Ref #2018-01
Statutory Accounting Principles (E) Working Group
Maintenance Agenda Submission Form
Form A
Issue: Federal Income Tax Reform
Check (applicable entity):
P/C Life Health
Modification of existing SSAP
New Issue or SSAP
Interpretation
Description of Issue: This agenda item has been drafted to consider the impact of the 2018 federal income tax changes on SSAP No. 101—Income Taxes. The tax law was signed on Dec. 22, 2017. Generally, the amendments are applicable to taxable years beginning after Dec. 31, 2017, but there are sections that take effect on the date of the enactment of the Act. The following key items have been noted as federal income tax changes that could impact the existing guidance in SSAP No. 101:
1. Corporate federal income tax rate will decline from 35% to 21%.
o This will reduce future current federal income taxes.
o This will reduce gross deferred tax assets (DTAs) and deferred tax liabilities (DTLs).
(DTAs/DTLs are computed using enacted tax rates expected to apply to taxable income in the periods in which the DTA or DTL is expected to be settled or realized. As such, with the new 21% tax rate, there will be an immediate (Dec. 31, 2017) reduction to existing gross DTAs and DTLs.)
2. Carryback Provisions: Ability to carry back net operating losses (NOLs) for life entities will be eliminated. Non-life entities can continue to carryback NOLs 2 years. (The life entity changes in NOLs are specific to operating losses and are not expected to capture capital losses. The ability for non-life entities to continue with the carryback provisions was a change incorporated in the final bill.)
3. Carryforward Provisions: The NOL carryforward period for life entities will change from 20 succeeding taxable years to an indefinite period, with an 80% taxable income limitation. The NOL carryforward period for non-life companies will continue to be limited to 20 years and will be exempt from the 80% taxable income limitation that is imposed on life entities.
4. Repeal of the alternative minimum tax (AMT), with transition provisions for accelerated recovery of any AMT credit carryforward that exists as of Dec. 31, 2017.
With the changes in the federal tax code, the following needs to be considered for statutory accounting and RBC:
Federal Income Tax Rate – The change in the federal income tax rate will have an immediate impact on the amount of recognized “gross” DTAs/DTLs (as DTAs/DTLs are measured using the tax rate expected to apply when the DTA/DTL is expected to be settled / realized) and will reduce future federal income tax. The change in Federal income tax rate should also be considered in the tax factors for the Life Risk-Based capital calculations.
· DTAs and DTLs are calculated based on the “enacted tax rate.” The guidance in the SSAP No. 101 Exhibit A Implementation Questions and Answers (Q&A) (paragraphs 3-3.6) is consistent with U.S. GAAP in that DTAs and DTLs are measured using the enacted tax rate that is expected to apply to taxable income in the periods in which the DTA/DTL is expected to be settled or realized. The effects of future changes in tax rates are not anticipated in the measurement of DTAs and DTLs. DTAs and DTL are adjusted for changes in tax rates and other changes in the tax law, and the effects of those changes are recognized at the time the change is enacted.
· Guidance currently exists in SSAP No. 101 and SSAP No. 72—Surplus and Quasi-Reorganizations on how changes in DTAs/DTLs, including changes attributed to tax rates, shall be recognized. The guidance in both SSAPs is identical and indicates that these changes shall be recognized as a separate component of gains and losses in unassigned funds (surplus). Guidance in the Annual Statement Instructions identifies that these changes shall be recognized on dedicated reporting lines. (The change in net deferred income tax, excluding changes in nonadmission, is reported on line 26 for P/C entities and line 40 for life entities in the Summary of Operations.)
· SSAP No. 101 does not specify use of a tax rate. Rather, the guidance refers to the “enacted tax rate.” However, in the Q&A, paragraph 3.4 there is a notation that the current enacted tax rate is 35%. Furthermore, all of the examples and illustrations in the Q/A are based on the 35% tax rate.
· With regards to RBC, there are currently two types of tax factors: 26.25% and 35%.Revisions to these factors will need to be considered by the Capital Adequacy (E) Task Force.
