On Wednesday, November 2, 2017, Chairman of the House Committee on Ways and Means, Representative Kevin Brady (R.-TX), introduced the proposed Tax Cuts and Jobs Act and an accompanying section-by-section summary (together, the House Proposals).1 The House Proposals are the latest effort to enact comprehensive reform of the U.S. tax code for the first time since 1986. Certain of the proposed changes are specific to the taxation of insurance companies, and if enacted, could materially affect the insurance industry. However, passage of the bill faces a number of hurdles as it moves through Congress, including complex procedural requirements imposed by the budget reconciliation process. Therefore, uncertainty remains as to whether the House Proposals or any similar tax reforms will ultimately be enacted.

This summary addresses only provisions specific to the insurance industry. A separate Sidley update summarizing other aspects of the House Proposals is forthcoming.

Provisions Applicable to the Insurance Industry

The House Proposals would affect the taxation of insurance companies in the following ways:

Industrywide Changes

  • Excise tax on certain payments from domestic corporations to related foreign corporations; election to treat such payments as effectively connected income. Under current law, foreign corporations that are not engaged in a trade or business in the U.S. are not subject to U.S. federal income tax. Withholding tax is imposed at the rate of 30% on payments of U.S.-source income that is fixed, determinable, annual or periodical (FDAP income), and federal insurance excise tax is imposed on premiums paid to a foreign reinsurer at the rate of 1% of gross premiums. Some industry participants have argued that the existing framework provides a competitive advantage to foreign reinsurers. Various proposals that attempted to address this perceived advantage have been introduced over the past several years, but none have been enacted. A general provision of the House Proposals appears to address this issue, albeit not specifically. The House Proposals would impose a 20% excise tax on “any specified amount” (defined as a payment other than interest that is deductible, includible in cost of goods sold, includible in inventory, or includible in the basis of a depreciable or amortizable asset) paid by a domestic corporation to a foreign corporation “which is a member of the same international financial reporting group as the domestic corporation,” unless the related foreign corporation elects to treat the payments as income effectively connected with the conduct of a U.S. trade or business (ECI). The term “international financial reporting group” is defined as “any group of entities, with respect to any specified amount, if such amount is paid or incurred during a reporting year of such group with respect to which (i) such group prepares consolidated financial statements … with respect to such year, and (ii) the average annual aggregate payment amount of such group for the three-reporting-year period ending with such reporting year exceeds” $100 million. A foreign corporation that elects to treat the payments as ECI is permitted a deduction for a deemed amount of expenses to offset the income. The deemed expense deduction is intended to be in an amount that would result in the foreign corporation paying U.S. federal income tax on its profit, by presuming that the foreign corporation had the same overall profitability (before taking interest income, interest expense and taxes into account) as the remainder of the group. No credit would be allowed for foreign taxes paid with respect to the profits subject to U.S. tax. The Joint Committee on Taxation estimates that this rule change will increase revenue by $154.4 billion over the ten-year period from 2018-2027. The bill does not address the existing federal insurance excise tax. Thus, in the absence of an election to treat a payment as ECI, the federal excise tax will presumably continue to be imposed.
  • Restriction on insurance business exception to passive foreign investment company rules. The passive foreign investment company (PFIC) regime imposes certain adverse tax consequences on U.S. shareholders of a PFIC (generally, a foreign corporation with primarily passive forms of income or assets). A foreign corporation is generally not a PFIC if it is predominantly engaged in the active conduct of an insurance business and would be taxed as an insurance company were it a U.S. corporation (the “active insurance” exception). The House Proposals would amend this exception so that it would only apply if the foreign corporation were a “qualifying insurance company,” which is a new term defined as an entity that (1) would be subject to tax under subchapter L if it were a domestic corporation, and (2) has “applicable insurance liabilities” equal to at least 25% of its total assets. The phrase “applicable insurance liabilities” is defined as “loss and loss adjustment expenses” and “reserves (other than deficiency, contingency, or unearned premium reserves) for life and health insurance risks and life and health insurance claims with respect to contracts providing for coverage for mortality or morbidity risks.” An insurance company that has “applicable insurance liabilities” equal to less than 25% of total assets can still qualify for the “active insurance” exception to PFIC treatment if three requirements are met: (i) “applicable insurance liabilities” equal at least 10% of the company’s assets, (ii) the company is predominantly engaged in an insurance business, and (iii) the reason “applicable insurance liabilities” equal less than 25% of total assets is due solely to run-off-related or rating-related circumstances involving the insurance business. The Joint Committee on Taxation estimates that this provision would increase revenue by $1.1 billion over the ten-year period from 2018-2027.
  • Repeal of special estimated tax payments. Insurance companies may currently elect to claim a deduction equal to the difference between the amount of reserves computed on a discounted basis and the amount computed on an undiscounted basis. If an insurance company makes this election, then it is required to pay a special estimated tax equal to the tax benefit attributable to the deduction. The House Proposals would repeal this elective deduction and the accompanying special estimated tax payment rules. The Joint Committee on Taxation has estimated that this change will increase revenue by less than $50 million over the ten-year period from 2018-2027.

