Facilitators Barbara Gold Donald Drees

Transcription

1 Product Tax Seminar September 20 21, 2012 Washington, DC Life Insurance Product Tax Update Chair John Adney Chris DesRochers Facilitators Barbara Gold Donald Drees

2 2012 Product Tax Seminar Session 1 Life Insurance Product Tax Update September 20, 2012 Marriott Metro Center Washington, DC Presenters Moderators: Chris DesRochers, Ernst & Young LLP John Adney, Davis & Harman LLP Faculty: Barbara Gold, Prudential Don Drees, Internal Revenue Service 2 2

3 What Is Section 7702 Cash Surrender Value? 3 3 Defining Cash Value Statutory definitions Legislative History Proposed Regulations Letter Rulings Guidance Plan FATCA Definition 4 4 4

4 Cash Surrender Value Timeline 1984: 7702: Legislative History 1992: 1993: 2005: PLRs Proposed Notice Regulations 37 & : PLR : PLR : PLR : Priority Guidance Plan 2012: FATCA 5 5 Cash Surrender Value Defined 7702(f)(2)(A): The cash surrender value of any contract shall be its cash value determined without regard to any surrender charge, policy loan, or reasonable termination dividends Cash surrender value is a necessary element of compliance with section 7702 Cash value accumulation test Section 7702(d) cash value corridor 6 6

5 1984 Legislative History Any amount to which the policyholder is entitled upon surrender and, generally, against which the policyholder can borrow Determined without regard to any surrender charge, policy loan or reasonable termination dividend Excludes amounts returned under credit life insurance policies (because amount is not subject to borrowing) 7 7 Proposed Treas. Reg Cash value of a contract is the greater of: Maximum amount payable under the contract (determined without regard to any surrender charge or policy loan); or Maximum amount that the policyholder can borrow under the contract Amounts excluded from cash value Death benefit and qualified additional benefits Other benefits Amounts returned on termination of credit life Reasonable termination dividends not exceeding $35 per $1,

6 FATCA Cash Value Definition The term cash value means the greater of The amount that the policyholder is entitled to receive upon surrender or termination of the contract (determined without reduction for any surrender charge or policy loan), and The amount the policyholder can borrow under or with regard to the contract 9 9 FATCA Cash Value (cont.) Amounts excluded from cash value include amounts payable as Personal injury or sickness benefit Indemnification of an economic loss incurred upon the occurrence of the event insured against Premium refund (other than from a life or annuity contract) Policyholder dividend Prop. Reg (b)(1)(iv) and (b)(3)(v) 10 10

7 Return of Premium/Cash Value Enhancements Section 7702 Treatment Question How to treat return of premium/cash value enhancement under section 7702? 5 private letter rulings address the issue: PLR (waiver request) PLR (waiver request) PLR PLR (waiver request) PLR (waiver request) Return of Premium/Cash Value Enhancement Features No borrowing gpermitted against enhancement in the private letter rulings All rulings held: enhancement is included in the contract s section 7702 cash surrender value IRS granted all waiver requests insurers were required to remediate failed contracts 12 12

8 Return of Premium/Cash Value Enhancements In General Focus of discussion: enhancement to cash value payable on full contract surrender guaranteeing g return of premium, credit on expenses, etc. Available on individual and corporate owned contracts Provided by insurer s guarantee or via third party wrap provider s payment to insurer Available on CVAT and GPT contracts Implications for product design Cash surrender value is defined broadly Uncertainty of Assumptions Under Sections 7702 & 7702A 14 14

9 Low Interest Rate Environment We are in an historically low interest rate environment Federal Reserve s main tool for stimulating the economy is interest rates Fed has pledged it would keep short term rates near zero until at least the end of 2014 SF Fed Bank President said open to extend Fed s low-rate pledge into Historical 5 and 10 Year Treasury Rates 16.0% Historical Treasury Rates 14.0% 12.0% 10.0% Rates 8.0% 6.0% 10 Year 5 Year 4.0% 2.0% 0.0% 16 16

10 7702 & 7702 A Restrictions on Interest Rates Greater of the rate or rates guaranteed on issuance and minimum prescribed rates CVAT 4% GLP 4% GSP 6% To place in historical perspective /20/ year Treasuries 12.5% 1.8% 5 year Treasuries 12.3% 0.8% If 7702 minimum rates are greater than contract s guaranteed rates Three categories of contracts UL tested using CVAT UL tested using Guideline premium test Traditional whole life tested using CVAT 18 18

