Odomirok - Taxation

Question 1

What is the basis for taxation for Insurance companies in the US

Answer 1

In the U.S., an insurance company is taxed based on its statutory income, but withadjustments provided by the Internal Revenue Code (“IRC”):

Question 2

What is the formula for tax basis income?

Answer 2

TBI = TBEP + InvInc – TBIL

TBEP -= Tax Basis EP ; TBIL = Tax Basis Incurred Loss

Question 3

What 2 components of income need to be adjusted to go from statutory income to taxable incomea

And Why!

Answer 3

• Statutory EP needs to be converted Tax Basis EP
  
  • Because under SAP, Aquisition expenses are expensed up front causing an initial “loss” on a policy that will unwind. Tax basis gives a 20% “credit” for expenses on the EP (an increase to EP)
• Incurred Loss needs to be converted to Tax Basis Incurred Loss
  
  • SAP Incurred Losses without the time of value of money (ie interest) long tailed lines of business may show a statutory loss.
  • Tax Basis Incurred Loss requires discounting of reserves to recongnize the interest that will be earned.

Question 4

What is the formula(s) for Tax Basis EP (TBEP)?

Answer 4

From SAP EP
Tax Basis EP = SAP Earned Premium + [0.2 x Chg(UEP)]

or

From WP
Tax Basis EP = WP – 80% x chg(UEP)

Recall: SAP EP = WP - chg(UEP)

Question 5

What is the formula for Tax Basis Incurred Loss (TBIL)?

Answer 5

From Paid Loss
TBIL = Paid Losses + Change in Discounted Reserves

From SAP Incurrend Loss
TBIL = Statutory Incurred Losses – Change in Reserve Discount

Question 6

In the Tax Basis Income formula (TBI) how is Investment Income treated.

Answer 6

For most companies these are tax exempt, but insurance companies are required under the IRC to include a portion of such tax-favored income and earnings in taxable income under a rule known as “proration”.

The desired tax rate for this income is 5.25%. With an actual tax rate of 21%, we prorate investment income by a factor of .25 to get the desired 5.25% impact (ie .21 x .25 = 5.25%)

should the tax rate change, the proration rate will change.

Question 7

What is the purpose of the Base Erosion and Anti-Abuse TAX (BEAT)?

Answer 7

BEAT limits the ability of multinational corporations to shift profits from the United States
* Before BEAT, a US domicile company could shift profits by making a tax deductible payment to a foreign affiliate.

this payment is called ““base erosion payment”

Question 8

What is the criteria for the BEAT Tax?

Answer 8

BEAT Tax can apply if:
* insurer is part of a U.S. group of companies with average gross receipts in the past three years ≥ $500M
* insurer makes base erosion payments ≥ 3% of the total deductions taken by the U.S. group on its current tax return.

Exemption
* If the foreign company to which tax-deductible payments have been made has elected to be taxed as a U.S. taxpayer then the U.S. corporation or insurer is not subject to BEAT

Question 9

Assuming company meets the criteria, how do you test the BEAT Tax?

Answer 9

• BEAT Tax operates as an alternative “minimum tax” added to regular tax.
• Need to calulate Modified Taxable Income (MTI)
  
  • MTI = TBI + Base Erosion Payments

BEAT Tax = Max(MTI x 0.1 - TBIL x 0.21, 0)
Total Tax = TBI x 0.21 + Beat Tax

TBI may also be called Regular Taxable Income (RTI)

Question 10

What are the 3 items need to discount reserves and where to do you get the information?

Answer 10

• undiscounted loss reserves:
  
  • Schedule P, Part 1 (since this is net of tabular, need to add that back in)
• discount rate for the AY reserves to be discounted
  
  • corporate bond yield curve (determined by the U.S. Treasury for each AY)
• payment pattern
  
  • use Schedule P, Part 1 from industry data (IRIS does the calcs)

Question 11

What is the difference between a company’s own estimate of discounted reserves versus the estimate derived for tax purposes?

Answer 11

• Company is primarily interested in economic impact of assets and liabilities to make sure there is enough to cover claims
  
  • Assume compnay expects to pay $1,000 in one year, but expects in earn 10% on assets only need to set aside $909 (1000/1.1) at start of year.

The tax calculations are not concerned about covering of claims, etc., so it’s likely to be different.

Question 12

Why is the payment pattern derived from Schedule P, Part 1 instead of Part 3 (for tax purposes)

Answer 12

• Part 3 may be skewed because it doesn’t include adjusting/other expenses
• Part 3 is not audited (Part 1 is audited)
• Part 1 requires no judgment for the IRS method

Question 13

How do you determine the discount factor for AY?

Answer 13

• Determine Paid to Incurred Ratio for each AY (ie cumulative Paid)
• Calculate Incremental Paid for each AY by looking at the change in cumulative Paid (AY minus year followiing).
• Using presecribed discount rate, calculate discounted incremental paid for each AY.
• Take the sum of the nominal unpaid (excl latest AY)
• Take the sum of the discounted unpaid (excl latest AY)
• The ratio of discounted unpaid to nominal unpaid is the discount rate.