On December 22, 2017, President Donald Trump signed into law the Tax Cuts and Jobs Act (TCJA), providing one of the most comprehensive changes to U.S. tax code in decades. As a result, insurance companies must begin to understand the impact this historic new tax law has on future tax liabilities, surplus, risk-based capital ratios, and tax planning strategies. In general, the tax provisions will become effective for taxable years beginning after 2017. However, the financial reporting for the new tax bill will need to be considered for the year end December 31, 2017 financial statements and will likely result in impacts to reported tax balances.
The bill contains general business provisions affecting all corporations as well as key changes impacting P&C Insurers and Life Insurers. Congress and the IRS will provide guidance in many areas to clarify many questions that exist on the application of the new law.
General Corporate Provisions
Following are several of the general provisions that affect all corporations, including insurance companies:
- Modifies the current graduated rate system with a maximum tax rate of 35% to a flat tax rate of 21%
- Repeals the corporate alternative minimum tax (AMT)
- Allows for 100% expensing of new and used equipment purchased from September 28, 2017, through December 31, 2022
- Increases Section 179 expensing limitations to $1 million, the phaseout to $2.5 million, and allows Section 179 expensing of qualified improvement property
- Limits net interest deduction to 30% of adjusted taxable income
- Decreases the dividend-received deduction from 80% to 65% and from 70% to 50%
- Disallows deductions for entertainment expenses
- Includes an employer credit for paid family and medical leave
- Repeals the two-year carryback for net operating losses (NOLs)
- Limits use of NOL carryforwards generated in 2018 and later to 80% of taxable income. The use of NOL carryforwards generated prior to 2018 are not limited.
Insurance-Related Tax Provisions
Property and Casualty (P&C) Insurers
The legislation enacts the following changes for P&C insurers:
- Replaces the fixed 15% proration reduction in the reserve deduction with a reduction equal to 5.25% divided by the current maximum corporate tax rate. This equates to a 25% proration with a 21% corporate tax rate.
- Requires P&C insurance companies to use the corporate bond yield curve, which typically will be a higher rate than what is used currently, in order to discount unpaid loss reserves under IRC Section 846.
- Modifies the computation rules for “long-tail” loss payment patterns by extending the payout periods by up to a 14-year period.
- Repeals the election to use company-specific rather than industrywide historical loss payment patterns pursuant to Section 847.
- Repeals the rules for special estimated tax payments found in Section 847.
- Preserves the current law for P&C NOLs, which will allow such NOLs to be carried back two years and carried forward 20 years to offset 100% of taxable income in applicable years.
The legislation makes the following changes for life insurers:
- Amends Section 807(d) life insurance reserves for a contract generally equal to the greater of the net surrender value of the contract or 92.81% of the reserve prescribed by the NAIC with respect to that contract. The commissioners’ reserve valuation method (CRVM) and the commissioners’ annuity reserve valuation method (CARVM) are specifically prescribed for life and annuity contracts, respectively. For variable contracts, the amount of life insurance reserves for a contract is the sum of the greater of the net surrender value of the contract or the separate-account reserve amount under Section 817 for the contract, plus 92.81% of the excess of the amount determined using the tax reserve method.
- Takes into account any resulting Section 481 adjustment from the difference in computing life insurance reserves from the current law to the new law over an eight-year period.
- Increases the deferred acquisition expense capitalization percentages to 2.09% for annuity contracts, 2.45% for group life, and 9.20% for all other contracts. It also lengthens the amortization period from a 120-month to a 180-month period.
- Repeals the small life insurance company deduction.
- Adjusts the 10-year spread for changes in computing life insurance company reserves under IRC Section 807(f) to be consistent with IRS accounting change methodologies prescribed by Section 481.
- Repeals policyholder surplus accounts put into effect prior to 1984. Any remaining policyholder surplus account balances are taken into income over an eight-year period beginning in 2018.
- Modifies the life insurance company proration rules so that the company share of dividends equals 70% and the policyholder’s share equals 30%.
- Modifies life insurance companies’ NOL deduction by adopting the general corporation rules under Section 172, as discussed in the important general business provisions.
Financial Reporting Impacts of the New Tax Law
The tax bill impacts previously described are mostly applicable to reporting taxable income for periods subsequent to 2017. Less noticed has been the financial reporting implications of the new tax law beginning in 2017. Since the new law was “enacted” into law on December 22, 2017, the new tax law must be applied in calculating income tax provisions and deferred income taxes as of December 31, 2017. The most noticeable impact will be remeasuring all deferred income tax assets (DTA) and deferred tax liabilities (DTL) for the impact of the lowered 21% corporate tax rate.
As a backdrop, the overall tax regime for the insurance industry generally results in insurance companies recognizing income from operations earlier for income tax purposes than for financial reporting purposes. The accelerated recognition of taxable income typically results in insurers recognizing deferred tax assets for financial reporting purposes related to this timing difference of accelerating recognition of taxable income. Since insurance companies generally recognize DTAs for financial reporting, these DTAs will need to be remeasured as of December 31, 2017, using the lowered 21% corporate income tax rate which were previously recognized at 35%. The remeasurement alone is expected to result in reductions in DTAs and surplus in most cases.
Unrealized gains and losses on investment portfolios also give rise to deferred tax assets and liabilities which will also need to be remeasured using the lower tax rates at December 31, 2017. The impacts of this remeasurement will depend on whether the investment portfolio is in an unrealized gain or loss position.
U.S. Generally Accepted Accounting Principles (GAAP)
Under GAAP, as set forth in Section 740 of the Accounting Standards Codification (“ASC 740”), the effects of changes in tax rates on deferred tax balances are to be recognized as a component of income tax expense in continuing operations during 2017. Consequently, under current GAAP guidance, the tax effects of items originally recognized within accumulated other comprehensive income (referred to as stranded tax effects) would not reflect the appropriate tax rates.
The Financial Accounting Standards Board (FASB) has recently exposed guidance which, if approved, would remedy the stranded tax effects in accumulated other comprehensive income.
NAIC Statutory Accounting Principles (SAP)
Under SSAP No. 101 – Income Taxes (SSAP No, 101), all changes in deferred tax balances, including the effects of changing enacted tax rates are recognized as direct adjustments to capital and surplus during 2017, the year of enactment.
The Statutory Accounting Principles Working Group has evaluated the new tax law’s impacts on SSAP No. 101 and has proposed nonsubstantive revisions to reflect current considerations; however, these revisions are not expected to significantly change statutory accounting principles.
If you have any questions on how the changes might impact your organization, contact us today. For more resources on tax law changes, check out our Tax Reform page.