11 If 7702 minimum rates are greater than contract s guaranteed rates UL tested using CVAT Can comply with 7702 if guaranteed rate in contract is less than 4% Death benefit = greater of original face amount and cash value divided by NSP NSP calculated using 4% If 7702 minimum rates are greater than contract s guaranteed rates UL tested using Guideline premium test Can comply with 7702 if guaranteed rate in contract is less than 4% Issue: Policyholder could pay maximum GLP and contract could run out of value before the end of the mortality table 7702(f)(6) a contract can still comply with 7702 if a premium is paid which results in the premiums paid exceeding the guideline premium limitation it ti if the amount of such premium does not exceed the amount necessary to prevent the termination of the contract on or before the end of the contract year if the contract will not have any cash value at the end of such period 20 20

12 If 7702 minimum rates are greater than contract s guaranteed rates Traditional whole life tested using CVAT Fails as of the date of issue If contract could ever become paid up (e.g., fully paid up by its term; reduced paid-up) 7702 maximum cash value = 4% State minimum cash value = 3.75% This is true even if the 7702 limit is based on an endowment at age 100 and the state minimum is based on an endowment at age 121 Male non smoker for Endowment at age 100 is less than 3.75% for Endowment at age 121 until age 94 (continuous and curtate) Possibility of Maximum Nonforfeiture Rate less than 4% Maximum Nonforfeiture Rate = 125% of maximum valuation rate Maximum valuation rate cannot be less than 3% If maximum valuation rate is 3%, then maximum nonforfeiture rate will be 3.75% Maximum valuation rates % % Must change by at least ½% If 2012 maximum valuation rate had been 3.25%, would not be looking at possibility of issue in near future 22 22

13 Timing of changes in maximum nonforfeiture rate When maximum nonforfeiture rate changes, have one additional year to implement 2013 maximum nonforfeiture rate = 4.5% If 2014 maximum valuation rate = 3%, then 2014 maximum nonforfeiture rate = 3.75% 2014 issues can continue to use 2013 maximum nonforfeiture rate If 2015 maximum valuation rate increases to 3.5%, then 2015 maximum nonforfeiture rate would be greater than 4% When could the maximum valuation rate drop to 3%? July, 2012 Moody s 4.03% If Moody s stays level at 4.03%, then the maximum valuation rate will stay at 3.5% If Moody s drops 6 basis points per month from August, 2012 through June, maximum valuation rate will be 3% 2014 maximum nonforfeiture rate will be 3.75% 2014 issues could continue to use the 2013 maximum nonforfeiture rate of 4.5%. Solution would be needed for 2015 issues Fed has pledged it would keep short term rates near zero until at least the end of

14 Principle-Based Reserving and New Mortality Tables Tax reserve mortality table Prevailing Commissioners Standard Table Table becomes the prevailing commissioners standard table once it is permitted to be used by at least 26 states for statutory valuation Code provides a transition period of 3 full years before a new table must be used for tax reserve calculations 7702 & 7702A mortality charge requirements Must be reasonable Absent an exception provided in regulations, cannot exceed the rates in the prevailing commissioners table at the time contract is issued Principle-Based Reserving and New Mortality Tables 7702 & 7702A mortality charge requirements (continued) not clear the specific 3 year transition rule for tax reserves carries over when the 2001 CSO was in the process of being adopted by the states conversations were held with the Treasury and IRS about what date would be appropriate to require use of the 2001 CSO for product tax calculations. l Treasury and IRS decided an appropriate required date would be the required date in the NAIC Model Reg implementing the 2001 CSO, that is, January 1,

15 Principle-Based Reserving and New Mortality Tables For tax purposes when a new mortality table is approved for inclusion in the Valuation Manual, it will most likely be considered to have been adopted by 26 states thus becoming the prevailing table Original process of adopting mortality tables through the Valuation Manual - depending on the first permissible date for use of a new table, the new table would become prevailing on either July 1 of the year adopted or January 1 of the following calendar year Principle-Based Reserving and New Mortality Tables This will likely not allow sufficient time for revisions to state Nonforfeiture Laws resolution of potential product tax issues Valuation Manual as exposed has a drafting note providing for an approximately 4.5 year transition period the table be adopted by July 1 of a given year, that it be permitted to be used starting ti January 1 of the second following calendar year; that it be optional until January 1 of the fifth following calendar year, thereafter mandatory 28 28

16 Revenue Procedure : Post-Age 100 Calculations Under Sections 7702 & 7702A Section 7702/7702A Calculations Post-100 Limiting age of 121 under 2001 CSO tables Section 7702(e)(1)(B) requires calculations to assume maturity between ages 95 and 100; section 7702A follows this rule 2001 Maturity Age Task Force of SOA Taxation Section published report on section 7702 issues in Taxing Times in May 2006 Notice published in June 2009 Rev. Proc published August

