Company Share % 42nd Annual Insurance Tax Conference

  34. DRD and Proration: Current Tax Schedule A Step 1 Step 2 Step 4 Step 3 4) Report the prorated DRD deduction on pg. 1, Line 21a and Sch. J, Line 2c Schedule J Step 4 Step 4 42nd Annual Insurance Tax Conference

  35. Reserves 42nd Annual Insurance Tax Conference

  36. Tax Reserves: Overview • Reservesarerecomputedfortaxpurposes • Lifeandannuityreservesshown onannualstatementexhibits5through7,including non-cancellableandguaranteedrenewable accidentandhealthreserves,are recomputedfortaxpurposesunderCode §807. • Changesreservesresultinincome ordeductions • Alifeinsurancecompanyincludesasincomeorexpensethedecreaseorincreasein lifeandannuityreserves. • Section803(a)(2):decreasesinreservesresultintaxableincome. • Section805(a)(2):increasesinreservesresultintaxdeductions. • Guidance • The CodeandtherelatedTreasuryRegulationsoutlinetheappropriatetaxreserve methodstoutilizeforthevariouscategoriesoflifeandannuitycontracts. 42nd Annual Insurance Tax Conference

  37. Life Reserves: GAAP and STAT • For both GAAP and STAT purposes, changes in a life insurance company’s reserves are recognized as income or loss in an effort to match income earned with the deduction for insurance claims • However, based on differences in accounting guidance, reserves maintained for GAAP and STAT purposes may differ • STAT insurance loss reserves may be larger than GAAP reserves for a particular company because of more stringent cash requirements under statutory accounting in comparison to GAAP • STAT interest rates used for discounting cash flows in determining reserves is much more conservative than interest rates use for GAAP 42nd Annual Insurance Tax Conference

  38. Life Reserves: Tax • Life Insurance Companies maintain statutory reserves for future policy claims and benefits determined by actuarial forecasts • Unlike most accrued liabilities, insurance companies are entitled to deduct reserves for future policy claims before they are paid pursuant to Section 807, subject to discounting for tax purposes • Life insurers revalue reserves based on actuarial determinations using recognized mortality/morbidity tables and assumed interest rates as described in Section 807 • Differs from property and casualty insurers who discount based on prescribed IRS discount factors  42nd Annual Insurance Tax Conference

  39. Life Reserves: Tax • Reserve strengthening/weakening • Change in basis of tax reserves • Amortized over 10 years pursuant to Section 807(f) • Decreases to reserves (reserve weakening) result in additional income spread over a 10-year period; results in a net DTL balance • Increases to reserves (reserve strengthening) result in additional deduction spread over a 10-year period; results in a net DTA balance • Principle-Based Reserving 42nd Annual Insurance Tax Conference

  40. Life Reserves: Tax • Reserves: 1120-L, Schedule F, line 1 • Life Reserves (Sch. F, Line 1): Change in reserves for future life insurance claims deductible for tax purposes • Unearned Premiums and Unpaid Losses (Sch. F, Line 2): Change in premiums unearned on contracts other than life insurance contracts • Advance Premiums (Sch. F, Line 5): Change in premiums received to secure coverage for policies not yet in force • Special Contingency Reserves (Sch. F, Line 6): Change in additional contingency reserves maintained for certain group term life or group accident and health insurance 42nd Annual Insurance Tax Conference

  41. Life Reserves: Current Tax • Step 1: Calculate tax basis reserves based on IRS prescribed methods and actuarial determinations • Step 2: Compare PY tax reserves to CY tax reserves and report the change on Sch. F, line 8 • Step 3: Factor in additional investment income ratio items and company share percentage of income • Step 4: Report the net increase (decrease) in reserves from Sch. F, line 35 on Form 1120-L, pg. 1, line 2 (decrease) or pg. 1, line 10 (increase) 42nd Annual Insurance Tax Conference

  42. Life Reserves: Current Tax (cont). Step 2 1) Calculate tax basis reserves based on actuarial determinations 2) Report change in tax reserves on Sch. F, Line 8 42nd Annual Insurance Tax Conference

  43. Life Reserves: Current Tax (cont). Step 3 Step 3 3) Factor investment income ratio and company share % into reserve calculation *Note that investment income ratio and company share % are discussed later in this section 42nd Annual Insurance Tax Conference

  44. Life Reserves: Current Tax (cont). Step 4 4) Report change in reserves on Form 1120-L, Page 1, Line 2 (decrease), or Line 10 (increase) 42nd Annual Insurance Tax Conference

  45. Life Reserves: Tax Financial Reporting • Step 5: Adjust the prior year loss reserve DTA by the current year M-1 amount • Step 6: Report the total in the current year cumulative temporary difference inventory • Cumulative temporary difference for loss reserves should be the tax-effected difference between reserves for financial reporting purposes and deductible reserves for tax purposes 42nd Annual Insurance Tax Conference

  46. Life Reserves: Tax Financial Reporting (cont.) 2011 Reserves M-1: $ 10,498 (949) $ 9,549 @ 35% $ 3,343 2011 DTA: $ 14,395 10,444 $ 24,839 @ 35% $ 8,694 6) Report total reserves DTA in cumulative temporary differences inventory 5) Adjust the PY DTA by the CY M-1 amount 42nd Annual Insurance Tax Conference

  47. Calculationoftaxbasischangein reserves Thechangeintheliabilityforadvancepremiumsanddeposittype contractsarecommonly classifiedasreclassadjustmentsandshouldgenerallyequalthecorrespondingpremium adjustment. 42nd Annual Insurance Tax Conference 10

  48. Deferred Acquisition Costs 42nd Annual Insurance Tax Conference

  49. Deferred Acquisition Costs (“DAC”): GAAP/STAT Financial Reporting (GAAP/STAT) Overview: • Deferred Acquisition Costs (“DAC”) is an asset on the balance sheet that represents the capitalization of the costs incurred by life insurance companies in acquiring new business (policies) • Examples of DAC are agent commissions, underwriting costs, and policy issuance costs • For GAAP purposes, DAC associated costs are capitalized and amortized as the gross profit emerges over the life of the insurance contract • For STAT purposes, the costs to acquire a policy are expensed immediately (i.e., there is no DAC capitalization for STAT) • Difference in treatment for DAC between GAAP and STAT creates significant GAAP/STAT differences 42nd Annual Insurance Tax Conference

  50. Deferred Acquisition Costs: Tax • Enacted in the 1990 Act • Requires life insurance companies to capitalize a portion of its general expenses and to amortize them to better match with income of the underlying policies; similar to GAAP DAC and 20% disallowance (or haircut) of UPR for P&C companies • Congress intended section 848 to operate as a proxy for all expenses incurred by an insurance company in connection with the selling of its products, including those incurred to develop such policies or to modify them to remain competitive (IRS CCA 200220006 (I.R.S. 2002)) • Service concluded that section 848 applies to direct selling costs as well as the cost of developing new products (IRS CCA 200220006 (I.R.S. 2002)) • Capitalized amount is generally amortized over 120 months 42nd Annual Insurance Tax Conference

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