Life and P&C Update Agenda

Life and P&C UpdateAgenda • IIR Hedging • IIR Section 166 • New York Life • Mass Mutual • State Farm • Acuity • Principal • Southern Family • Legislative proposals • Proposed 1.162-27 • Revenue Ruling 2011-9 • Revenue Ruling 2011-15 • TAM 201117027 • PLR 201045017 • PLR 201115012

Life and P&C UpdateAgenda (continued) • PLR 201047019 • PLRs 201114015, 201101029, 201126038 • LTR 201112004 • PLR 201108025 • LTR 201105020 and 201114018 • LTR 201121029 • LTR 201119010 • Notice 2011-2 • Notice 2010-79 • Notice 2011-4 • Notice 2011-51 • Notice 2011-23

Variable annuities often provide guaranteed minimum benefits and companies hedge the associated risk with derivatives Tax Issues Is it a tax hedge? What method of accounting clearly reflects income? How are reserve deductions claimed? If hedge gain is deferred, how is it recognized into taxable income? ACLI has requested IRS national office to issue guidance through the industry issue resolution (IIR) program Industry “ask” Matching of hedge gain against reserve deductions Any deferred gain to be recognized against future reserve deductions. If gain not recognized within five years of realization, then recognized over five additional years. IIR - Hedging

Insurers experienced significant impairment charges in 2008-2010 Taxpayers may get a deduction for partially worthless debt under §166 Debt instrument cannot be a security Taxpayer must have proof of partial worthlessness, and The worthless portion must be “charged off” Key benefits Ordinary rather than capital loss Acceleration of deduction REMIC’s are not securities for tax purposes IIR request submitted and accepted Industry ask is for book-tax conformity for the credit component of the SSAP 43R impairment charge IIR - §166 Partially Worthless

New York Life Insurance Co. Case • NY Life deducted : • Dividends “credited” to policyholders in December but paid in January. • Dividends paid within 8 ½ months after year end on the basis that the recurring item exception applied. • The case held the dividends were not deductible because: • The all events test had not been met • The liability to pay the dividends was not fixed at year end. • Did not get to the economic performance issue addressed in TAM 200948042

Mass Mutual • Guaranteed dividends • Payment liability • Recurring items exception

State Farm Mutual Automobile • Included punitive damages in loss reserves filed with insurance department • Discounted and deducted them as loss reserves on their tax return • Tax court agreed with the IRS that punitive damage claims were extra-contractual and could not be included in loss reserves

Acuity • The company deducted guaranty assessments under Rev Proc 2002-46. • IRS disallowed deduction • The IRS also assert that reserves are redundant based on a point estimate by IRS actuary

Principal • Entered into an arrangement to invest with Citi and French bank • Received return in the form of foreign taxes paid • The court found there was no business purpose

Southern Family Insurance Bonuses received from a state-created joint underwriting association for taking out residential insurance policies were non-shareholder capital contributions and were excludable from gross income.

Legislative Proposals • Neal bill • Modify DRD for life insurance • Transfer for value • Expand pro rata interest expense disallowance for COLI

Proposed Reg 1.162-27 On June 23, 2011, the Internal Revenue Service issued proposed regulations that purport to clarify the application of certain existing regulations under Section 162(m).

Rev. Rul. 2011-9 • Section 264(f)(1) pro rata disallowance of interest expense allocable to unborrowed policy cash values • Shall not apply to any policy by an entity engaged in a trade or business if such policy or contract covers only 1 individual and if such individual is: (i) a 20-percent owner of such entity, or (ii) an officer, director, or employee

Rev. Rul. 2011-15 • Affirms that the 1994 OID regs rendered Rev. Rul. 58-225 obsolete. • Life insurance companies are not required to include in taxable income interested collected in advance under policyholder loans.

