CPAs & ADVISORS
experience clarity //
FUNDAMENTALS OF INSURANCE COMPANY TAXATION
Tom Wheeland, Partner
BKD, LLP
T4
AGENDA
Annual Statement Walk-Through
Revenue Recognition
Deductions & Losses
Other 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
Premiums
Premiums are deferred until earned under SAP
Tax 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 expenses
Creates a deductible temporary difference
REVENUE RECOGNITION
Investment income
Interest
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 taxexempt (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. 78-117
Dividends received deduction available for certain dividends - IRC §243
Qualification based upon whether domestic or foreign
Percentage based upon ownership interest
A 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-1
SAP treatment typically accounted for on equity method
May create a taxable or deductible temporary difference
REVENUE RECOGNITION
Capital gains & losses
SAP “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 difference
Limitations 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 differences
Tax net capital losses (essentially a deductible temporary difference)
Can be carried back 3 years (but cannot create an NOL) & forward 5 years
Ordinary losses can offset capital gains but capital losses cannot offset ordinary
income
DEDUCTIONS & LOSSES
Losses incurred
Loss & LAE reserves for P&C companies are discounted for tax purposes
Companies can elect to discount using industry or company-specific discount factors
Election to use company data applies only to eligible lines
Ineligible lines must be discounted using industry factors
Election applies to all years in 5 year election period
Reserves discounted for SAP
Should first be grossed-up & then discounted for tax purposes
Tax 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 differences
Salvage & subrogation is also discounted and offsets loss & LAE reserves
Essentially the inverse of losses & LAE
Must be accrued for tax purposes, even if not accrued for SAP
Must be discounted using industry factors
Represents 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 costs
For life policies, a percentage of premiums are capitalized as acquisition costs &
amortized over a specified period of time
For P&C policies, the unearned premium haircut was established to accomplish
the same goal – better matching of income & related expenses
DEDUCTIONS & LOSSES
General expenses
Subject to the general deductibility rules applicable to all corporations
IRC §461 for non-compensation related expenses
All events test
Liability can be determined with reasonable accuracy
Economic performance
Recurring 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 20
OLD can be carried back 3 years & forward 15
Policyholder dividends
Deductible as essentially a return of premiums
Governed by rules similar to IRC §461
To the extent deferred for tax purposes, these create deductible temporary
differences
OTHER ITEMS
Small life insurance company deduction (“SLICD”) – permanent difference
Alternative minimum tax (“AMT”)
Tax-exempt interest (net of proration) creates ACE add-back
DRD (net of proration) creates ACE add-back
SLICD treatment varies
AMT credit is a DTA
QUESTIONS?
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Tom Wheeland, CPA// Partner
twheeland@bkd.com // 314.231.5544