C.2 LIME Flashcards
Overview of DB treatment for tax purposes
- tax-free for beneficiaries if there is an insurable interest
- DBs are not tax free if the policy is sold to someone else
- COLI DB is usually taxable
- payout of DB over time - Prorated between taxable and non-taxable portions
- Accelerated DBs - generally tax free for terminally or chronically ill recipients
Inside buildup for MECs and Non-MECs
- increases in CSV are generally not taxable as long as they remain inside the contract
- always tax free when paid as a DB
- Taxation of lifetime distributions depend on whether contract is a MEC
MEC:
- LIFO
- Any gain in the contract is included in the PH taxable income first
- 10% penalty tax on the taxable portion of the distribution
- policy loans are taxed like any other cash distribution
Non-MEC:
- FIFO
- only the distribution in excess of the investment of the contract is taxable
- no penalty tax
- policy loans are not taxed
3 Classes of Life Insurance created by 7702 and 7702A
- Non-MEC - complies with 7702 and 7702A
- MEC - Complies with 7702 but not 7702A
- Failed Contract - fails 7702
- called a “short term endowment”
- increase in CSV is taxable
- NAR portion of DB is not taxable
- limits insurers tax reserve deductions to the net surrender value
LIME: Applicable law requirement 7702
To satisfy 7702:
- contract must be a life insurance contract under “applicable law”
- pass 1 of 2 actuarial tests:
- CVAT
- Guideline premium && CV corridor requirements
- a policy will fail 7702 if there is no insurable interest in the insured (ie: COLI)
- goal is to limit the CSV relative to the DB
LIME: Model Plan Concept
model plan - combination of contractual benefits and STAT restrictions on assumptions for benefits, interest, expenses, and assumed maturity age
Net Single Premium NSP = Amount needed to pay for all future DBs on a PV basis
How are contracts tested under CVAT
to pass CVAT: policy CSV must be less than the CVAT NSP at ALL durations (Prospective test)
CSV = CV without deducting for SC and policy loan
IR = max(4%, gtd contract rate)
how to assure compliance with CVAT through product design:
- restrict the future cash value
- restrict how dividends can be applied in the future
- include provision to increase death benefits automatically if the CSV threaten to exceed NSP
Testing: Guideline Premium Test and CV Corridor test
-GPT = retrospective, more applicable to UL products
to pass, satisfy both:
1. total premiums paid through current time <= Guideline Premium Limitation
guideline prem limit = max (GSP, sum[GLP])
2.Corridor test: DB(t) >= CSV(t) * Corridor Factor(t)
GSP = Guideline Single Premium = (PV0 future ben + PV0 expenses) / (1 - Premium Load %)
GSP IR = max (6%, max contract gt)
same mortality as CVAT
Future benefits = same as CVAT NSP
GLP = Guideline Level Premium = (pvbenefits + pvexpenses) / (Annuity factor * (1-premLoad%)
GLP IR is floored at 4%
Corridor Factors:
- age 0-40: 250%
- age 41-75 will grade down to 105%
- 75-90 = 105%
- 90-95 will grade to 100%
Impact of 7702 on limitations on product designs
CVAT:
- easier to design for traditional products to pass a prospective test
- simpler than GPT
- product design errors are difficult to deal with
GPT: good for flexible premium products like UL
- allows for more variety in premium payment patterns
- errors are easier to handle since usually limited ot policy specific situations
- hard to apply to fixed premium products
- requires extensive accurate book keeping
UL contracts have provisions that will allow the DB to increase relative to the CSV level in order to remain compliant with 7702
policy design considerations based on 7702A
-contracts that pass 7pay usually pass CVAT
7702A 7-pay test
- Similar to the GPT, except the level annual net premium is calculated to pay up the contract in 7 years instead of age 95+
- 7pay premium = PVben / 7 yr annuity certain
-a policy will be compliant so long as the amount paid year t <= 7pay premium * t
-test only applies to the policy’s first 7 years
-IR = max (4%, contract gt max)
mortality is “reasonable”, compared to CSO
-future benefits = DBs, endowments, QABs
-exclude expenses
-if DB < 10,000, add $75 to each 7 pay premium
-if 7pay test fails: allows 60 days at the contract year-end to return premiums and remain in compliance
-7 pay test will need to be reclalc’d from issue if the policy DBs are reduced
MECs
- issued after june 1988
- compliant with 7702
- Fails the 7 pay test
LIME: Interest rate assumptions and treatment of guarantees
- 7702(A) requires generally higher interest rates. GSP requires 6%, the rest of the tests require 4% minimum
- use the contract gt IR if its higher
- GLP uses the ultimate IR in calculation years beyond year 1
-non gtd benefits are considered PH dividends
for Net rate plans:
- Net rate plan = LI product that doesnt have explicit mortality charges
- use the Gross up Rule - the gtd IR for 7702 must be increased to reflect the implicit mortality charge
LIME: Mortality Assumptions
originally, TAMRA required “reasonable mortality table”, however this was not well defined
Safe Harbor - 100% CSO
- Contracts before 2009 use 1980 CSO table
- After 2009 use the 2001 CSO table
Product Design impact:
- Products generally do not gt charges less than 100% of the CSO table
-mortality rates can be exponential or arithmetic
COI rates - beginning of period mortality rates
LIME: Expense charge assumptions
Expense charges refer to:
- QAB charges
- Expense charges and loads included in guideline premium
- use “reasonable” expenses, but no safe harbor
- Expense charges are based on actual company experience.
- common to use what is shown in illustrations
LIME: Future benefits assumed
future benefits for 7702 calcs:
- DB excluding QAB
- Endowment benefits
- QABs
-note: the 7pay test will also include riders on base insured in the DBs, such as term life
Computational Rues under 7702:
- Assume DB in guideline premium adn CVAT NSP cannot increase
- assume maturity date is between age 95-100
- assume DB lasts until maturity date
- the assumed endowment cannot exceed the lowest DB offered in the contract
Alternative DB rules:
- Increasing DBs
- in the GLP calc only
- can only be used to keep the NAR from decreasing - Net Level Reserve Test
- Can increase DBs for CVAT if CSVs satisfy a net level reserve: CSV < Net level Reserve
QAB -if a benefit is a QAB, then include charges int he PV future ben. 7702 QAB Examples: -Gt Insurability -ADD -Family term coverage -Disability Waiver
non-QABs are disregarded in the future benefits calc
prefunding non-QABs can increase the premium paid amount
LIME: adjustment events and rules
Recalc of 7702 and 7702A to reflect changes after contract issue
- Change in DB
- addition of a rider
- Change in UW class
-recalcs can result in loss of grandfathered status
CVAT Adjustments:
- future benefit changes must be reflected in current attained age based NSP
- after the change, policy must pass CVAT for current and future CSVs
GPT adjustments:
- most changes triggered by the policyholder.
- recalc the GLP and GSP as of the current attained age
7 pay test adjustments
- if DB reduce, 7702A requires recalc of 7pay premium from issue
- the new 7 pay premium will apply retroactively
- if the policy fails the new 7pay test any distributions made 2 years before the reduction are also subject to MEC tax
- any “Material change” will require a new 7pay test based on the amount of DB that isnt fully paid up by the CSV