TAM 201117027 • TAM concludes HMO should be taxed as an insurance company • Licensed and regulated in State A as an HMO • Files an Annual Statement as required by the NAIC • Is subject to insurance department examinations • Makes capitation payments to networks for the provision of health care services through participating providers • Majority of premium is from comprehensive hospital and medical line of business

TAM 201117027 • “Capitation” means paying providers based on the number of subscribers they are responsible for serving, without regard to the frequency or extent of services actually provided. • TAM 200033046 held that if the HMO operates on a staff model and pays its physicians on a salaried basis, the risk assumed is predominately a normal business risk of an organization engaged in furnishing medical services on a fixed-price basis, rather than an insurance risk. • TAM 200033046 extended this rationale to HMOs that compensate non-employee health care providers on a fixed fee (capitation) basis. • The issue in the TAM thus appears to be whether the HMO’s capitation arrangements shift risk to the providers.

TAM 201117027 • Paying a provider network on a capitated basis does not shift the risk to the provider network. • Capitation arrangements are comparable to reinsurance contracts and as such do not take the primary insurer out of the insurance business. • Implications for tax exempts under section 501(m) • Can capitation be relied on to avoid the restriction on exemption for “providing commercial-type insurance”?

PLR 201045017 • US Holding co sells US Life Holding co to Second Tier Foreign Parent at a loss • Loss was duplicated principally within Lifeco • Represented by NOLs, capital loss carryovers, built in losses, deferred deductions etc. • The unified loss rules of reg sec 1.1502-36 applied to the duplicated losses • Required to choose either the stock loss or the tax attributes • Elected to reduce basis in US Life Holding co to eliminate the loss on the sale and preserve Lifeco tax attributes.

PLR 201045017 • US Life Holding co was then the common parent • it recognized that it could not elect to file a life/nonlife return for 5 years • and Lifeco was not a member of the same affiliated group • Under -36 regs if corporations are no longer members of the same affiliated group, there is a deemed disposition of the members • Under this rule US Life Holding co was deemed to dispose of the stock of Lifeco • The election made by US Holding co to reduce basis in US Life Holding co failed to consider this deemed disposition of Lifeco

PLR 201045017 • Consequently US Life Holding retained its basis in the stock of Lifeco, but Lifeco had to reduce its tax attributes. • 9100 relief was sought to allow US Holding co to extend the time for filing the election to reduce basis in the Lifeco stock • IRS provided the 9100 relief

PLR 201115012 • Life Insurance co and Sub Life co in PLR 201045017 also sought a waiver from the section 1504(a)(3)(A) five year reconsolidation rule to allow the filing of a life/life consolidated return • Prior to inclusion in the life/nonlife consolidated return, the companies filed a life/life consolidated return. • The companies were included in the life/nonlife consolidated return for only two years • Consequently the five year reconsolidation rule applied. • PLR 201115012 granted the requested relief.

PLR 201047019 Merger of life insurance companies will not produce a disproportionate asset acquisition under reg. section 1.1504-47(d)(12)(viii).

PLRs 201114015, 201101029, 201126038 • PLR 201114015 • Amounts paid by a medical practice for insurance policies provided by a risk retention group the medical practice plans to form with other medical practices will be deductible business expenses under section 162. • Found adequate risk shifting and risk distribution. • Comfort ruling? • PLR 201101029 • Lack of risk distribution where mutual company had only four insureds • PLR 201126038 • Lack of risk distribution because of heavy concentration of risks in just a few insureds.

PLR 201112004 • Conversion of stock insurance holding company (Parent) into a mutual insurance holding company was a reorganization under section 368(a)(1)(E) • At the time of its formation state law did not permit the creation of mutual insurance holding companies • Parent and insurance company subsidiary in effect operated as mutuals • Steps to convert: • Stock insurer converted into a mutual company • New mutual company formed new mutual insurance holding company (New Parent) • Mutual insurer converted back to stock company as a wholly-owned sub of New Parent and policyholders will become members of New Parent • Parent merges into New Parent

PLR 201108025 • Section 953(d) company (Oldco) pursuant to a written plan of reorganization proposed to change its place of incorporation from Country X to Country Y as (Newco) • Ruling concludes that • The transaction qualified as a reorganization under section 368(a)(1)(F) • Oldco's 953(d) election will not terminate as a result of the Proposed Transaction. • Representation made that Newco will constitute an “eligible corporation” within the meaning of § 1.1502-47(d)(12)(i) with respect to the Parent's consolidated group.

