March 2014


Obama Budget Proposal and Treasury Greenbook

On March 4, the Obama Administration released its Fiscal Year 2015 Budget Proposal.  The Department of the Treasury also released its Greenbook.  The proposal and general explanations include the same series of insurance related and other financial product proposals that we have highlighted in previous years, including:

  • Expansion of Pro-Rata Interest Expense Disallowance for COLI under IRC § 264(f);
  • Modification to the Proration Rules for Life Insurance Company General and Separate Accounts;
  • Expanded Information Reporting for Private Separate Accounts of Life Insurance Companies;
  • Modification of Rules Applying to Secondary Market Sales of Life Insurance Contracts;
  • Limitation on the Total Accrual of Tax-Favored Retirement Benefits; and
  • Requirement that Derivative Contracts be Marked-to-Market with Resulting Gain or Loss Treated as Ordinary.

Below is a brief overview of each of these proposals.  Again, none appear to be materially different from the Obama Administration’s previous proposals.

Expansion of Pro-Rata Interest Expense Disallowance

IRC section 264(f) reduces interest expense deductions that are allocable to unborrowed policy cash values (i.e., of permanent life insurance policies owned by corporations) based on a statutory formula.  However, policies covering 20% owners, officers, directors or employees of the taxpayer are exempted from the pro-rata interest expense disallowance.

The proposal seeks to limit the exemption to policies covering 20% owners; thereby expanding the pro-rata interest expense disallowance to encompass policies covering officers, directors and employees of the taxpayer.

The proposed change is prospective in nature; so, if legislation were enacted consistent with the proposal, it would only impact policies purchased after the effective date and existing policies that are subsequently subject to a material change (or IRC §1035 exchange).

The OMB estimates that this proposal will produce ~$5.5 billion in tax revenue over ten years, ~6% lower than last year’s projection (which was 19% lower than the prior year’s projection for this proposal).

Modification to the Proration Rules for Life Insurance Company General and Separate Accounts

Companies are allowed a tax deduction for a portion of dividends received from other corporations in order to prevent or limit triple taxation of dividends (e.g., at the corporate payor level, the corporate receiver level, and the individual shareholder level).

Similarly, life insurance companies are allowed a deduction that is pro-rated between a policyholder’s share and the company’s share.  The proposal seeks to modify the pro-ration rules for this purpose.  In the government’s view, the modification would result in the allowed deductions being more reflective of a life insurance company’s actual economic interest in the dividends.

The OMB estimates that this proposal will produce ~$6.3 billion in tax revenue over ten years.  The estimate is ~24% higher than last year’s projection (which was 34% lower than the prior year’s projection).

Require Information Reporting for Private Separate Accounts of Life Insurance Companies

This proposal would require life insurance companies to report to the IRS, the policyholder’s taxpayer identification number (TIN), the policy number, the amount of accumulated untaxed income, the total contract account value, and the portion of that value that was invested in one or more “private separate accounts.”  A private separate account would be defined as any account with respect to which a related group of persons owns policies whose cash values, in the aggregate, represent at least 10 percent of the value of the separate account.  The stated purpose of this reporting requirement is to help the IRS to more easily identify which contracts qualify as insurance contracts and which should be disregarded under the investor control doctrine.

It is our understanding that this initiative is directed primarily towards the high net worth individual market, where it is not uncommon for wealthy individuals and/or families to invest substantial sums in hedge funds on a highly bespoke basis.  If nothing else, this serves as an excellent reminder of how important it is to maintain familiarity with and ensure compliance with investor control safe harbors.

The OMB estimates that this proposal will produce ~$8 billion in tax revenue over ten years.

Modification of Rules Applying to Secondary Market Sales of Life Insurance Contracts

This proposal applies to sales of life insurance contracts in the secondary market (i.e., Life Settlements and Viatical Settlements).  The proposal includes some recordkeeping requirements and also would modify the existing transfer for value rule to ensure that exceptions to the rule would not apply to buyers of policies.

