Tax Basis

Question 1

What is tax basis income for US Insurance Companies

Answer 1

tax basis income = SAP income with specific adjustments
- EP is adjusted with a revenue-offset
- losses (or reserves) are discounted

Question 2

Identify areas where federal taxation impacts insurance companies

Answer 2

• pricing
• valuation
• constructing capital models
• tax return preparation

Question 3

Describe IRS’s revenue offset procedure

Answer 3

• in SAP, acq costs are not deferred so insurer would incur a loss
• insurer would then be entitled to future tax refund on this loss
• IRS simplified process: IRS reduces UEP by 20% for all insurers (assumes acq cost ratio is 20% for all lines for all insurers)

Question 4

Effective tax rate for tax-exempt municipal bond

Answer 4

25% * 21% = 5.25%

Question 5

Effective tax rate for realized capital gains

Answer 5

21% (reduced from 35%)

Question 6

Effective tax rate for unrealized capital gains

Answer 6

0% (not considered investment income hence not taxable)

Question 7

Revenue offset formula and purpose

Answer 7

tax basis EP = EP + 20% * chg (UEP)
tax basis EP = WP - 80% * chg (UEP)

purpose: prevents insurer from claiming a loss due to acquisition expenses by increasing taxable income

Question 8

Loss reserve discounting formula and purpose

Answer 8

tax basis losses = paid losses + chg (discounted reserve)
tax basis losses = SAP losses - chg (discounted reserve)

purpose: prevents a tax refund on a loss that’s temporary until investment income is accrued

Question 9

Regular Income Tax formula

Answer 9

Regular Income tax = 21% * Tax Basis Income

Question 10

Purpose of BEAT (Base Erosion and Anti-Abuse Tax)

Answer 10

• limits ability of multinational corporations to shift profits from the US
  (previously, corporations could shift profits by making tax-deductible payments to affiliates in low-tax countries)
• Regular tax is 21% and alt tax is 10% of gross income, if alt tax > regular tax, companies must pay the difference

Question 11

Conditions that may make insurer subject to BEAT (3)

Answer 11

• a US ins company that makes a tax-deductible payment to a related foreign company
• insurer is part of a US group of companies with avg gross receipts in past years >= 500m
• base erosion payments >= 3% or more of the total deductions taken by the US group on its current tax return

Question 12

Condition that makes an insurer NOT subject to BEAT

Answer 12

• foreign company to which tax-deductible payments have been made has elected to be taxed as a US taxpayer

Question 13

3 components to calculate discounted loss reserves (for tax purposes)

Answer 13

• undiscounted loss reserves
• discount rate for AY reserves to be discounted (use US Treasury rate)
• payment pattern

Question 14

Where to get 3 components for discounting (for tax purposes)

Answer 14

• undiscounted loss reserves: Sch P, Pt 1
• discount rate: based on corporate bond yield curve (determined by US Treasury for each AY)
• payment pattern: use Sch P, Pt 1 from industry data (IRS does calcs for you)

Question 15

Why is payment pattern derived from Sch P, Pt 1 instead of Pt 3 (for tax purposes)

Answer 15

• Pt 3 may be skewed bc it doesn’t include A&O expenses
• Pt 3 is not audited (Pt 1 is)
• Pt 1 requires no judgement for IRS method