LTR 201105020 and 201114018 The IRS granted extensions to elect section 831(b)

LTR 201121029 • The IRS has denied tax-exempt status under section 501(c)(15) to an organization because it lacked sufficient risk distribution. • The taxpayer was a single-owner captive insurance company that wrote both direct insurance and reinsurance contracts. It received 69.5 percent of its total premium income from one insured, and it received the balance of its premium income in from its assumption of reinsurance (14.5 percent of its total premiums) and its participation in a reinsurance risk pool (15.8 percent of its total premiums).

LTR 201119010 • The IRS has granted an insurance company an extension to make an election under section 953(d) to be treated as a domestic corporation for U.S. tax purposes.

Notice 2011-2 • Provides guidance on section 162(m)(6) including: • examples, • de minimis rules, • definition of an “applicable individual”, • an exception for indemnity reinsurers • Asks for comments on the notice as well as all aspects of the application of section 162(m)(6).

Notice 2011-2 • Example 1 • For 2010, 2011, and2012, Corporation A is a pre-2013 covered health insurance provider. • Corporation A is a post-2012 covered health insurance provider for all taxable years after 2012. • Deferred deduction remuneration attributable to services performed in 2010, 2011, and 2012 is subject to the section 162(m)(6) deduction limitation in the taxable years after 2012 in which such amounts are otherwise deductible. • Example 2 • Same facts as Example 1 except that for all years after 2012 Corporation A does not qualify as a post-2012 covered health insurance provider. • Any deferred deduction remuneration attributable to services performed in 2010, 2011, and 2012 is not subject to the section162(m)(6) deduction limitation in the taxable year in which such amounts are otherwise deductible.

Notice 2011-2 • Example 3 • Same facts as Example 1 except that Corporation A does not qualify as a post-2012 covered health insurance provider for 2013, 2014 and 2015. Corporation A qualifies as a post-2012covered health insurance provider in 2016 and subsequent years. • Deferred deduction remuneration attributable to services performed in 2010, 2011, and 2012 that is otherwise deductible in 2016 and subsequent years is subject to the deduction limitation under section 162(m)(6) in the year in which such amounts are otherwise deductible. • Any deferred deduction remuneration attributable to services performed in 2010, 2011, and 2012 that is otherwise deductible in 2013, 2014, or 2015 is not subject to the deduction limitation under section162(m)(6) in the year in which such amounts are otherwise deductible. • Any deferred compensation attributable to services performed in Corporation A's 2013 through 2015 taxable years is not subject to the deduction limitation under section 162(m)(6) for the taxable years in which such amounts are otherwise deductible.

Notice 2011-2 • Example 4 • Same facts as Example 1 except that Corporation A is not a pre-2013 covered health insurance provider in 2010, 2011, and 2012 but it qualifies as a post-2012 covered health insurance provider. • Any deferred compensation attributable to services performed in Corporation A's 2010, 2011, and 2012 taxable years is not subject to the deduction limitation under section 162(m)(6) for the taxable years in which such amounts are otherwise deductible.

Notice 2011-2 • De Minimis Rule • An employer (including an employer as determined in accordance with the aggregation rules under section 162(m)(6)(C)(ii)) will not be treated as a covered health insurance provider within the meaning of section 162(m)(6)(C)(i)(I) for a taxable year beginning after December 31, 2009 and before January 1, 2013 if the premiums received by the employer for providing health insurance coverage as defined in section 9832(b)(1) are less than 2% of the employer's gross revenues for that taxable year. • For taxable years beginning after December 31, 2012, an employer will not be treated as a covered health insurance provider within the meaning of section 162(m)(6)(C)(i)(II) for a taxable year beginning after December 31, 2012 if the premiums received for providing health insurance coverage as defined in section 9832(b)(1) that are from providing minimum essential coverage (as defined in section 5000A(f)) for that taxable year are less than 2% of the employer's gross revenues for that taxable year.