Life Insurance Companies

  • Changes to the method for computing tax reserves. Life insurance companies currently use the greater of net surrender value or the Federally Prescribed Reserve (subject to a statutory reserves cap) to determine the value of their reserves. The House Proposals will eliminate the Federally Prescribed Reserve and allow tax reserves in an amount equal to 76.5% of the amount of statutory reserves held that are (i) “life insurance reserves” as defined under present law, (ii) “unpaid losses included in total reserves” as defined under present law, and (iii) “reserves solely for claims with respect to insurance risks.” The drafting leaves somewhat unclear whether reserves for net surrender values in excess of statutory reserves otherwise required would continue to be a valid tax reserve, or whether any unearned premiums or any of the items listed in present Code sections 807(c)(3) through (6) would be allowed in whole or in part. With respect to newly-issued business, this provision represents a substantial acceleration of taxable income (and therefore cash tax payments) as compared to current law. The effect of this provision will undoubtedly be anticipated in pricing newly-issued business. With respect to existing business, the provision represents a substantial acceleration of taxable income that was not anticipated when the business was initially priced. The intended transition rule calls for restatement of 1/1/18 reserves on the new basis and requires taxpayers to take the net decrease into income over eight years. The Joint Committee on Taxation estimates that this provision will increase revenue by $14.9 billion over the ten-year period from 2018-2027. Industry experts have suggested that this revenue estimate is understated by a factor of 10 or more.
  • Repeal of 10-year spread for reserve changes. The House Proposals would repeal the Code’s special ten-year spread for the impact of a change in a life insurance company’s basis for computing reserves (section 807(f) under present law). Under the proposed bill, such changes would be treated in the same manner as accounting method changes initiated by the taxpayer with the consent of the IRS, and Code section 481 would apply. Existing section 807(f) amounts would not be accelerated but would continue to be taken into account over their remaining spread period under present law. The Joint Committee on Taxation estimates that this provision would increase revenue by $1.2 billion over the ten-year period from 2018-2027.
  • Increases in the DAC capitalization rates. Under current law, insurance companies having premium income from “specified insurance contracts” (generally life and annuity business) must defer over ten years arbitrary amounts of otherwise deductible business expenses. The three broad categories of specified insurance contracts subject to this requirement under current law are annuity, group life, and other specified contracts (e.g., individual life contracts). The House Proposals would establish only two contract categories, group and other, increasing the capitalization rate for group life premium from 2.05% to 4%, increasing the rate for group annuity premium from 1.75% to 4%, and increasing the rate for “other” business from 7.7% to 11%. Individual annuity business would be part of the “other” category, such that the capitalization rate for such business would be increased from 1.75% to 11%. The current law exception for pension contracts would be continued. The Joint Committee on Taxation estimated that such changes will increase revenue by $7 billion over the ten-year period from 2018-2027.
  • Changes to the deductibility of NOLs by life insurance companies. In general, under current law, NOLs may be carried back up to two tax years and carried forward 20 tax years. Life insurance companies, however, may carry back NOLs three years and carry forward NOLs 15 years. The House Proposals will bring the rules governing NOLs for life insurance companies into conformity with the proposed general rules for NOLs under the new rules, namely by permitting life insurance companies to carry forward NOLs indefinitely but prohibiting carry backs (although the draft reflects some uncertainty over this point that may be corrected in technical amendments). Also, under the proposed general rules for NOLs, carryforwards are only permitted to offset 90% of taxable income, and they will increase each year by an interest factor outlined in the proposed legislation (i.e., the “annual federal short-term rate” as defined in Code section 1274(d) for the last month ending before the beginning of the taxpayer’s taxable year plus four percentage points). The Joint Committee on Taxation has not yet specified how much this change will contribute to the $156 billion expected increase in revenue following the proposed reforms of the general NOL rules.
  • Modification of rules for life insurance company proration for purposes of determining the dividends received deduction (DRD). The proration rules applicable to life insurance companies require that they reduce certain tax benefits (e.g., the DRD) to reflect the portion of dividends and tax-exempt interest that is used to fund tax-deductible reserves for obligations to policyholders. Life insurance companies currently use a complex formula that computes the respective shares of net investment income that are attributable to the company and to the policyholders. The respective shares are computed separately for the company’s general account and for each separate account. Long-standing IRS guidance relating to the separate account computation resulted in a substantial amount of DRD for companies holding dividend-paying stock in support of variable contracts. The House Proposals would establish a 40-percent “company share” for all companies and repeal the complex present law formula. The Joint Committee on Taxation has estimated that this change would increase revenue by $1.1 billion over the ten-year period from 2018-2027.
  • Repeal of provisions relating to pre-1984 policyholders’ surplus accounts. Taxable income of certain life insurance companies that was deferred under pre-1984 law continued to be deferred unless treated as distributed to shareholders. A tax holiday in effect during 2005-6 permitted tax-free distributions from such balances, and most companies eliminated or reduced their balances during the holiday period. The House Proposals would eliminate this holdover from prior law and require any life insurance company with a remaining policyholder surplus account balance to include such amount in income over an 8-year period. The Joint Committee on Taxation estimates this provision would increase revenue by less than $50 million over the ten-year period from 2018-2027.