The OMB estimates that this proposal will produce ~$500 million in tax revenue over ten years (~22% lower than last year’s projection; which was 21% lower than year prior).

Limit the Total Accrual of Tax-Favored Retirement Benefits

Under current law, the maximum benefit permitted to be paid under a qualified defined benefit plan in 2014 is $210,000 per year, adjusted for increases in cost of living.  Although subject to contribution limits, defined contribution plans and IRAs currently do not limit the amount that can be accumulated within the accounts.

This budget proposal seeks to implement an aggregate cap on accumulated amounts within tax-favored retirement plans (currently, the maximum permitted accumulation for an individual age 62 would be ~$3.2 million) whereby total accumulations may not exceed an amount required to fund a joint and survivor annuity for the maximum amount permitted for tax-qualified defined benefit plans.

If a taxpayer reached the maximum permitted accumulation, no further contributions or accruals would be permitted, but the taxpayer’s account balance could continue to grow with investment earnings.

The OMB estimates that this proposal will reduce the deficit by ~$28.4 billion over ten years.

Require that Derivative Contracts be Marked to Market with Gain or Loss Treated as Ordinary

Currently, different derivative transaction structures have varied tax timing and/or uncertain tax treatment.  This proposal seeks to require all derivative contracts (other than those that are identified in advance of acquisition and accounted for as hedging positions) to be marked-to-market by the last business day of the year and the gain or loss to be treated as ordinary.

The OMB estimates that this proposal will produce ~$18.8 billion in tax revenue over ten years (essentially the same estimate as the prior year).

Comparison of Proposals and Revenue Estimates with the Camp Tax Proposal

The table below compares the Federal budget estimates of various insurance-related provisions within the Obama proposal and the tax reform bill released by Congressman Dave Camp in February.  The revenue estimates shown are for the ten year period (2015-2024).

Revenue Estimates Camp/JCT Obama/Treasury
264(f) Interest Expense Disallowance $7.3 billion $5.5 billion
Proration Rules for Life Insurance Companies $4.5 billion $6.3 billion
Increase in DAC Tax $11.7 billion No provision
Life Settlements / Transfer for value $200 million $500 million
Computation of Life Ins. Tax Reserves $24.5 billion No provision


Dave Camp Press Release

On March 31, Ways and Means Committee Chairman Dave Camp (R-MI) issued a statement that he will not seek re-election in November.  He also stated his priorities for the remainder of his term, including that he will redouble his efforts on tax reform.


Collins Introduces Bill on Insurance Capital Standards

On March 10, Sen. Susan Collins (R-ME) introduced a bill (S.2102) that would clarify the FRB authority to develop insurance-based capital standards for insurance companies under its supervision.  The insurance industry continues to oppose the application of bank-centric capital standards to life insurance companies.

Among other things, Section 171 of the Dodd-Frank Act authorizes the FRB to establish capital standards for systemically important financial institutions (SIFIs), including certain insurance companies.  Section 171 is also known as the Collins Amendment as it is attributed to Senator Collins.  On March 11, Ms. Collins testified during a Senate Subcommittee on Financial Institutions and Consumer Protection hearing to explain her intent in drafting Section 171.



Basel III Conforming Amendments

On March 7, the OCC released Bulletin 2014-6 announcing an interim final rule to amend various regulations in order to make those regulations consistent with the recently adopted Basel III Capital Framework.  The conforming amendments provide cross-references to the new capital rules and delete obsolete references, where necessary.  The final rule also clarifies and revises various aspects of the OCC’s rules governing subordinated debt.

The final rule is effective March 31, 2014.


