HEALTHCARE

1. HEALTHCARE

2. Patient Protection and Affordable Care Act PL 111-148 HR 3590

3. Patient Protection and Affordable Care Act • Important Features: • An annual fee on health insurance providers • Mandatory Form 1099 reporting • Inclusion of annuities in the definition of unearned income subject to the 3.8 percent Medicare tax imposed on certain individuals • 40 percent excise tax on high-cost employer health plans • $500,000 section 162(m) limitation • Elimination of the employer deduction for the portion of retiree prescription drug coverage offset by Medicare Part D coverage • Limitation on eligibility for section 833 benefits to otherwise qualifying Blue Cross Blue Shield organizations

4. Health Reform • Medicare Advantage provisions: • Moves benchmarks closer to parity with FFS • Bonuses for quality • 85% minimum MLR beginning in 2014 • Medical costs to include medical management / quality expenses • Limits annual selling season: October 15 – December 7 (2012 plans) • Insurance industry tax beginning in 2014 • Accountable Care Organization pilots are a potential positive • Lengthy implementation timeline creates opportunity for policy/political changes

5. The Timeline of Reform • Open enrollment period 10/15-12/7 (2012 plans) • Begin phase-in of bonuses to plans based upon Star quality rating system • Begin ACO pilots • Introduce MA minimum MLR of 85% • $8 billion annual fee on insurance sector • $11.3 billion annual fee on insurance sector • $13.9 billion annual fee on insurance sector • $14.3 billion annual fee on insurance sector (indexed to premium growth in 2019+)

6. Form 1099 – Processing an IRS B-Notice • IRS Sends out B-Notice lists twice a year: fall and spring (relates to immediately prior year 1099s) • Most penalties assessed for name/TIN mismatch or missing TINs • New requirements related to first & second B-Notice letters: • Which notice you send depends on the number of times within a three calendar year period the payee has appeared on the list. • IRS will not tell you how many times a payee has appeared. Company must track all notifications over that three year period. • First appearance (First Notice) • First B-Notice letter sent – IRS language • Form W-9 • Payee responds with Form W-9 • Second appearance (Second Notice) • Second B-Notice letter sent – IRS language • No Form W-9 • Payee must obtain government documentation of the payee’s correct name and TIN • Deadlines for processing B-Notice list • 15 business day from ‘basis date’: mail B-Notice letters to payees • 30 business days from ‘basis date’: backup withhold on payments to payees who have not responded to the letters • B-Notice mailing contents • Envelope with bold and conspicuous “Important Tax Document Enclosed” or “Important Tax Return Document” language on it • Required B-Notice letter – first or second • Form W-9 (if first notice) • Return envelope (optional) • Processing and documenting a Company’s handling of B-Notices is important as this is how you get penalties waived • IRS has announced back-up withholding audits on the increase • Potential for increased revenues • Form 1099 penalties to increase from $50 to $100 (starts for 2010 Form 1099s filed in 2011) • IRS TIN matching program should be utilized

7. 2010 Tax Legislation: Section 162(m)(6)Compensation Limitation • Health Act – Limits on Deductibility of Compensation for “Covered Health Insurance Providers” • The new code Section 162(m)(6) limits the deduction for compensation to the amount of $500,000.00 for compensation paid to employees, directors and independent contractors for years 2013 and after. Impact on compensation earned during years 2010 to 2012 and deferred until 2013 and later. • One definition of covered health insurance provider for years 2010 through 2012-health insurance coverage under Section 9832 (b)(1). • Another definition for years 2013 and later- any health insurance company which has 25% or more of its gross premiums from health insurance for “minimum essential coverage”.

8. WellPoint Inc. v. Commissioner • WellPoint Inc. v. Commissioner, 599 F.3d 641 (7th Cir. 2010 • The Seventh Circuit (affirming the Tax Court) held that an insurance company is not entitled to deduct as business expenses the amounts it paid to settle lawsuits and for related legal and professional expenses, finding that the suits were to resolve its title to assets and the expenses are capital expenditures.

9. Property & Casualty Insurance

10. Tax Treatment for Protected Cell Insurance Arrangements - Proposed Treas. Reg. §301.7701-1- Notice 2008-19

11. Tax Treatment for Protected Cell Insurance Arrangements • Prop. Treas. Reg. §301.7701-1: • Issued Sept-14-2010 to expand on Notice 2008-19 (which requested comments) • An individual cell will be treated as a separate entity for Federal income tax purposes if the cell qualifies as an “insurance company” under the Code. • The Prop. Regs. do not apply to an individual cell that is organized under foreign laws unless the cell is engaged in an insurance business. • Effective date: Date the final regulations are published.