Property & Casualty (“P&C”) Insurance Companies

  • Modification of proration rules. Currently, P&C insurance companies are required to reduce reserve deductions for losses incurred by 15% of (a) the company’s tax-exempt interest income, (b) the deductible portion of dividends received, and (c) the increase for the tax year in the cash value of life insurance, endowment, or annuity contracts that the company owns. The House Proposals will change the 15% rate to a 26.25% rate. Technical amendments are expected to allow the 26.5% rate to float with future changes in the statutory corporate tax rate. The Joint Committee on Taxation estimates that this change to the P&C proration rules will increase revenue by $2.1 billion over the ten-year period from 2018-2027.
  • Modification of discounting rules. Under current law, P&C insurance companies are allowed to deduct unpaid losses using an interest rate equal to a rolling average of the applicable federal mid-term interest rate. P&C insurers may also base their unpaid loss estimates on either the company’s own loss payment patterns or an industry-wide average loss payment pattern published by Treasury. The Treasury published patterns generally assume payment over a period ending either three years or ten years after the accident year; except that for certain long-tail lines of business, the assumed loss payment pattern is extended to the accident year and the following 15 years. The House Proposals will require P&C insurance companies to use the higher corporate bond yield curve to discount unpaid losses. Finally, the proposed bill will repeal elections to use company-specific loss payment patterns, instead extending the loss payment pattern period to 18 years for short-tail lines of business and 25 years for long-tail lines of business. The Joint Committee on Taxation estimates that these changes to the discounting rules and assumptions regarding the discounting period will increase revenue by $13.2 billion over the ten-year period from 2018-2027.

Nontax Effects of Tax Reform

The changes introduced by the House Proposals would have significant accounting and capital consequences for insurers, including at least the following:2

Balance Sheet Impact

  • Deferred tax assets and liabilities that have already been recorded and valued for tax purposes will be re-valued using the 20% statutory tax rate. Companies with balance sheets reflecting a net deferred tax asset (i.e., more deferred tax assets than liabilities) will experience a decline in the value of the net DTA.
  • Interest maintenance reserves are likely to increase. At present, companies with interest-sensitive liabilities are required, upon disposition of an interest-sensitive asset supporting such liabilities, to establish a liability known as interest maintenance reserve (IMR) equal to 65% of any gain recognized on the disposition, effectively the after-tax gain. This after-tax statutory liability will presumably increase to an amount equal to 80% of the gain, if the corporate rate is reduced to 20%, thus increasing a life insurance company’s IMR. The amount of current tax expense that is actually booked by the company as a result of the disposition is separately determined. Although it is generally expected that current tax expense will decrease from 35% to 20%, for the reasons described elsewhere in this alert the actual amount may be different, and surplus could therefore be affected.
  • Taxable domestic life insurers will experience a substantial increase in the gross amount of deferred tax assets relating to DAC and the difference between statutory reserves and tax reserves. Insurers are generally permitted to admit only a small fraction of net deferred tax assets, and accordingly the increase in gross deferred tax assets is not likely to result in a material corresponding increase in admitted assets.
  • U.S.-based multinationals with funds that have been “permanently reinvested” outside the U.S. will be required to establish new tax liabilities as a result of the deemed repatriation provisions contained in the House Proposals.

Risk-Based Capital Impacts

Regulators, insurance rating agencies, and others measure the financial strength of insurance companies by reference to ratios known as risk-based capital ratios (RBC ratios). To compute an insurer’s RBC ratio, the amount of the company’s reported total adjusted capital is compared to the company’s hypothetical minimum capital requirement, computed by reference to a prescribed formula. Total adjusted capital (essentially, the statutory capital and surplus, with certain adjustments) is the numerator of the ratio; hypothetical minimum capital is the denominator of the ratio. The greater the RBC ratio, the more financially secure a company is considered to be.

Obviously, each of the balance sheet effects described above will change a company’s reported total adjusted capital, and thus affect the numerator of the ratio. Notably, however, the enactment of tax reform is also likely to change the denominator of each company’s ratio, because the various components of the prescribed formula for calculating the denominator are affected by the statutory tax rate. In general, the reduction of the corporate tax rate from 35% to 20% is expected to increase the denominator of the RBC ratio of insurers.3 Note that changes to the denominator have a disproportionate impact on RBC. For example, in a company with a 500% RBC ratio, if the denominator is increased by $1, the numerator must be increased by $5 in order to maintain the same ratio.


The Tax Cuts and Jobs Act faces a number of obstacles that it must overcome before it becomes law. As the bill goes through markups by various Congressional committees, it is expected that provisions will be amended, struck, or added to any final proposal. Sidley will continue to monitor these developments as they unfold.