Notice 2011-2 • Definition of Applicable Individual • For purposes of section 162(m)(6)(F), the term "applicable individual" for a taxable year does not include an independent contractor with respect to whom a compensation arrangement would not be subject to section 409A pursuant to Treasury Regulation section 1.409A-1(f)(2) (generally excepting arrangements with independent contractors providing substantial services to multiple unrelated customers).

Notice 2011-2 • Certain Reinsurers Are Not Covered Health Insurance Providers • Solely for purposes of determining whether a taxpayer is a "covered health insurance provider" within the meaning of section 162(m)(6)(C), premiums received under an indemnity reinsurance contract are not treated as premiums from providing health insurance coverage.

Notice 2011-2 • Effective Date • Notice 2011-2 is effective for taxable years beginning on or after January 1, 2010. • The Treasury Department and the IRS anticipate incorporating this guidance into regulations. Any future guidance, including regulations, addressing the issues covered by this notice in a manner that would expand the coverage of section 162(m)(6), such as a modification of, or a restriction on, the application of the de minimis rule or broadening of the definition of an applicable individual will apply prospectively.

Notice 2011-2 • The Treasury Department and the IRS request comments as to the application of this notice, as well as all aspects of the application of section 162(m)(6), including: • The deduction limitation to remuneration for services performed for insurers who are captive or who provide reinsurance or stop loss insurance, and specifically with respect to stop loss insurance arrangements that effectively constitute a direct health insurance arrangement because the attachment point is so low; • The term "covered health insurance provider", including the de minimis rule set forth in the notice and possible alternative de minimis rules; • The term "covered health insurance provider" in the case of a corporate event such as a merger, acquisition or reorganization; • Whether the allocation rules set forth in Notice 2008-94, 2008-2 C.B. 1070, Q&A-9, should be applied for purposes of determining the services and the taxable year to which deferred deduction remuneration is attributable. • Comments were requested by March 23, 2011.

Notice 2010-79 • Interim guidance on the interpretation and application of new section 833(c)(5), which limits the application of section 833 to otherwise-qualifying taxpayers with a medical loss ratio that is not less than 85 percent. • For purposes of determining whether a taxpayer's percentage of total premium revenue expended on reimbursement for clinical services provided to enrollees is not less than 85 percent, taxpayers must use the definition of "reimbursement for clinical services provided to enrollees" that is set forth in HHS interim final regulations. • The Service will not challenge the inclusion of "amounts expended for activities that improve health care quality" as defined in HHS interim final regulations.

Notice 2010-79 Solely for the first taxable year beginning after December 31, 2009, the Service will not treat a taxpayer as losing its status as a stock insurance company by reason of section 833(c)(5) provided the following conditions are met – • the taxpayer was described in section 833(c) in the immediately preceding taxable year; • the taxpayer would have been taxed as a stock insurance company for the current taxable year but for the enactment of section 833(c)(5); and • the taxpayer would have met the requirements of section 831(c) to be taxed as an insurance company for the current taxable year but for its activities in the administration, adjustment or settlement of claims under cost-plus or administrative services-only contracts.

Notice 2010-79 • The application of section 833 in a tax year followed by non-application of that section in the later tax year (or vice versa) may result in accounting method changes. • A taxpayer that is required to change one or more methods of accounting by reason of the application or nonapplication of section 833 must secure consent for these changes under the advance consent procedures of Rev. Proc. 97-27.

Notice 2011-4 Notice 2011-4 clarified and modified Notice 2010-79 to provide that changes in method of accounting for unearned premiums that are required as a result of the operation of § 833(c)(5) must be implemented under the automatic method change procedures.

Notice 2011-51 The interim guidance provided in Notice 2010-79 is extended to any taxable year beginning in 2010 and the first taxable year beginning after December 31, 2010.

Notice 2011-23 • The IRS intends to publish a revenue procedure describing how an organization may apply for recognition of exempt status as an organization described in section 501(c)(29). • Until the revenue procedure is published, the IRS will not accept applications. • The revenue procedure will provide that a Qualified Issuer may not submit its request for recognition of exemption under section 501(c)(29) until it has entered into an agreement with HHS under section1322(b)(2)(C) of the Affordable Care Act.

Life and P&C Update Agenda