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CPAs & ADVISORS

FUNDAMENTALS OF INSURANCE COMPANY TAXATIONTom Wheeland, PartnerBKD, LLP

T4

AGENDA

Annual Statement Walk-ThroughRevenue RecognitionDeductions & LossesOther Items

SAP ASSETS (PART 1)

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SAP ASSETS (PART 2)

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SAP LIABILITIES

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SAP SURPLUS

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SAP SURPLUS ROLLFORWARD

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SAP PREMIUMS EARNED

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SAP INVESTMENT INCOME

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INVESTMENT INCOME FOOTNOTE

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SAP CAPITAL GAINS/LOSSES

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SAP UNREALIZED GAINS/LOSSES

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SAP INCOME STATEMENT

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SCHEDULE P SUMMARY

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REVENUE RECOGNITION

PremiumsPremiums are deferred until earned under SAPTax law allows a deferral of a portion of premiums

For PC companies, deferral is generally 80% pursuant to §832(b)(4)

(A) From the amount of gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance.(B) To the result so obtained, add 80 percent of the unearned premiums on outstanding business at the end of the preceding taxable year and deduct 80 percent of the unearned premiums on outstanding business at the end of the taxable year

Results in a better matching of income & related expensesCreates a deductible temporary difference

REVENUE RECOGNITION

Investment incomeInterest

Most companies elect to defer the accrual of market discount (a taxable temporary difference) – IRC §§1276 and 1278

Original issue discount can generally not be deferred - IRC §1272

Interest from bonds issued by state & local governmental authorities may be tax-exempt (a permanent difference) - IRC §103

P&C companies subject to 15% proration charge on tax-exempt interest and DRD (reduction in losses incurred) - IRC §832(b)(5)(B)

Life companies must consider company share percentage (IRC §§805 and 812)

REVENUE RECOGNITION

Investment income (cont.)Dividends

Most companies elect to defer recognition of dividends until received (a taxable temporary difference) – Rev. Rul. 78-117Dividends received deduction available for certain dividends - IRC §243

Qualification based upon whether domestic or foreignPercentage based upon ownership interestA permanent difference

P&C companies subject to proration (see discussion on losses incurred)Life companies must consider company share percentage

REVENUE RECOGNITION

Investment income (cont.)Partnerships

Taxation governed by K-1SAP treatment typically accounted for on equity methodMay create a taxable or deductible temporary difference

REVENUE RECOGNITION

Capital gains & lossesSAP “realized” gains & losses may result from actual sales/dispositions or other than temporary impairments (“OTTI”)Tax realized gains & losses generally result from actual sales/dispositions (some exceptions apply)Assuming OTTI losses are not currently claimed for tax purposes, this creates a deductible temporary differenceLimitations on deductibility of capital losses

Can only offset capital gains - IRC §1211

3 year carryback and 5 year carryforward - IRC §1212

REVENUE RECOGNITION

Capital gains & losses (cont.)SAP unrealized gains & losses also create temporary differencesTax net capital losses (essentially a deductible temporary difference)

Can be carried back 3 years (but cannot create an NOL) & forward 5 yearsOrdinary losses can offset capital gains but capital losses cannot offset ordinary income

DEDUCTIONS & LOSSES

Losses incurredLoss & LAE reserves for P&C companies are discounted for tax purposes

Companies can elect to discount using industry or company-specific discount factorsElection to use company data applies only to eligible linesIneligible lines must be discounted using industry factorsElection applies to all years in 5 year election period

Reserves discounted for SAPShould first be grossed-up & then discounted for tax purposesTax reserve is lower of discounted SAP or discounted tax reserve (by line of business & accident year)

Life tax reserves are calculated by life actuaries

DEDUCTIONS & LOSSES

Losses incurred (cont.)Reserves result in deductible temporary differencesSalvage & subrogation is also discounted and offsets loss & LAE reserves

Essentially the inverse of losses & LAEMust be accrued for tax purposes, even if not accrued for SAPMust be discounted using industry factorsRepresents a taxable temporary difference (unless not accrued for SAP, in which case it represents a deductible temporary difference)

Losses incurred deduction is reduced by proration (15% of tax-exempt interest & DRD) – a permanent difference

DEDUCTIONS & LOSSES

Deferred acquisition costsFor life policies, a percentage of premiums are capitalized as acquisition costs & amortized over a specified period of timeFor P&C policies, the unearned premium haircut was established to accomplish the same goal – better matching of income & related expenses

DEDUCTIONS & LOSSES

General expensesSubject to the general deductibility rules applicable to all corporationsIRC §461 for non-compensation related expenses

All events testLiability can be determined with reasonable accuracyEconomic performanceRecurring item exception

DEDUCTIONS & LOSSES

General expenses (cont.)Compensation-related expenses are subject to the same rules, but must be paid within 2.5 months after year-end (see IRC §404 & related regulations)To the extent deferred for tax purposes, these create deductible temporary differences

OTHER ITEMS

Net operating losses/operations loss deductions (essentially deductible temporary differences)

NOL can be carried back 2 years & forward 20OLD can be carried back 3 years & forward 15

Policyholder dividendsDeductible as essentially a return of premiumsGoverned by rules similar to IRC §461To the extent deferred for tax purposes, these create deductible temporary differences

OTHER ITEMS

Small life insurance company deduction (“SLICD”) – permanent differenceAlternative minimum tax (“AMT”)

Tax-exempt interest (net of proration) creates ACE add-backDRD (net of proration) creates ACE add-backSLICD treatment variesAMT credit is a DTA

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