E2. Feldblum: Computing Taxable Income for the P&C Insurance Co.

Question 1

Economic income equation

Answer 1

Economic income = PV (future premiums) - PV(future losses)

Question 2

How is the discount rate to be used in tax calculated

Answer 2

For each AY, the discount rate is the 60mnth moving average of the “federal mid-term rates”, ending Dec 1 of the prior AY

Question 3

Portion of Tax exempt income that is taxed due to proration provision

Answer 3

15%

Question 4

Reason that tax calculations use Schedule P Part 1, instead of Part 3

Answer 4

• Part 3 contains only DCC, not AAO. Part 1 contains all LAE.
• Part 1 is audited, whereas Part 3 is not.
• Some actuarial methods rely on judgment to select paid LDFs. The IRS method does not involve judgment.

Question 5

Equations to derive RTI from incurred losses according to direct and indirect methods

Answer 5

• Direct: Paid loss + change in discounted reserves

- Indirect: Statutory incurred loss - change in reserve discount.

Question 6

Due to the DRD, what portion of dividends are tax exempt

Answer 6

• if the taxpayer owns less than 20% of the firm, 70%
• if the taxpayer owns between 20 and 80%, 80%
• if the taxpayer owns more than 80%, 100%

Question 7

Equations to derive RTI from dividends according to direct and indirect methods.

Answer 7

• Direct: 40.5% of unaffiliated common stock dividends
• Indirect: Statutory income - 59.5% of dividends

Question 8

Equations to derive RTI from bond income according to direct and indirect methods.

Answer 8

• Direct: 15% municipal bond income

- Indirect: Statutory income - 85% municipal bond income

Question 9

AMTI equation:

Answer 9

AMTI = RTI + 0.75 Income that escapes taxation

Question 10

Equations to derive RTI from revenue offset according to direct and indirect methods.

Answer 10

Direct: WP - 80% *Change in UEPR Indirect: Statutory EP + 20% *Change in UEPR

Question 11

Factors that management need to consider when deciding portions of stocks versus bonds to hold:

Answer 11

• relative tax rates
• yield
• diversification
• asset liability management
• SAO
• Management dislike of erratic income

Question 12

ARIT equation:

Answer 12

ARIT = RIT - prior year’s minimum tax credit

Question 13

Relationship between RTI and AMTI that would produce the optimal tax strategy:

Answer 13

AMTI = RTI*175%

Question 14

Reasons municipal bonds often provide a higher after tax yield than corporate bonds of similar risk levels:

Answer 14

• Callability: most municipal bonds are callable
• Liquidity: Municipal bonds are less liquid.
• Tax legislation: The proration provision reduced the tax advantage of municipal bonds

Question 15

Reduce taxable income?

Answer 15

Use company specific discounts if factors are closer to 1 because it imposes less discounts and higher incurred losses

Question 16

Stat vs Tax incurred losses

Answer 16

Statutory: IL=paid losses + change in full value reserves

Tax: IL=paid loss + change in discounted reserves

Question 17

Stat and Tax accounting loss occurrence

Answer 17

Tax: investment income on the assets backing the loss reserves offsets the amortization of the interest discount of the reserves

Statutory: earns positive investment income. No changes in reserves to offset this

Question 18

Determining discounted rates

Answer 18

1. Undiscounted loss reserves
   - from schedule P part 1
2. Discount rate promulgated each year by the treasury
   - varies by AY
3. Loss payment pattern by LOB
   - applies a CY payment pattern to an AY of loss reserves

Question 19

Determination year

Answer 19

The “2” or the “7”

Question 20

5 adjustments to stat income for taxable income.

Answer 20

• Remove tax exempt income
• add proration on tax exempt income
• adjust for change in discounting of loss reserves
• dividend received deductible: to avoid potential double taxation!