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Outlook for Taxation in Insurance

During his campaign, President Trump identified tax reform as a central pillar of his agenda to create 25 million jobs over the next decade. Similarly, Congressional Republicans have said that tax reform is essential to increasing economic growth and hope to complete action on tax reform legislation before the end of this year. Many Congressional Democrats, including Senate Democratic leader Schumer and Senate Finance Committee ranking member Wyden, also have supported corporate rate reduction to boost U.S. international competitiveness, provided it is done on a revenue-neutral basis.

While there is little detail on specific tax reform proposals at this early stage in the process, insurance companies will be asking how various tax reform proposals may affect the U.S. tax treatment of their domestic and foreign operations as tax reform efforts advance in 2017. With the proviso that the tax-reform situation is very fluid, here is what the proposals currently put forward by the president, the House and the Senate could mean:

During his campaign, President Trump proposed reducing the U.S. corporate tax rate from 35% to 15%. He also would repeal the corporate alternative minimum tax (AMT). His plan would eliminate “most business tax expenditures,” except for the research credit. President Trump’s tax plan also would impose a one-time, 10% repatriation tax on overseas corporate profits. Earlier in his campaign, Trump’s tax plan specifically called for the repeal of tax deferral on the foreign earnings of U.S.-based companies, but his most recent plan does not address the taxation of future foreign earnings.

A House Republican task force on tax reform, led by Ways and Means Committee Chairman Brady, prepared the Blueprint. Chairman Brady and committee staff have been working since July of last year to draft statutory language that reflects the goals and principles outlined in the Blueprint. Under the Blueprint, the top U.S. corporate income tax rate would be reduced from 35% to 20%. The Blueprint generally proposes eliminating all business tax expenditures except for the research credit. In addition, the Blueprint would move the U.S. from a worldwide international tax system to a “territorial” 100% dividend-exemption system and impose a mandatory “deemed” repatriation tax
(8.75% for cash or cash equivalents and 3.5% for other accumulated foreign earnings).

The cash flow system proposed by the Blueprint includes immediate expensing of all depreciable and amortizable new business investment and denying a deduction for net interest expense. The Blueprint notes that special rules are needed for banking, insurance and leasing business activities under the proposed border adjustable destination-based cash-flow tax system. As of mid- February 2017, the details of such special rules remain under consideration by Chairman Brady and his staff.

The Blueprint proposes to establish a “destination-based” business tax system that would be “border adjustable” by exempting the gross receipts from export sales and imposing tax on imports, which could be achieved through the denial of a deduction for the cost of the imports.

In recent interviews, Chairman Brady has described border adjustability as a critical part of the Blueprint, stating, “It became clear we needed border adjustability to eliminate all the incentives for companies to move jobs, innovation and headquarters overseas.”

Chairman Brady and other House Republican leaders also have cited border adjustability as a key means of offsetting the cost of lowering the U.S. corporate tax rate to 20%. Although there are no official revenue estimates for the House Republican Blueprint, the Brookings Institution-Urban Institute Tax Policy Center has estimated that border adjustment raises $1.2 trillion over 10 years. The cost of lowering the U.S. corporate tax rate to 20 percent and the cost of repealing the corporate AMT was projected to be $1.8 trillion over the same period.

House Republican leaders have noted that they would need to identify alternative means offsetting a reduction in corporate tax rates if their border adjustment proposal is not adopted. In 2014, former House Ways and Means Committee Chairman Dave Camp (R-MI) introduced a tax reform bill (H.R. 1) that included provisions to lower the U.S. corporate tax rate to 25% and included a broad range of revenue offsets affecting various industries. Revenue offsets in H.R. 1 affecting insurance companies included proposals to change the way life insurance reserves and non-life insurance reserves are computed, and changes to the taxation of deferred acquisition costs (the “DAC” tax). Other offsets included changes to life and non-life insurance company proration for DRD and tax-exempt interest. H.R. 1 also proposed an increase in the discount rate used to compute life insurance reserves. Under H.R. 1, U.S. insurance companies also were not permitted to deduct reinsurance premiums paid to a related company that is not subject to U.S. taxation on the premiums, unless the related company elects to treat the premium income as effectively connected to a U.S. trade or business (and thus subject to U.S. tax).

