experience clarity // CPAs & ADVISORS 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) 3 // experience clarity

SAP ASSETS (PART 2) 4 // experience clarity

SAP LIABILITIES 5 // experience clarity

SAP SURPLUS 6 // experience clarity

SAP SURPLUS ROLLFORWARD 7 // experience clarity

SAP PREMIUMS EARNED 8 // experience clarity

SAP INVESTMENT INCOME 9 // experience clarity

INVESTMENT INCOME FOOTNOTE 10 // experience clarity

SAP CAPITAL GAINS/LOSSES 11 // experience clarity

SAP UNREALIZED GAINS/LOSSES 12 // experience clarity

SAP INCOME STATEMENT 13 // experience clarity

SCHEDULE P SUMMARY 14 // experience clarity

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 tax- exempt (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 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 § 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

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