12. Tax Treatment for Protected Cell Insurance Arrangements • Prop. Treas. Reg. §301.7701-1: • Preamble to regulations notes that industry-specific guidance may still be issued to address issues indentified in Notice 2008-19 • … whether activities of the cell are disregarded in determining the status of the cell company as an insurance company. • Other insurance issues unanswered in proposed regulations: • How are protected cells to be treated? • How are foreign protected cells (that do not qualify as insurance) to be treated? • What are the tax implications of a cell that is treated as a separate company one year … yet fails to qualify as a separate company in a following year?

13. Tax Treatment for Protected Cell Insurance Arrangements • Notice 2008-19: • Previously provided guidance on the standards for determining whether an arrangement between a participant and cell of a protected cell company is insurance for income tax purposes and whether amounts paid to the cell are deductible as insurance premiums under section 162. • Notice 2008-19 describes how arrangements between an individual cell and its owners are analyzed for purposes of determining whether there is adequate risk shifting and risk distribution so as to constitute insurance.

14. Coordinated Issue Paper on Loss Reserves • The IRS recently issued a Coordinated Issue Paper (CIP) entitled “Non-Life Insurance Industry — Margins and Other Unsubstantiated Additions to Insurance Company Reserves for Unpaid Losses and Claims, Coordinated Issue Paper (LMSB4-1109-041)” • Issued November 18, 2009 • CIPs are generally issued in an attempt to identify and resolve industry-wide issues that the IRS views as significant. • CIPs are not official IRS pronouncements, • CIPs provide insight into IRS’s current thinking, • CIPs provide guidance to IRS field examiners on treatment of issue in examinations, and • CIPs cannot be cited or relied upon as IRS authority.

15. Coordinated Issue Paper on Loss Reserves • Deals with the deductibility of margins and other unsubstantiated additions to reserves. • Concludes: • That estimates for unpaid losses must be fair and reasonable and must represent actual unpaid losses. • Margins and other unsubstantiated additions not based on actual loss experience are not deductible as losses incurred.

16. LMSB-4-1109-041 Issue • Issue: May margins or other additions to reserves for unpaid losses shown on an insurance company's Annual Statement be included in the computation of "losses incurred" for federal income tax purposes where the taxpayer fails to establish that the additional amounts are based upon the company's actual loss experience and the total reserve is in excess of a fair and reasonable estimate within the meaning of Treas. Reg. § 1.832-4(b)?

17. LMSB-4-1109-041 Background • Statutory Accounting • Note that SSAP No. 55 refers to management’s best estimate for estimating loss reserves, not the actuary’s best estimate. • Annual Statement conservatism • The primary goal of regulation is to preserve the financial assets and solvency of the company, thereby assuring that the insurer will satisfy loss claims". • The working group reached a consensus that the concept of conservatism is inherent to the estimation of reserves and as such should not be specifically prohibited in the consideration of management’s best estimate. 

18. Coordinated Issue Paper on Loss Reserves • Other Comments and Conclusions: • Not all ‘reserves’ shown on the Annual Statement or allowed by state insurance regulators are allowable as deductions for federal income tax purposes. • The Service is not bound by the numbers shown on the Annual Statement. • The Service is not bound by the statement of Actuarial Opinion • For tax purposes, the deduction for unpaid losses must be based on actual loss events. • The deduction for unpaid losses must represent a fair and reasonable estimate of the amount the company expects to pay. No administrative "margin" or "tolerance" is required or allowable. • The determination of a fair and reasonable estimate of unpaid losses is a factual determination to be made based on the standards set forth in the Regulations. The taxpayer must establish that the deduction for unpaid losses is comprised of only actual unpaid losses, and the taxpayer may be required to submit detailed information with respect to its actual experience as is deemed necessary to establish the reasonableness of the deduction.