The Blueprint states that transition rules will be needed for tax reform in general and in particular for the move to a destination-based cash-flow business tax system; however, it does not describe those transition rules. Chairman Brady recently has reaffirmed that he does not support exemptions for individual business sectors, but he is prepared to consider transition relief.

See also: Implications for Insurance Taxation?  

Senate tax reform proposals

In a Feb. 1 speech, Senate Finance Committee Chairman Orrin Hatch (R-UT) said the Senate is working on its own tax reform plan, and the “hope is to have a tax reform proposal in one form or another to discuss publicly in the near future.”

Chairman Hatch has expressed hope that the Senate tax reform effort will be able to secure bipartisan support. Without Democratic support, Chairman Hatch has noted that “we’ll basically need universal Republican support to pass anything through [budget] reconciliation” procedures that allow for legislation to pass with a simple majority. Most Senate legislation requires approval by a 60-vote supermajority.

Chairman Hatch has not taken a position on the border tax adjustment. However, he has noted that several senators have expressed concerns or opposition to the House proposal. Senators who have announced opposition to the House border adjustment proposal include Senate Majority Whip John Cornyn (R-TX), who also serves on the Finance Committee, and Sen. David Perdue (R-GA).

“What it means is that the Senate will have to work through its own tax reform process if we’re going to have any chance of succeeding,” Chairman Hatch said in his Feb. 1 remarks. “No one should expect the Senate to simply take up and pass a House tax reform bill, and that’s not a bad thing.”

While now focused on pursuing comprehensive tax reform, Chairman Hatch and his staff had been working over the last two years on a corporate integration proposal that would subject business income to a single level of tax. The proposal, which has not been released to date, has been expected to adopt a dividends-paid deduction approach in which dividends are treated like interest (i.e., deductible payments) and a withholding tax is imposed on both to ensure one level of U.S. tax on interest and dividend income.

Implications

  • There is little detail on specific tax reform proposals that could affect the insurance industry at the time of this document’s publication. Accordingly, insurance companies will need to closely monitor how various tax reform proposals may affect the U.S. tax treatment of their domestic and foreign operations as tax reform efforts advance later in 2017. PwC will provide timely updates on developments as they arise.

Administrative Developments

A number of administrative developments occurred in 2016 concerning insurance companies.

These developments affected insurers in various lines of business:

  • Life insurers – The most significant development for life insurers remains the adoption of Life Principles Based Reserves (PBR), effective as early as Jan. 1, 2017, for some companies and some contracts issued on or after that date. Life PBR has a number of related tax issues, and the IRS and Treasury Department provided its first guidance in Notice 2016-66, setting forth rules for implementing the 2017 CSO mortality tables. Life PBR remains on the annual Priority Guidance Plan, was recently identified as one of 13 “campaigns” to which the IRS will devote significant resources in the coming months, and is the subject of an Industry Issue Resolution (IIR) project.

Two other 2016 administrative developments are particularly important for life insurers. First, Notice 2016-32 provides an alternative diversification rule under section 817(h) for a segregated asset account that invests in a government securities money market fund. The new, alternative diversification rule in Notice 2016-32 facilitates such investments. Second, Field Attorney Advice 20165101F concludes that a change in the computation of the statutory reserves cap that applies to life insurance reserves is a change in basis and therefore required to be spread over 10 years. Although Field Attorney Advice is not precedential, this conclusion was controversial, and companies are still considering the issue as potential changes in basis arise.

