December 2017


Implications of Tax Cuts and Jobs Act (TCJA) for BOLI/COLI

On December 22, President Trump signed into law the “Tax Cuts and Jobs Act” (TCJA). The implications of the TCJA are, of course, wide reaching for businesses. In this LRA update, we highlight several potential implications for BOLI/COLI. We will be publishing more detailed analyses of our findings as we are able to more fully research key topics in the coming months.

Corporate Rate Reduction

The corporate tax rate is reduced from 35% to 21% effective 1/1/2018. While this doesn’t change the tax treatment of BOLI/COLI directly, it nevertheless has a number of potentially significant implications.

  • The tax cost associated with surrendering contracts is reduced.
    • This creates a fundamental change for ongoing analyses of the financial impact of surrendering contracts.
    • Note: There is no change to the 10% MEC excise tax or any other associated recognition rules for MEC and Non-MEC contracts.
  • The tax equivalent yield of BOLI is reduced.
    • While there appears little, if any, likely impact on the after-tax yields of BOLI, the tax equivalent yields are reduced due to the reduction in the corporate rate.
  • NQDC hedging ratios may need to be increased.
    • Several banks utilize COLI to hedge NQDC plans. To the extent such COLI plans are designed to hedge the after-tax cost of the NQDC plans, the hedge ratios will require adjustment (i.e., from ~60% to ~80% of notional deferral balances).
  • Existing Stable Value Protection (SVP) contracts may require adjustments.
    • It remains to be seen if SVP providers will invoke any provisions within existing agreements (e.g., termination provisions or forced money market/immunization provisions) as a result of the TCJA.
    • One leading SVP provider has issued limited waivers for existing stable value agreements in order to provide time to assess the implications.
  • Active SVP providers may perceive less disincentive for policyholders to surrender.
    • It remains to be seen how the TCJA will impact active BOLI SVP providers with respect to new offerings (e.g., will it impact pricing proposals, investment flexibility, terms?).
  • Appetite for new BOLI/COLI purchases from banks may decrease.
    • While it remains to be seen how the market evolves (e.g., how long it takes for interest rates to rise to more historical norms), we anticipate fewer new BOLI/COLI purchases in a post-TCJA environment. We will follow the evolution of BOLI/COLI products with keen interest and monitor whether more insurers formally (or informally) exit the market?

Repeal of Corporate AMT

Effective 1/1/2018, a business’ determination of alternative minimum taxable income (AMTI) under IRC Section 55 shall be done without regard to sections 56 through 59 of the Code. Among other things, section 56 requires the inclusion of life insurance inside build-up and death benefit proceeds as AMTI.

  • BOLI AMTI will need to be calculated for the 2017 tax year, but is likely not necessary for tax years beginning in 2018.
    • We recommend maintaining records of “adjusted bases” for BOLI from prior AMT computations so that they are available for utilization should future legislatures reinstate the corporate AMT in some form.
    • For the same reason, we recommend considering whether continuing to perform these computations is worthwhile.

Life Settlement – Cost Basis Provisions

Section 13521 of the TCJA modifies IRC Section 1016(a) to make clear that a taxpayer’s cost basis is not adjusted for mortality, expense, or other reasonable charges incurred under an annuity or life insurance contract.

  • Banks no longer need to consider tracking/computing an “adjusted basis” associated with BOLI/COLI contracts.
    • Note: This adjusted basis is distinct and unrelated to the adjusted bases associated with AMT calculations.
    • Previously, the IRS took the position that cost basis had to be reduced under application of Section 1016 if policies were surrendered at a loss or if the policies were sold/transferred in a secondary market transaction. Under the prior guidance, the “adjusted basis” would reflect reductions for insurance charges such as M&E and Cost of Insurance.
  • This rule may spur various operational/structuring opportunities for managing existing blocks of policies.

Life Settlement – Transfer for Value Provisions

Section 13522 of the TCJA eliminates, in the event of a “Reportable Policy Sale,” the exclusions to the transfer for value rules under IRC Section 101(a)(2) that previously applied to carryover basis transactions [§101(a)(2)(A)] or if the transfer was to a corporation in which the insured is a shareholder or officer [§101(a)(2)(B)].

The Act defines Reportable Policy Sale as follows:

Reportable Policy Sale means the acquisition of an interest in a life insurance contract, directly or indirectly, if the acquirer has no substantial family, business, or financial relationship with the insured apart from the acquirer’s interest in such life insurance contract. For purposes of the preceding sentence, the term ‘indirectly’ applies to the acquisition of an interest in a partnership, trust, or other entity that holds an interest in the life insurance contract.’’