19. Coordinated Issue Paper on Loss Reserves • Other IRS Observations and Comments: • Formula reserves are not allowable • No administrative tolerance is allowed • Tax and Annual Statement reserving standards are different

20. Coordinated Issue Paper on Loss Reserves • Instructions to IRS Examiners: • The first step in the examination of unpaid losses is to make an independent evaluation of the amount claimed as a deduction, without regard to the manner in which the taxpayer's Annual Statement reserves were determined or the labels or descriptions which the taxpayer attaches to any additions to its Annual Statement reserves. • If the independent evaluation results indicate reserves are redundant, then “any excess over a fair and reasonable amount may be disallowed on that basis alone.” • Estimates of unpaid losses must represent actual unpaid losses“where an overstatement of loss reserves is due to distinct and identifiable additions to unpaid losses, including ‘explicit’ margins or other ‘add-ons,’ any excess over a fair and reasonable amount may be disallowed on the basis that it does not comprise actual unpaid losses … the reserve addition fails the ‘fair and reasonable’ standard and also constitutes an unallowable contingency reserve or solvency reserve.”

21. Rev. Rul. 2009-26 - Risk Distribution • Situation 1- In Year 1 Z enters into a single reinsurance contract with Y in which it assumes 90 percent of the premiums and policy obligations on 10,000 underlying policies issued by Y. The reinsurance contract was Z’s only business in Year 1. • The ruling held that Z could “look through” the single reinsurance contract to the underlying risks assumed in assessing whether it met the risk distribution requirements necessary to qualify as an insurance company for federal income tax purposes. • Cites Alinco Life Insurance Co. v. United States, 373 F.2d 336 (Ct.Cl. 1967) as authority.

22. Rev. Rul. 2009-26 - Risk Distribution • Situation 2 – In Year 1 Z enters into a 90 percent quota share arrangement with Y which covered only the risks of X a policyholder of Y unrelated to Z. In addition Z assumed risks of other policyholders unrelated to X but in the same line of business through contracts with other insurance companies. The reinsurance contracts were Z’s only business in Year 1 • Z's agreement with Y is treated as “reinsuring risks” underwritten by insurance companies because, even though the agreement with Y covered only the risks of a single policyholder, Z assumed sufficient risks under agreements with other insurance companies in Year 1 such that the requirement of risk distribution was met.

23. TAM 201006029 • TAM 201006029 • The IRS determined that a taxpayer's general declaration of its surplus does not constitute a policyholder dividend under section 832(c)(11).

24. TAM 200939019 • P/C insurance company included in unpaid loss adjustment expense an amount for future retiree medical benefits for claims personnel • Company deducted as discounted unpaid losses under section 832(b)(5) • Ruling concluded section 404(a) controlled timing of deduction, i.e., when amounts are included in income of claims personnel • Section 404(a) controls over section 832(b) • Application to claims personnel salaries included in unpaid loss adjustment expense?

25. Life Insurance Companies

26. Overview – Life Insurance Companies Corporate Tax • Terminal Dividends – PLR 200948042 • Reserves – American Financial Group • Segregated Asset Amounts 953(d) Companies – PLRs 201027838 & 201038008 • Section 351 & Revenue Rule 94-95 – PLR 201006002 • Section 338(h)(10) – PLRs 21015028 & 201026008 Investment Tax • Finance Reform and IRC Section 1256 Contracts • Impairment and IRC Section 166 Product Tax • Annuity Tax – Partial Annuitization • Annuity Tax – Partial Exchange • Policyholder Tax 7702/7702A – Revenue Procedure 2010-28 Other • Foreign Life Branch – CCA 201013001

27. Corporate Tax - PLR 200948042: Terminal Dividends • The Taxpayer issues “participating” life insurance policies that entitle policyholders to receive two types of dividends: annual dividends and termination dividends. • An annual dividend is payable to each policyholder on the anniversary date of his or her policy, and represents a share of the Taxpayer’s divisible surplus earned from business operations during the preceding year. • A termination dividend is a one-time dividend payable to certain policyholders when the policy terminates due to the death of the insured or the maturity or surrender of the policy. • The Taxpayer accrues and deducts on December 31 of each taxable year the amount of dividends that will become payable with anniversary dates in January of the following year on the basic amount of the annual dividend to policyholder accounts prior to December 31. • PLR concludes that following “all events” test that: • The Taxpayer may not accrue and deduct the taxable year annual dividends on an insurance policy that, under the terms of the policy, may become payable during the first month of the succeeding taxable year. • The Taxpayer may not accrue and deduct in the taxable year the lesser of the termination dividend or annual dividend that, under the terms of the policy, become payable in the succeeding taxable year. • Liability is a “Payment Liability”.

28. Corporate Tax – ReservesAmerican Financial Group, 105 AFTR 2d 2010-1587 • At issue was the application of AG 33 to annuity contracts issued before 1995 • IRS argued that AG 33 constituted a change to CARVM and reserves for contracts issued before 1995 could not take AG 33 into account. • Taxpayer agreed that AG 33 was not a change to CARVM but was an interpretation of the proper application of CARVM. • Court found for the Taxpayer. • Government has appealed.