  • Non-life insurers – IRS Attorney Memorandum (“AM”) 2016-002 addresses the mechanics of a change in method of accounting for unearned premiums by a Blue Cross or Blue Shield organization that fails to meet the medical loss ratio (MLR) requirement of section 833(c)(5). The guidance is helpful to a broader class of nonlife insurers than Blue Cross organizations because it illustrates the operation of the unearned premium reserve and the application of section 481 to changes in accounting method more generally.

In addition, in early 2017, the Departments of Labor (DOL), Health and Human Services (HHS) and Treasury issued Frequently Asked Questions about ACA implementation, including guidance defining the term “health insurance coverage.” Under that guidance, the provision of Medicaid coverage to Medicaid recipients as a managed care organization, and the provision of coverage under a Medicare Advantage organization or plan or a Medicare prescription drug plan is not “health insurance coverage.” This interpretation could excuse some companies from the compensation deduction limitation of section 162(m)(6) and could clear up confusion created by two prior Chief Counsel Advice memoranda (201610021 and 201618010).

  • Health insurers – No payments will be required in 2017 under the Affordable Care Act (ACA) Health Insurance Provider fee, as a result of that fee’s suspension under the Consolidated Appropriations Act of 2016. Health insurance providers are still required to file Form 8963 for the 2016 year pending legislative developments on the ACA.

In addition, some insurers (particularly health insurers) anticipate significant guaranty fund assessments as a result of the liquidation of Penn Treaty America Insurance. Many such companies (other than Blue Cross organizations) account for those payments on a reserve basis as premium- based assessments under Rev. Proc. 2002-46.

  • Captive insurance companies – Section 831(b) allows certain small, non-life insurance companies to elect to be taxed only on investment income and not on underwriting income. The IRS and Treasury Department have not provided guidance on changes that the Protecting Americans from Tax Hikes (PATH) Act of 2015 made to the requirements to qualify for that provision.

See also: Be on the Lookout for These 3 Tax Scams  

Captive insurance companies – particularly small (“micro”) captive insurance companies — remain a significant administrative priority, however. For example, Notice 2016-66 identifies a significant number of such companies as “transactions of interest” for which reporting is required. Those reporting requirements are drafted broadly, and a large number of companies are in the process of reporting. The IRS also has identified “micro captive” insurance companies as a “campaign” issue that is a priority for the IRS in targeting its examination resources. Furthermore, practitioners and taxpayer alike are still waiting for the Tax Court’s decision in Avrahami v. Commissioner, which could provide even more judicial guidance on insurance qualification in the context of captive insurance.

  • Regulations under Section 385 (characterization as debt or equity) – In spring 2016, the IRS and Treasury Department proposed regulations that would establish a contemporaneous documentation requirement that must be satisfied for certain related- party debt to be respected as debt and recharacterize as equity certain instruments that were intended to be treated as debt for Federal income tax purposes if they are issued in connection with certain distributions and/or acquisitions, even if they met the documentation requirements. The proposed regulations generated significant Congressional and taxpayer concern, including nearly 200 unique comment letters. In fall 2016, the IRS and Treasury Department released final and temporary regulations. The government made significant changes in the final regulations in response to taxpayer comments. The overall scope of the proposed regulation has been reduced through a number of exemptions in the final and temporary regulations. The final and temporary regulations do not apply to debt instruments issued by foreign corporations. They also do not apply to interests issued by regulated insurance companies other than captive insurance companies. The final regulations also treat surplus notes of an insurance company as meeting the documentation requirements of the regulations, even though approval or consent of a regulator may be required for payments under the notes. However, the final regulations make no special provision for life insurance companies that are prevented from joining a consolidated return by the life-nonlife consolidated return limitations, nor do they provide specific guidance on the treatment of a company’s obligations under funds withheld reinsurance.
  • Regulations Under Section 987 – The IRS has issued final and temporary Section 987 regulations in December 2016. The final regulations implement an accounting regime based largely on proposed regulations issued in September 2006, to account for income earned through a qualified business unit (QBU) that operates with a functional currency different than that of its owner (e.g. foreign branches). Similar to the 2006 proposed regulations, the final regulations generally do not apply directly to insurance companies but may be relevant to non-insurance affiliates.