As we’ve noted in prior LRA updates, these provisions may impact certain transactions, such as M&A transactions. This is an area we will be researching further.

Note: Reportable Policy Sales are also subject to numerous information reporting requirements that apply to the buyer, the seller and the insurance underwriter. To the extent that any BOLI-related transactions are deemed to be a Reportable Policy Sale, these requirements should be carefully reviewed.

DAC and Life Insurer Reserves

The TCJA increases the DAC tax rate for new BOLI/COLI contracts from 7.7% of net premiums to 9.2% and extends the amortization period from 10 years to 15 years. While the base rate and amortization period have been increased, it is worth noting that the marginal rate reduction more than offsets the cost impact of this provision. For example, one leading BOLI issuer historically calculated a DAC asset of 4.146% [i.e., 7.7% x 35%/(1-35%) = 4.146%]. Using the new variables (9.2% charge and a 21% tax rate), the resulting DAC asset would be 2.446%.

The TCJA also modifies existing rules regarding life insurers’ tax reserves. It is expected that the changes will increase the tax cost to insurers; however, it remains to be seen by how much and what, if any, impact such a change will have on new and existing products.



FNB PA Voluntarily Dismisses Appeal versus Transamerica

On December 18, First National Bank of Pennsylvania agreed to dismiss, with prejudice, its appeal of a District Court’s summary judgment ruling in favor of Transamerica.

This dispute centered on whether FNB was paid the entire amount it was owed after it surrendered certain Separate Account BOLI policies. FNB claimed that in addition to the amount it was paid at surrender (approximately $18 million), it was owed an amount known as the “Bank Enhancement Amount” (worth more than $2.5 million) from a third-party, and that Transamerica’s actions directly prevented FNB from receiving it.

The District Court’s opinion summarized the central issues of the case, and ultimately concluded that JPMorgan was correct with respect to each determination:

The amount owed to the Policyowner at surrender under the Stable Value Subaccount is governed by various provisions in the SVA and the EAA. Under the EAA, JP Morgan promised that, subject to certain limits and conditions which had to be “strictly satisfied,” it would pay an amount known as the “Bank Enhancement Amount” to Commonwealth General [Transamerica’s affiliate] at surrender. Two conditions in the EAA are relevant to this dispute. The first condition was that “[t]he Polices are not, and have not been previously, owned by an entity other than the Policyowner on or prior to the Immunization Termination Date.” The second condition required that, within a specified time period, the Policyowner deliver “a fully executed and complete Surrender Certificate” that is “substantially in the form of the document attached as Exhibit C” to the EAA. Failure to strictly satisfy either of these conditions under the EAA discharged JP Morgan’s obligation to pay the Bank Enhancement Amount to Commonwealth General.

Citation: US-APP-CA3 17-2691



U.S. Banking Agencies Support Conclusion of Reforms to International Capital Standards

On December 7, the US banking regulators issued an interagency statement in support of the conclusions reached to reform the international bank capital standards initiated in response to the global financial crisis.

Here is a link to the BIS release of the finalized post-crisis reforms. Below are a few noteworthy aspects of the final Basel regulatory standard:

  • Standardized approach for credit risk
    • A new framework has been set for exposures to banks in jurisdictions that are not permitted to rely on external ratings, called the Standardized Credit Risk Assessment Approach (SCRA).

    • Exposures to investment grade general corporates are subject to a 65% risk weight; however, exposures to small and medium-sized enterprises (SMEs) are set to 85%.
  • Internal ratings-based approaches – The Committee has made the following revisions to the IRB approaches:
    • Removed the option to use the advanced IRB (A-IRB) approach for certain asset classes;
    • Adopted “input” floors for metrics such as probabilities of default (PD) and loss-given-default (LGD) to ensure a minimum level of conservativism in model parameters for asset classes where the IRB approaches remain available;2 and
    • Provided greater specification of parameter estimation practices to reduce RWA variability.
  • Operational risk framework
    • The advanced measurement approaches (AMA) for calculating operational risk capital requirements (which are based on banks’ internal models) and the three existing standardized approaches are replaced with a single risk-sensitive standardized approach to be used by all banks.
  • Output floor
    • The existing Basel II floor was replaced by a floor based on the revised Basel III standardized approaches. The revised floor places a limit on the regulatory capital benefits that a bank using internal models can derive relative to the standardized approaches.
    • Under the revised output floor, banks’ risk-weighted assets must be calculated as the higher of (i) total risk-weighted assets, calculated using the approaches that the bank has supervisory approval to use in accordance with the Basel capital framework (including both standardized and internal model-based approaches); or (ii) 72.5% of the total risk-weighted assets, calculated using only the standardized approaches.
  • Transitional arrangements
    • Most of the reforms are intended to be implemented by 1/1/2022.