29. Corporate Tax – Segregated Asset Accounts of Electing Section 953(d) Companies – PLR 201027038; PLR 201038008 • At The separate accounts to which the company allocates all or part of the amounts received under life insurance and annuity contracts issued by the company, which pursuant to foreign country law, are segregated from the general asset accounts of the company, will be treated as accounts that are segregated from the general asset accounts of the company, "pursuant to State law or regulation." • Pursuant to foreign country law, these accounts are segregated from the company’s general accounts. The ruling addressed whether the separate accounts should be treated as accounts segregated from the general asset accounts of the company, “pursuant to State law or regulation.” • Anomalies cited as bases for conclusions: • If the separate account products are denied variable account status, the diversification rules of section 817(h) and the regulations there under will not apply to the separate account products. The result will be that the separate account products will be recognized as life insurance contracts without meeting the diversification rules. Congress' stated purpose in enacting the diversification requirements, to discourage the use of tax-preferred variable annuity and variable life insurance primarily as investment vehicles, would be subverted. • A foreign insurance company that elected to be treated as a domestic insurance company under section 953(d) would be able to issue separate account products that do not meet the diversification rules, but nevertheless qualify as life, endowment, or annuity contracts. The inside buildup on the electing foreign company's non-diversified contracts would not be subject to current taxation, while the inside buildup on non-diversified contracts issued by domestic companies would be subject to current taxation.

30. Corporate Tax – Section 351 & Revenue Rule 94-95PLR 201006002 • Reaffirms that assumption reinsurance will qualify for IRC treatment as per Revenue Ruling 94-45. • Ruled on a series of exchanges done by an international group. • In general no gain or loss will be recognized except that the transferee company will recognize as ordinary income gain affiliated with market discount bonds. • Indemnity reinsurance may not be sufficient.

31. Corporate Tax – IRC Section 338(h)(10)PLR 201015028; PLR 201026008 • Reconfirmation of use of IRC 338(h)(10) in a spin off • Parent and Seller plan to dispose of more than 50% of NewCo • NewCo was formed to acquire all the stock of certain Parent subs • Seller will enter into a binding agreement with an unrelated third party and will enter into a firm commitment underwriting agreement to effect the subs of NewCo common stock in an IPO • An affiliate of Parent may act as one of several underwriters in an IPO • PLR concluded that Parent on behalf of Seller and NewCo will be eligible to make the election under IRC Section 338(h)(10)

32. Investment Tax – Finance Reform and IRC Section 1256 Contracts • “2010 Financial Regulation Act” amends Code Section 1256 and broadens the list of contracts that are excepted from the definition of Section 1256 that is excepted from mark-to-market treatment. • Section 1256 contracts are mainly regulated futures contract, foreign currency contract, non-equity option, dealer equity option, and dealer securities futures contract. • Section 1256 contracts are marked-to-market at year end. • Any capital gain or loss on a Section 1256 contract that is marked-to-market is treated as if 40% of the gain or loss is short-term capital gain or loss, and as if 60% of the gain or loss is long-term capital gain or loss. • For tax years beginning after the enactment date, the 2010 Financial Regulation Act provides that all of the following are excepted from the definition of a Section 1256 contract: Any interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement. • The change addresses the re-characterization of income as a result of increased exchange-trading of derivative contracts by clarifying that Code Section 1256 does not apply to certain derivatives contracts transacted on exchanges.

33. Investment Tax – Impairments – SSAP 43R • Recently adopted SSAP 43R requires insurers to allocate other than temporary impairment (OTTI) charges between interest-and non-interest-related declines in the value of all loan-backed and structured securities. • The requirements are similar to those in U.S. GAAP. • SSAP 43R defines a non-interest-related decline in value as one caused by the issuer’s fundamental credit problems. An interest-related decline in value is caused by increases in the risk-free interest rate and/or general credit spread widening.

34. Investment Tax – Impairments – SSAP 43R • If the fair value of a loan-backed or structured security is less than its amortized cost basis at the balance-sheet date, the insurer must determine whether the following circumstances exist and, if so, recognize a loss: • If the insurer intends to sell the security or does not have the intent and ability to retain the security until its amortized cost is recovered, the security is other-than-temporarily impaired. • A realized loss is recognized for the entire difference between the security’s amortized cost and its fair value at the balance sheet date.