2016-17 Priority Guidance Plan

As in prior years, the IRS and Treasury jointly issued a Priority Guidance Plan outlining guidance it intends to work on during the 2016-2017 year. The plan continues to focus more on life than property and casualty insurance companies.

The following insurance-specific projects, many of which carried over from last year’s plan, were listed as priority items:

  • Final regulations under §72 on the exchange of property for an annuity contract. Proposed regulations were published on October 18, 2006;
  • Regulations under §§72 and 7702 defining cash surrender value;
  • Guidance on annuity contracts with a long-term care insurance rider under §§72 and 7702B;
  • Guidance under §§807 and 816 regarding the determination of life insurance reserves for life insurance and annuity contracts using principles-based methodologies, including stochastic reserves based on conditional tail expectations;
  • Guidance on exchanges under §1035 of annuities for long-term care insurance contracts; and
  • Guidance relating to captive insurance companies.

Less clear is what projects the 2017-2018 Priority Guidance might include. For example, the Trump administration may have different guidance priorities than its predecessor. In addition, a recent Executive Order requiring agencies to relieve existing regulatory burdens in exchange for imposing new ones could complicate the number of guidance items that may be published or the form those items may take.

Implications

  • Life insurers should consider the effect of Life PBR tax issues on product development, financial modeling, and compliance as some companies consider a January 1, 2017, effective date.
  • Nonlife insurers who move in and out of insurance company status (or whose products move in and out of insurance contract status) should consider whether the recent Attorney Memorandum sheds light on the application of section 481 to insurance- specific items such as unearned premium reserve.
  • Health insurers can expect significant changes in tax rules and, in particular, one-time transition rules as a result
    of the 2017 suspension of the Health Insurance Provider Fee and the likely repeal (and possible replacement) of the ACA.
  • Captive insurers should be prepared for additional IRS scrutiny as a result of the Priority Guidance Plan item promising guidance, identification of the micro captive issue as a “campaign,” and the possibility that a decision in the Avrahami case could shed more light on insurance qualification for Federal income tax purposes.

The One Thing to Do to Innovate on Claims

If you love football, then you know how frustrating it is to be a football fan. Every offseason, you get excited about the potential for the coming season. Before the season begins, you read all of the articles and watch the analysts.

They all say, “This is the year.” Your team added some of the top defensive players in the league. You’re convinced the team has solved its offensive woes, too. Your team added a star wide receiver, and the running back is looking great in training camp.

Then the season starts, and your team suffers loss after loss. You question how professionals can spend so much time and money on the sport yet fail to improve. As the season continues to sputter, more and more people call for the team to fire the coach. At the end of the season, they fire the coach and hire a new star coach from a great team.

“Next year,” you and the rest of the fan base tell each other.

The next season begins and your team still loses. Year after year, the cycle repeats itself.

When it comes to innovation, insurance company claims departments have a lot in common with your favorite underachieving football team. Top talent in every department. Great recruits from top companies. Lots of talk about the newest technology. But each year you get the same results.

How can you solve this problem?

The One Thing

In “The One Thing,” Gary Keller shares several lessons we should apply to the insurance claims industry. He does so by simplifying the decision-making process. Whether you’re the general manager of a football team or an insurance claims executive, you can apply Keller’s lessons to your situation.

The Six Lies Between You and Success:

  1. The idea that everything matters equally;
  2. Multitasking;
  3. Lack of discipline;
  4. The belief that willpower is always on will-call;
  5. A balanced life;
  6. The idea that big is bad.

These “Six Lies” insurance claims departments. Claims professionals will get what they put in each day. If that’s emailing about hundreds of claims, then claims professionals will get routine claim maintenance. They will not achieve innovation. By making routine claim maintenance the priority, claims departments are falling victim to the six lies standing between the claims department and innovation.