DTA / DTL Admittance Calculation – Under existing guidance in SSAP No. 101, entities are permitted to admit adjusted gross DTAs under a three-step calculation, summarized as follows:
Gross DTAs less Statutory Valuation Allowance = Adjusted Gross DTAs
The Statutory valuation allowance reduces the gross DTAs if it is more likely than not that some portion of all of the gross DTAs will not be realized. Entities are not permitted to report a net admitted DTA that exceeds the adjusted gross DTA.
After determining the Adjusted Gross DTA, the amount admitted is calculated as follows:
Step 1: Carryback Provision – Adjusted gross DTAs are admitted to the extent that federal income taxes paid in prior years could be recovered through loss carrybacks for existing temporary differences that reverse during a timeframe corresponding with IRS tax loss carryback provisions, not to exceed three years. The carryback provision is not restricted to limits or thresholds. Hence, 100% of DTAs that qualified under Step 1 are permitted to be admitted.
Step 2: Future Realization Provision – Entities are permitted to admit the amount of adjusted gross DTAs, remaining after application of Step 1, expected to be realized within the applicable period, not to exceed the applicable percentage of adjusted capital and surplus. (Adjusted capital and surplus excludes net DTAs, EDP equipment, operating system software and net positive goodwill.)
§ The applicable period and percentage is dependent on the entities’ financial condition (based on RBC or other tables in the SSAP). Most entities are permitted to admit adjusted gross DTAs expected to be realized within 3 years, not to exceed 15% of adjusted capital and surplus. (Entities that did not qualify for 3 years / 15% may have been limited to 1 year / 10% of adjusted capital and surplus, or not permitted to admit any DTAs under step 2.)
Step 3: Offset of DTLs – After application of Step 1 and Step 2, entities are permitted to admit the amount of adjusted gross DTAs remaining that could be offset against existing gross DTLs. In offsetting, the entity considers the character (ordinary versus capital); such that offsetting would be permitted in the tax return under existing enacted federal income tax laws and regulations. Additionally, the reporting entity is to consider reversing patterns of temporary differences.
With the federal tax changes, life entities will no longer have the ability to “carryback” DTAs under step 1. (Before the changes, net operating losses were permitted a 2-year (p/c) or 3-year (life) carryback period.) With the elimination of the carryback for life entities, the federal tax change will provide an unlimited carryforward period for these entities. P/C entities will still have the 2-year carryback provisions, with carryforwards for 20 years.
With the elimination of the life entity carryback provisions, NAIC staff has received questions regarding whether revisions will occur for the DTA admittance provisions. To assist with this discussion, NAIC staff has conducted an analysis of the deferred tax data reported in Note 9 of the 2016 statutory financial statements. Key information has been summarized within this document.
2016 Deferred Tax Key Financial Results:
· For 3,030 entities (97% - of a total population of 3,127 entities that reported an amount in the DTA note), representing all statement types, the combined DTAs (both capital and ordinary), admitted from carrybacks and carryforwards in 2016 was less than or equal to 15% of capital and surplus. As such, for these entities, it is presumed that the changes to the carryback guidance (step 1) for net operating losses will have no impact on the amount of DTAs permitted to be admitted. For life entities, the net operating losses currently admitted under step 1 of the calculation will be captured in step 2 of the calculation. Pursuant to the carryback guidance, DTAs captured in that section were required to reverse within 3 year (or less); hence, they would also be captured in the 3-year period permitted for most entities within Step 2. (This calculation considers both ordinary and capital DTAs for all statement types to illustrate that even when combined, the provisions in Step 2 would continue to allow admittance in most scenarios. As the tax reform continues to allow carrybacks for non-life entities and for capital losses, entities may continue to have carrybacks that would still be captured under step 1.)
o The 15% comparison in the paragraph above was to total capital and surplus, whereas the 15% limitation for qualifying companies is to “adjusted” capital and surplus. (Capital and surplus is adjusted for DTAs, EDP equipment, operating system software and net positive goodwill.) Although the use of “adjusted Capital Surplus” could slightly impact the assessment of whether DTAs are admitted under the calculation, with the reduction of the total DTAs permitted to be recognized under IRS provisions (as they will be calculated at a 21% tax rate instead of a 35% tax rate), the elimination of the carryback for life entities is still not expected to result in a significant reduction of admitted DTAs. (This statement assumes that the entities have a financial condition that qualifies for the 3-years / 15% threshold under Step 2. Entities that do not qualify for 3 years / 15% will continue to have a lower admitted DTA based on their financial condition.)