35. Investment Tax – Impairments – SSAP 43R • If the insurer does not expect to recover the entire amortized cost from the present value of the security’s future cash flows, it cannot assert it has the ability to recover the security’s amortized cost even though it has no intent to sell and has the intent and ability to retain the security. • The security is therefore other-than-temporarily impaired. A realized loss is recognized for the non-interest-related decline, which is the difference between the security’s amortized cost and the present value of cash flows expected to be collected. • OTTI related to interest-related declines is not recognized.

36. Investment Tax – Impairments – SSAP 43R • SSAP No. 43R applies to investments held as of September 30, 2009, and to new investments purchased and held by the reporting entity after September 30, 2009. • It supersedes SSAP No 98 and paragraph 13 of SSAP No. 99.

37. Investment Tax – Impairments – Tax Issues • Section 166 vs. section 165 deduction • Determination of the amount of partial worthlessness • Is it the same as the OTTI charge? • Pre and Post SSAP 43R • Write down to fair value vs. present value of cash flows

38. Product Tax – Annuity Taxation2010 Small Business Act – Partial Annuitization • In Rev. Proc. 2008-24, he IRS had ruled on the treatment of the partial exchange of annuity contracts, but specifically stated that the ruling did not apply to partial annuitization, which is the conversion of only a portion of an annuity, endowment or life insurance contract into annuity payments. • In Rev. Proc. 2010-3, IRS identified partial annuitization as a no ruling area that is under study by IRS. • Under 2010 Small Business Act, the basic annuity taxation rule Code Sec. 72(a)(1) is retained without change. However, the 2010 Small Business Act added a new rule that will permit the partial annuitization of a nonqualified annuity, endowment, or life insurance contract. • Effective for amounts received in tax years beginning after 2010.

39. Product Tax – Annuity Taxation – PLR 201038012 • LTR 201038012 Partial Exchange qualified under section 1035. • Ruling sought because insurer issued letter that a withdrawal from the retained contract following the partial exchange precluded section 1035 treatment. • Taxpayer argued that because he had attained the age of 59½ years, the withdrawal should qualify as a tax-free exchange under §4.01(b) of Rev. Proc. 2008-24. • IRS Ruled in favor of the Taxpayer.

40. Product Tax – Policyholder Tax 7702/7702A • Revenue Procedure 2010-28 • The 2001 CSO tables became the prevailing commissioners’ standard tables during calendar year 2004, and have been adopted by all 50 states. • Unlike the 1958 Commissioners Standard Ordinary Mortality Tables (“1958 CSO tables”) and the 1980 Commissioners’ Standard Ordinary Mortality Tables (“1980 CSO tables”), the 2001 CSO tables extend to age 121. • As a result, an increasing number of issuers now develop contracts with maturity dates beyond age 100, even though the qualification of a contract as a life insurance contract (and as a MEC) is tested using computational rules that deem the contract to mature between the day on which the insured attains age 95 and the day on which the insured attains age 100. • Revenue Procedure 2010-28 addressed this stating that the service will not challenge the qualification of a contract as a life insurance contract under §7702, or assert that a contract is an MEC under §7702A, if the contract satisfies the requirements of those provisions using all of the Age 100 Safe Harbor Testing Methodologies of this revenue procedure.

41. Other – Foreign Life Branch – CCA 201013001 • Taxpayer conducts a U.S. life insurance business through a branch that constitutes a U.S. permanent establishment. • In computing its interest expense allocable to its U.S. ECI under §1.882-5, Taxpayer included the branch’s insurance reserves in both U.S. booked and world-wide liabilities. • However, in determining its deductible interest expense, Taxpayer did not reduce the amount allocated to its U.S. ECI by items of interest in respect of the reserves described in section 807(c). • CCA concluded that: • Taxpayer must use the allocation method set forth in §1.882-5 to determine the interest expense allocable to its U.S. branch for purposes of determining its U.S. income tax liability for its 2001-2002 taxable years. • The amount of interest expense allocable to Taxpayer’s U.S. ECI is computed by applying the three-step method set forth in §1.882-5. • The amount of interest paid or accrued on Taxpayer’s U.S. booked liabilities includes interest in respect of items described in section 807(c). • Under the theory that money is fungible, a pro rata share of the total interest expense allocated to Taxpayer’s U.S. ECI should be allocated to each U.S. asset, including the undivided part of Taxpayer’s assets “reserved to meet insurance obligations.”