The Four Thieves of Productivity:

  1. Inability to say “No”;
  2. Fear of chaos;
  3. Poor health habits;
  4. An environment that doesn’t support your goals.

While I can’t make any assumptions about whether there are poor health habits in your claims departments (unless your claims professionals are gorging on the vendor-sponsored food!), I can assume that the four thieves should resonate with you.

Insurance claims professionals do what they do because that’s what everybody has always done. No one has ever been terminated for saying “yes” to a responsibility. People who follow the status quo feel safer than people who hinge their success on a business transformation. As a result, claims departments are productive at claims maintenance, but they often leave much to be desired when it comes to innovation.

The Focusing Question

Keller condenses the entire book into what he calls “The Focusing Question.”

What’s the one thing you can do now such that by doing it everything else will become easier or unnecessary?

Good questions are the path to great answers. By combining a small focus with a big goal, the “Focusing Question” provides you with the ideal starting point to achieve something great.

Claims innovation requires starting with “The One Thing” today: giving your best claims manager responsibility for transforming the claims department. While this may sound drastic, it truly is “The One Thing” that will transform an insurance company. I’ve seen it. With a strong leader dedicated to this project, executives will breeze through the process of selecting vendors, identifying key requirements, troubleshooting workflows and handling anything that stands in the way of true innovation.

Once “The One Thing” is addressed, many tasks will follow: assigning a good leader from the IT department, engaging an outside consultant and supporting the department with future-focused software. But until executives dedicate their best claims manager to “The One Thing,” claims departments will suffer from unnecessary obstacles.

Claims departments and football teams will keep underachieving until they get their franchise quarterbacks. You can hire all the star free agents and coach your teams to change, but if your quarterback spends his time focusing on the same old plays, get ready for another year with the same results.

Who will be your company’s Tom Brady?

Your Device Is Private? Ask Tom Brady

However you feel about Tom Brady, the Patriots and football air pressure, today is a learning moment about cell phones and evidence. If you think the NFL had no business demanding the quarterback’s personal cell phone—and, by extension, that your company has no business demanding to see your cell phone—you’re probably wrong. In fact, your company may very well find itself legally obligated to take data from your private cell phone.

New Norm

Welcome to the wacky world of BYOD—bring your own device. The intermingling of personal and work data on devices has created a legal mess for corporations that won’t be cleared up soon. BYOD is a really big deal—nearly three-quarters of all companies now allow workers to connect with private devices, or plan to soon. For now, you should presume that if you use a personal computer or cell phone to access company files or email, that gadget may very well be subject to discovery requirements.

Security & Privacy Weekly News Roundup: Stay informed of key patterns and trends

First, let’s get this out of the way: Anyone who thinks Tom Brady’s alleged destruction of his personal cell phone represents obstruction of justice is falling for the NFL’s misdirection play. That news was obviously leaked on purpose to make folks think Brady is a bad guy. But even he couldn’t be dumb enough to think destruction of a handset was tantamount to destruction of text message evidence. That’s not how things work in the connected world. The messages might persist on the recipients’ phones and on the carriers’ servers, easily accessible with a court order. The leak was just designed to distract people. (And I’m a Giants fan with a fan’s dislike of the Patriots).

But back to the main point: I’ve heard folks say that the NFL had no right to ask Brady to turn over his personal cell phone. “Right” is a vague term here, because we are still really talking about an employment dispute, and I don’t know all the terms of NFL players’ employment contracts. But here’s what you need to know:

Technology and the Law

There’s a pretty well-established set of court rulings that hold that employers facing a civil or criminal case must produce data on employees’ personal computers and gadgets if the employer has good reason to believe there might be relevant work data on them.

Practically speaking, that can mean taking a phone or a computer away from a worker and making an image of it to preserve any evidence that might exist. That doesn’t give the employer carte blanche to examine everything on the phone, but it does create pretty wide latitude to examine anything that might be relevant to a case. For example: In a workplace discrimination case, lawyers might examine (and surrender) text messages, photos, websites visited and so on.