1 A risk weight of 30% may be applied if the exposure to the bank satisfies all of the criteria for Grade A classification and if the counterparty bank has (i) a CET1 ratio of 14% or above; and (ii) a Tier 1 leverage ratio of 5% or above.

2 In some cases, these floors consist of recalibrated values of the existing Basel II floors. In other cases, the floors represent new constraints for banks’ IRB models.

It is worth noting that the regulators will consider how to apply the revisions to the Basel III reform package in the United States, and any proposed changes based on this agreement will be made through the standard notice-and-comment rulemaking process.


Ad Hoc LRA – December 18, 2017

Tax Cuts and Jobs Act – Summary of Final Bill Text

On December 15, the Conference Committee released its final, reconciled legislative text of the Tax Cuts and Jobs Act. The Committee also released a Conference Report and updated JCT revenue estimates.

The final bill removes the Corporate AMT. The last-minute retention of the Corporate AMT under the Senate plan, if retained, would have created material negative consequences for various income exclusions and deductions, including the tax treatment of COLI/BOLI. Of note, since life insurance inside build-up and death benefit proceeds are subject to inclusion under the AMT and the proposed AMT tax rate matched the regular tax rate (20%), it would have effectively made BOLI/COLI growth and death proceeds taxable.

As it relates to the insurance-related provisions, the final bill largely embodies the Senate proposals. Below is an updated summary of certain life insurance-related provisions that we have been monitoring.


Summary of Final Provision

MBSA Observations
Surtax on life insurance company taxable income The 8% surtax on life insurance company taxable income set forth in the House bill was not retained.
Computation of life insurance tax reserves The final text retains, with modification, the Senate bill’s provision regarding the taxation of life insurance company reserves.

The JCT estimates this provision to raise $15.2 billion in tax revenue over ten years.

One contact at a prominent BOLI/COLI carrier informally advised us that this provision was the most economically impactful provision under consideration for its business and thought the legislators were underestimating the implications of the original provision.  This view was echoed during a recent ALI CLE conference in Washington D.C.

We are seeking updated views on the likely impact of modifications incorporated in the final bill.

Capitalization of certain policy acquisition expenses


The conference agreement follows the Senate version with modifications.

Amortization Period: Extended from 120 months to 180 months.

DAC Tax Rates: For annuity contracts, the percentage is 2.09 percent; for group life insurance contracts, the percentage is 2.45 percent; and for all other specified insurance contracts, the percentage is 9.20 percent.

Effective Date: This section shall apply to taxable years beginning after December 31, 2017.

This provision will make new BOLI/COLI contracts more expensive for life insurance companies to issue. BOLI policies that would have historically been subject to DAC based on the 7.7% determination will be subject to 9.2% rate and the amortization will be extended by 5 years.

The JCT revenue estimate for the DAC provisions is $7.2 billion over ten years.

Clarification of Tax Basis of Life Insurance Contracts


The conference agreement follows the Senate version regarding “Tax reporting for life settlement transactions, clarification of tax basis of life insurance contracts, and exception to transfer for valuable consideration rules” without modification.

This provision would modify section 1016(a) to make clear, that “no such adjustment” to basis shall be made for mortality, expense, or other reasonable charges incurred under an annuity or life insurance contract.

This reverses the position of the IRS in Revenue Ruling 2009-13 that on sale of a cash value life insurance contract, the insured’s (seller’s) basis is reduced by the cost of insurance.
Exception to Transfer for Valuable Consideration Rules The conference agreement follows the Senate version without modification.

This provision would amend section 101(a) to eliminate any ability to apply the existing transfer for value exceptions (from 101(a)(2)(A) and (B)) in the context of commercial transfers of interests in life insurance contracts.

Among other implications, it appears that BOLI policies obtained via asset purchase acquisitions of other institutions will be materially impacted. If our interpretation of the provision is correct, all such policies’ death benefits will become subject to taxation (on amounts in excess of adjusted bases). Under current law, policies covering active officers at time of acquisition are exempt from the transfer for value rule and thus not subject to tax on death proceeds.

The Republican leadership in the House and Senate are anticipating final votes on the bill in the next couple of days.