Agencies Issue Final Dodd-Frank Act Stress Test Guidance for Medium Sized Firms

On March 5, the OCC, FDIC and FRB issued final guidance describing supervisory expectations for stress tests conducted by financial companies with total consolidated assets between $10 billion and $50 billion (“Medium-Sized Firms”).  The final guidance retains the overall structure and content of the proposed guidance (which was published in the Federal Register on August 5, 2013).  The guidance also reflects additional detail about certain requirements and a discussion of comments submitted to the proposal.

Medium-Sized Firms are required to conduct annual, company-run stress tests to implement a provision in the Dodd-Frank Act.  The stress test rules are flexible to accommodate the different risk profiles, sizes, business mixes, market footprints, and complexity of Medium-Sized Firms.  Companies are expected to apply each supervisory scenario (baseline, adverse and severe) across all business lines and risk areas in order to assess the effect of the scenario on the entire enterprise.

The guidance includes expectations for Model Risk Management and validation.  However, regulators acknowledged that a bank may not be able to validate all models prior to the DFA stress test submission.  The final guidance indicates that the use of such models may be appropriate provided that companies make an effort to identify and prioritize validation for models based on materiality and risk; apply compensating controls so that such output is not treated the same as output from a fully validated model; and document such instances in reports to model users, senior management and other relevant parties.

Although the rules do not specifically address stress testing of BOLI, it may be prudent to assess the form of stress testing applied to BOLI (e.g., interest rate and credit exposures within each type of BOLI).  We welcome the opportunity to provide assistance in this exercise.



SSA DMF Access – Certification Process Update

On March 26, the National Technical Information Service (NTIS) published an interim final rule in the Federal Register establishing a temporary certification program for subscribers to the DMF.  Pursuant to Section 203 of the Bipartisan Budget Act of 2013, access to decedent information during the three-calendar-year period following that individual’s death, will be limited to those certified under the program.

After March 26, 2014, in order to access the limited data, an entity must:

  • Review and submit completed a DMF Certification Form.
  • Pay the certification fee.
  • Once NTIS has accepted the certification form, the entity must submit a new Subscriber Agreement or Licensee Agreement.

Consistent with the Act’s requirements, the certification form has the following elements:

  1. A certification that the entity a) has a legitimate business purpose; b) has systems and procedures in place to safeguard the information pursuant to requirements similar to IRC Section 6103(p)(4); and c) agrees to satisfy such requirements.
  2. A statement of the specific basis for which the entity relies upon for access.
  3. A certification that restricted data will not be shared with any persons that do not meet the requirements for access directly.
  4. Information on whether the recipient will disclose the information to any other parties; and, if so, statements on how compliance with the requirements will be ensured for downstream recipients.
  5. Additional certifications and acknowledgements (e.g., potential penalties for non-compliance, NTIS audit rights, etc.).

We have again reached out to all of our significant insurance carrier and external sweep provider contacts to obtain updates and reactions to this development.  All have indicated awareness of this interim rule and reiterated expectations that access to data is not going to be disrupted.  It is not yet clear how the entities will intend to implement the third and fourth requirements listed above (relating to downstream disclosure of the records).


NAIC Separate Account Risk Working Group – Update

On March 6, a conference call was held by the NAIC’s Separate Account Risk (E) Working Group (SARWG) to continue discussions regarding BOLI/COLI products (with a primary focus on hybrid products).  The call included an educational session in which a representative from the American Council of Life Insurers (ACLI) presented an overview of the BOLI/COLI market and answered a number of questions from the working group.

The SARWG is charged with the task of determining if modifications to any existing regulatory rules should be developed for non-variable, insulated separate account products.  BOLI/COLI is one significant product category within this classification.  Insurance regulators are especially concerned with whether or not the general account is adequately compensated for any risks and/or guarantees provided in connection with such products.

Another conference call was held by this working group on March 24 to discuss proposed revisions to the working group’s Potential Actions / Recommendations, including:

  1. Suggested principles for insulating separate account assets for non-variable products;
  2. Consider updating SSAP No. 56 and Model #255; and
  3. Consider updating Model #200.

Exposure materials are available upon request.