It’s not a right, it’s a duty. In fact, when I first examined this issue for NBCNews, Michael R. Overly, a technology law expert in Los Angeles, told me he knew of a case where a company actually was sanctioned by a court for failing to search devices during discovery.

Work Gets Personal

“People’s lives revolve around their phone, and they are going to become more and more of a target in litigation,” Overly said then. “Employees really do need to understand that.”

There is really only one way to avoid this perilous state of affairs—use two cell phones, and never mix business with personal. Even that is a challenge, as the temptation to check work email with a personal phone is great, particularly when cell phone batteries die so frequently.

The moral of the story: The definition of “personal” is shrinking all the time, even if you don’t believe Tom Brady shrank those footballs.

For further reading: here’s a nice summary of case law.

How Literature and the NFL Shed Light on Innovation

Baltimore Ravens Coach John Harbaugh complained that Patriots Coach Bill Belichick used deceptive tactics in a playoff game last weekend, after a novel, efficiently executed series of third-quarter plays disoriented the Ravens defense and helped power the Patriots to AFC championship game. But the complaint is short on Henry Wadsworth Longfellow and Ralph Waldo Emerson and overlarded with Edgar Allan Poe.

Everything about the Patriots resounds with innovation, resourcefulness and the persistence celebrated by Longfellow and Emerson.

In “Paul Revere’s Ride,” Longfellow expressly celebrates those virtues achieving independence against a stronger adversary:

“In the books you have read,

How the British Regulars fired and fled,

–How the farmers gave them ball for ball,

From behind each fence and farmyard-wall,

Chasing the red-coats down the lane,

Then crossing the fields to emerge again

Under the trees at the turn of the road,

And only pausing to fire and load.”

Individual and organization, player and team, succeed when all embrace innovation, as Emerson says in “Self-Reliance”: “Power…resides in the moment of transition from a past to a new state…. This one fact the world hates, that the soul becomes; for that forever degrades the past…. [A] man or a company of men, plastic and permeable to principles, by the law of nature must overpower and ride all cities, nations, kings, rich men, poets, who are not.”

The Patriots’ clever disguise of which players were eligible receivers and which ineligible presented a new way of reading, a fresh legibility executing so quickly that the Ravens could not read the play until it had transpired.

The play was simply another of Belichick’s irrepressible innovations. A decade or so ago, in two Super Bowls, linebacker Mike Vrabel deployed on offense and caught touchdown passes in both games.

Ravens Coach John Harbaugh’s choice of words after last week’s deception captures his frustration. “It’s a substitution type of a trick type of thing,” Harbaugh told journalists. “They don’t give you a chance to make the proper substitutions…. It’s not something that anybody’s ever done before…. They…announce the ineligible player, and then Tom Brady would take them to the line right away and snap the ball before we had a chance to figure out who was lined up where. That was the deception part of it.” A complaint got nowhere with the league. Celerity trumped incumbent legibility.

In effect, Coach Harbaugh is perseverating Poe.

Poe portends as much in the team’s namesake, the poem “The Raven”:

“Prophet!” said I, “thing of evil!-prophet still, if bird or devil!-

Whether Tempter sent, or whether tempest tossed thee here ashore,

Desolate yet all undaunted, on this desert land enchanted-

On this home by Horror haunted-tell me truly, I implore-

Is there—is there balm in Gilead?-tell me-tell me, I implore!”

Quoth the Raven “Nevermore.”

Of course, no one is saying “nevermore” about the Ravens or the coach, whose team did well in a competitive game and won a Super Bowl but two years ago.

But immersive reading in Emerson and Longfellow charts the Colts’ best shot prepping for the AFC championship game against the Patriots. Colts coaches and players would find few other drills as efficient or effective as they get ready to challenge New England champs.

Comprehension of Emerson’s and Longfellow’s insights shows how to innovate in a highly competitive game.