· For the entities where the combined DTAs (both capital and ordinary) admitted from carrybacks and carryforwards in 2016 was greater than 15% of capital and surplus, only 58 reflected life entities. Several of these entities had small admitted DTA balances with small capital and surplus amounts:
o 18 entities had admitted DTAs of $10K or less.
o 12 entities had admitted DTAs between $10-20K
o 9 entities had admitted DTAs between $20-50K
o 6 entities had admitted DTAs between $50-$75K
o 7 entities had admitted DTAs between $100-200K
o 7 entities had admitted DTAs over $300K:
Total Admitted DTA / Percentage of C&S3,353,836 / 16.6 %
2,462,313 / 22.0%
1,837,734 / 32.1%
1,614,865 / 32.8%
1,009,360 / 19.3%
863,844 / 16.5%
315,217 / 18.8%
· After an NAIC staff simple calculation to adjust the 2016 reported DTA to reflect a 21% tax rate (rather than a 35% tax rate), the number of life entities where the combined DTA (both ordinary and capital) admitted in 2016 exceeded 15% of capital and surplus dropped to 11 entities. For those still in excess of 15%, the entities generally had very small capital carryback DTAs, therefore the continued ability to carryback the capital losses would not impact whether they would be above / below the 15% capital and surplus threshold.
NAIC Staff Summary Conclusion: Based on the assessments from the 2016 data, the change in the federal tax code is not expected to have a significant impact on the admittance of DTAs, therefore revisions are not recommended to revise the existing SSAP No. 101 concepts for admittance.
· The amount of DTAs that can be recognized will be reduced to reflect the 21% tax rate.
· The elimination of the carryback is specific to life companies. Non-life companies are not impacted.
· The 2016 admitted DTA under both step 1 and step 2 for most entities was below 15% of surplus. As step 1 required realization / settlement in 3 years for life entities, the DTAs previously captured within this step will be captured within the “3 year / 15% of adjusted capital and surplus” settlement timeframe permitted under step 2.
· Although a limited number of companies may exceed 15% under step 1 and step 2, these entities may still be permitted to admit additional DTAs to the extent that they are offset by DTLs under step 3.
2016 Current Federal Tax Key Financial Results:
The adjustment from a 35% federal tax rate to a 21% federal tax rate will result with less federal tax expense. Information aggregated from Note 9.C.1 (a) - (Federal Current Income Taxes Incurred) illustrates the following federal tax expense incurred in 2016 by type of reporting entity:
Entity Type / Number of Entities / Current Federal Tax Incurred / Percentage to SurplusL / 603 / $14,863,703,914 / 3.333%
P / 2,017 / $8,430,117,865 / 0.973%
X / 557 / $6,811,331,775 / 6.563%
T / 35 / $345,341,906 / 7.429%
Total / 3,212 / $30,450,495,460 / 2.143%
Although the ultimate benefit to surplus will depend on company operations and specific tax provisions, the reduction of the federal tax rate is expected to reduce significantly the amount of reported current federal tax incurred. Using a simple calculation to adjust the 2016 amount incurred to reflect a 21% tax rate (from a 35% tax rate), in total, reporting entities may incur $12 billion less in federal taxes, with a projection of the total current federal income tax projected to only reflect 1.29% of aggregate surplus. (The calculation based on a 21% tax rate results with only $18 billion in current federal income tax in comparison to the $30 billion reported in 2016.)