Tax Reform: Insurance Provisions—Spotlight on Property & Casualty Insurers
A number of provisions included in the Senate’s tax reform bill, H.R. 1 (the Senate Bill) would impact the insurance sector. Many of the provisions would affect only the life insurance industry. Others affect property & casualty (P&C) insurance companies. Still others affect both life and P&C insurance companies.
Many of these proposals align with proposals in the tax reform bill passed by the House of Representatives and given that alignment, may be on the way to becoming law. We will be watching these provisions closely as this historic tax reform initiative proceeds.
Much of the public discussion regarding tax reform has focused on the international provisions. Two provisions in particular are likely to affect taxpayers with offshore captive insurance companies. In addition to watching these provisions, the insurance industry has been monitoring a number of other provisions. Relevant to the P&C insurance industry are provisions affecting net operating losses, discounted loss reserves, and, for P&C carriers with a diverse portfolio, the provisions affecting amortization of policy acquisition expenses.
Property & Casualty Insurance Provisions
Net Operating Losses
Both the House and the Senate propose to repeal section 810. Section 810 provides for an operations loss deduction, and permits a 3 year carryback and a 15 year carryforward. Both the House and the Senate bills would replace section 810 with the general net operating loss rules in section 172. Section 172 would be amended to eliminate the loss carryback provisions and to provide an unlimited carryforward period. Under the House Bill, losses would be able to offset only 90 percent of taxable income; under the Senate Bill, losses would be able to offset 90 percent of taxable income through 2022 and then 80 percent thereafter.
The Senate Bill adds a special rule for P&C insurance companies. Under proposed section 172(d)(1), an insurance company other than a life insurance company would be allowed to carry losses back for 2 years and forward for 20 years and to apply losses against 100 percent of taxable income.
The changes would be effective for losses arising in taxable years ending after December 31, 2017.
Discounted Loss Reserves
Both the House and the Senate propose changes to the computation of discounted unpaid losses. The changes are intended to align the loss reserve deduction with changes to the corporate income tax rate. Losses incurred by an insurance company generally include discounted unpaid losses. Section 832(b)(5) reduces discounted unpaid reserves by 15 percent of the sum of (1) tax-exempt interest; (2) certain dividends from affiliated corporations, and (3) the increase in policy cash values of certain types of insurance contracts. Both the House and the Senate bills adjust the factor by which the loss reserves are reduced to align to the proposed reductions in the corporate tax rate. For example, under the Senate Bill, the applicable percentage reduction is 5.25 percent divided by the highest rate in effect. Thus, if the highest rate is 35 percent, the applicable percentage is 15 percent. If the highest rate is 20 percent, the applicable percentage is 26.25 percent. The provision generally operates to prohibit a deduction for losses funded with untaxed earnings.
The House and Senate proposals are expected to generate $2.1 and $2.2 billion in revenues, respectively.
The House also proposes a modification to the discount rate applicable to unpaid losses. Under current law, the discount rate is the mid-term applicable federal rate. The House Bill proposes an amendment to section 846 which would apply the corporate bond yield curve as the discount rate. The House provision would also amend the loss payment pattern rules for discounting. The House proposal has a revenue score of $13.2 billion; the Senate bill does not have similar provisions.
Capitalization of Certain Policy Acquisition Expenses
Certain types of policies are subject to rules requiring capitalization of a portion of policy acquisition expenses. Under current law, these expenses are capitalized and amortized over a 120-month period. Policies covered by these rules are annuity contracts, group life insurance contracts and other group contracts covering a group of connected individuals, such as by employment or membership in an organization. These policies are typically issued by life insurance carriers but multi-line P&C carriers with life portfolios also may be affected by these provisions.
The House proposals would increase the percentage of policy acquisition expenses subject to the capitalization rules. The Senate proposal would both increase the percentage of policy acquisition expenses subject to the capitalization rules and would lengthen the amortization period from 120 months to 180 months. As originally proposed, the Senate proposal would have increased the amortization period to 600 months. In the bill that was passed, the period was changed to 180 months and the percentage of policy acquisition expenses subject to the rules was aligned with the House proposals.
The House proposal projects $7.0 billion in revenues; the Senate proposal projects $7.2 billion.
Both the Senate and the House propose changes to the active insurance business exclusion from passive income for purposes of the passive foreign investment company (PFIC) provisions. The proposal would limit the availability of this exception to insurance companies with specified levels of active insurance assets.
In addition, both the Senate and the House bills contain proposals aimed at base erosion. The House proposed a controversial 20 percent excise tax on payments by a US taxpayer to non-US related parties. The Senate proposes a base erosion minimum tax which imposes a tax on amounts paid or accrued by certain US taxpayers to a foreign related party with respect to which a deduction is allowed. Both the House and the Senate provisions may be applicable to certain cross-border related party insurance and reinsurance premiums notwithstanding the Internal Revenue Service’s position in Rev. Rul. 89-91 that the excise tax imposed under section 4371 is Congress’ mechanic for imposing and collecting tax on such premiums. Of note, that ruling applies to insurance premiums and does not specifically address reinsurance premiums.
The base erosion minimum tax is likely to be the subject of much discussion and debate over the several next days.
The House and the Senate appear aligned on a number of key provisions impacting P&C carriers suggesting perhaps a clear path to these provisions becoming law. These provisions impact both public and private P&C carriers. We will be watching these provisions as tax reform unfolds over the course of the next several days.