17 Post-100 Calculations Notice Notice proposed section 7702/7702A calculation safe harbor drawn from [Task Force] proposal, with modifications Safe harbor consists of all Age 100 testing Methodologies in Notice 3.02 Notice 3.02(i): a contract that remains in force would additionally be required to provide at all times a death benefit equal to or greater than 105 percent of the cash value Rev. Proc , I.R.B. 270 Replaces Notice Effective August 23, 2010 Generally accepts Age 100 Testing Methodologies from Notice Eliminates the 105% requirement No adverse inference on qualification or MEC status if safe harbors are not met Does not address additional issues on which comments were requested in Notice

18 Rev. Proc Safe Harbor Rules (a) All section 7702/7702A calculations assume age 100 maturity (b) Net single premium (CVAT) and necessary premium calculations assume endowment at age 100 (c) Guideline level premium (GLP) is calculated assuming premiums through age 99 (d) GLPs accrue through date between ages 95 and 99, after which limit applies indefinitely Rev. Proc Safe Harbor Rules (e) 7-pay premiums computed using remaining durations to age 100 (f) If 7-pay premiums accrue over fewer than 7 years under (e), accrual ends at age 100, after which limit applies indefinitely (g) Reduction-in-benefit rules apply regardless of attaining age 100 (h) Benefit change after age 100 is not material change or adjustment event 34 34

19 Material Changes: Private Letter Rulings Under Sections 7702 & 7702A Death Benefit Reduction: PLR (Jan. 30, 2012) Notice provided safe harbor rules for mortality assumptions for sections 7702 & 7702A, including continued use of 1980 CSO mortality (grandfather) Notice 5.01 Transition rules in DEFRA (1984) legislative history treating contract changes as exchanges apply to determine if change maintains or loses 1980 CSO grandfather Notice 5.02 Also, change pursuant to right in contract maintains 1980 CSO grandfather 36 36

20 Death Benefit Reduction (cont.) In PLR, IRS was asked about maintaining 1980 CSO grandfather if death benefit is reduced at policyholder request, absent explicit right in contract Citing Notice 5.02 rule & absence of explicit right in contract to obtain reduction, IRS held that 1980 CSO grandfather was lost ACLI has asked IRS to reconsider this ruling position, arguing that Notice 5.01 & special rule in DEFRA legislative history should govern Death Benefit Reduction (cont.) DEFRA legislative history said that death benefit reductions are not treated as exchanges for purposes of transition rules Accordingly, under Notice 5.01 death benefit reductions do not lose 1980 CSO grandfather, whether or not based on contractual right; rule in Notice 5.02 not relevant Current status 38 38

21 Use of Expense Charges in Necessary Premiums for CVAT Contracts: PLR (June 14, 2011) Under section 7702A(c)(3), material change (new contract) treatment does not apply to benefit change attributable to necessary premiums Necessary premiums: basically, premiums needed to fund lowest benefits under contract in 7-year testing period Different calculation for CVAT vs. GPT contracts Use of Expense Charges in Necessary Premiums (cont.) According to TAMRA (1984) Conference Report, for CVAT contracts: t (net) premium is "necessary" " so long as it does not exceed difference between (1) attained age NSP for lowest death benefit during the 7-year testing period and (2) lesser of contract s "deemed cash surrender value" or its actual cash surrender value (CSV) Deemed CSV = value based on guaranteed interest rate less certain mortality and expense charges; described in legislative history 40 40

22 Use of Expense Charges in Necessary Premiums (cont.) In PLR, IRS was asked whether expenses charged against account value in CVAT-based universal life contract reduced deemed CSV in determining necessary premiums Expenses were represented to be reasonable under section 7702(c)(3)(B)(ii) rule IRS held that expenses reduced deemed CSV, looking to section 7702A legislative history See Feb article in Taxing Times Living Benefits Under Life Insurance Contracts 42 42

23 Guaranteed Distribution Rider PLR What is a guaranteed distribution rider? Similar to a GMWB rider on a deferred annuity Notable differences Rider is attached to a life contract Form of distribution can vary between loan and withdrawal Policyholder can alter both timing / magnitude of the benefit Ruling addressed the effect of the rider on the determination of: Cash surrender value Section 7702 values (guideline, net single and 7 pay premiums) Issues - Guaranteed Distribution Rider Treatment of adjustment events Does the rider generate an adjustment? Identification of interest guarantee Does the rider create an enhanced interest guarantee? Measurement of cash surrender value Does the rider create cash surrender value under the IRS definition? 44 44

24 Any Questions? 45 45