On February 9th, the Obama administration released its Fiscal Year 2017 Budget Proposal. The Department of the Treasury also released its Greenbook. The proposal and general explanations include the same series of proposals relating to insurance and other financial products that we have highlighted in previous years, including:
Below is a brief overview of the recurring proposals. None appear to be materially different from the Obama administration’s previous proposals.
Expansion of Pro-Rata Interest Expense Disallowance
IRC section 264(f) reduces interest expense deductions that are allocable to unborrowed policy cash values (i.e., of permanent life insurance policies owned by corporations) based on a statutory formula. However, policies covering 20% owners, officers, directors, or employees of the taxpayer are exempted from the pro-rata interest expense disallowance. The proposal seeks to limit the exemption to policies covering 20% owners, thereby expanding the pro-rata interest expense disallowance to encompass policies covering officers, directors, and employees of the taxpayer.
The proposed change is prospective in nature; if legislation were enacted consistent with the proposal, it would only impact policies purchased after the effective date and existing policies that are subsequently subject to a material change (or IRC §1035 exchange). This proposal is projected to produce roughly $7.1 billion in tax revenue over ten years, as compared to $6.3 billion in last year’s projection.
Modification to the Proration Rules for Life Insurance Company General and Separate Accounts
Companies are allowed a tax deduction for a portion of dividends received from other corporations in order to prevent or limit triple taxation of dividends (e.g., at the corporate payor level, the corporate receiver level, and the individual shareholder level). Similarly, life insurance companies are allowed a deduction that is prorated between a policyholder’s share and the company’s share. The proposal seeks to modify the proration rules for this purpose. In the government’s view, the modification would result in the allowed deductions being more reflective of a life insurance company’s actual economic interest in the dividends.
This proposal is projected to produce roughly $5.7 billion in tax revenue over ten years, as compared to $7.5 billion in last year’s projection.
Expanded Information Reporting for Private Separate Accounts of Life Insurance Companies
This proposal would require life insurance companies to report to the IRS the policyholder’s taxpayer identification number (TIN), the policy number, the amount of accumulated untaxed income, the total contract account value, and the portion of that value that was invested in one or more “private separate accounts.” A private separate account would be defined as any account with respect to which a group of related persons owns policies whose cash values, in the aggregate, represent at least 10% of the value of the separate account. The stated purpose of this reporting requirement is to help the IRS more easily identify which contracts qualify as insurance contracts and which should be disregarded under the investor control doctrine.
It is our understanding that this initiative is directed primarily towards the high-net-worth-individual market, where it is not uncommon for wealthy individuals and/or families to invest substantial sums in hedge funds on a highly bespoke basis. If nothing else, this serves as an excellent reminder of how important it is to maintain familiarity with and ensure compliance with investor control safe harbors.
This proposal is projected to produce an estimated $9 million in tax revenue over ten years, largely unchanged from the prior year’s projection.
Modification of Rules Applying to Secondary Market Sales of Life Insurance Contracts
This proposal applies to sales of life insurance contracts in the secondary market (e.g., Life Settlements and Viatical Settlements). The proposal includes some recordkeeping requirements and would modify the existing transfer for value rule to ensure that exceptions to the rule would not apply to buyers of policies. This proposal is projected to produce approximately $0.5 billion in tax revenue over ten years, unchanged from last year’s projection.
Limit the Total Accrual of Tax-Favored Retirement Benefits
Under current law, the maximum benefit permitted to be paid under a qualified defined benefit plan in 2016 is $210,000 per year, adjusted for increases in cost of living. Although subject to contribution limits, defined contribution plans and IRAs currently do not limit the amount that can be accumulated within the accounts.
This budget proposal seeks to implement an aggregate cap on accumulated amounts within tax-favored retirement plans whereby total accumulations may not exceed an amount required to fund a joint and survivor annuity for the maximum amount permitted for tax-qualified defined benefit plans. Currently, the maximum permitted accumulation under this proposal for an individual age 62 would be roughly $3.4 million. If a taxpayer reached the maximum permitted accumulation, no further contributions or accruals would be permitted, but the taxpayer’s account balance could continue to grow with investment earnings.
This proposal is projected to produce approximately $30 billion in tax revenue over ten years, as compared to $26 billion in last year’s projection.
Require that Derivative Contracts Be Marked-to-Market with Gain or Loss Treated as Ordinary
Currently, different derivative transaction structures have varied tax timing and/or uncertain tax treatment. This proposal seeks to require all derivative contracts (other than those that are identified in advance of acquisition and accounted for as hedging positions) to be marked-to-market by the last business day of the year and the gain or loss to be treated as ordinary. This proposal is projected to produce an estimated $21.0 billion in tax revenue over ten years, as compared to $19.8 billion in last year’s projection.
Modification to the Net Operating Loss (NOL) Rules of Life Insurance Companies
This proposal was newly added in last year’s budget. The proposal would conform the net operating loss rules of life insurance companies to the same carryback and carryforward periods that apply to corporations. Currently, life insurance companies are allowed a three-year carryback (versus two years for corporations) and a fifteen-year carryforward (versus twenty years for corporations). The projected budget impact of this proposal is a little more than $300 million over ten years, largely unchanged from last year’s projection.
On February 10th, the District Court of Western District of Pennsylvania issued its opinion on JPMC’s motion to dismiss the third-party complaint for lack of personal jurisdiction. The court ruled in favor of JPMC.
This is an update to the ongoing litigation between First National Bank of Pennsylvania (FNB PA) and Transamerica Life Insurance Company and Clark Consulting. The defendants had sought to add JPMC as a third-party defendant. The underlying controversy stems from the surrender proceeds that FNB PA received upon the surrender of a separate account BOLI program that it had inherited via an acquisition of a community bank. FNB PA asserts that it should have received the full, reported cash surrender value. Transamerica asserts that FNB PA was not entitled to a so-called enhancement amount by virtue of the policyholder being changed in connection with the M&A activity. Transamerica further asserts that the amount in controversy has arisen solely as a result of JPMC’s decision that it (as a stable value provider) was not obligated to pay the enhancement amount.
The Pennsylvania court concluded that it did not have general jurisdiction over JPMC because it was not formed in Pennsylvania (rather it is a banking association chartered under federal law) and Pennsylvania is not JPMC’s principal place of business.
The Pennsylvania court also concluded there was no specific jurisdiction over JPMC. The court summed up its analysis stating the following: “Third-Party Plaintiffs identify no solicitation, no communication, no direct exchange of payments, no contract, or any other form of contact between JPMC and FNB. Therefore, Third-Party Plaintiffs’ argument that JPMC effectively made a new decision to do business with FNB when there was no contact whatsoever between the two is without merit.” It then went on to state that the passive conduct JPMC did engage in does not merit specific jurisdiction.
On February 11th, the District Court of the Southern District of New York issued its decision regarding American General Life Insurance Company’s (AGL) motion to dismiss. The court denied the motion to dismiss for the breach of contract claim as to all parties.
In December 2014, Bancorp Services LLC (Bancorp) and an affiliated entity, Addle Management LLC, filed a lawsuit against American General Life Insurance Company (AGL) alleging misappropriation of trade secrets and breach of confidentiality agreements (i.e., breach of contract). The controversy centers around a stable value protection (SVP) technology that Bancorp’s majority owner developed and owned through a separate company. AGL executed several non-disclosure agreements (NDAs). The litigation alleges that AGL breached an NDA it executed with Bancorp in 2010.
According to the court’s ruling, the NDA has a broad definition of confidential information and provides Bancorp Services and its affiliates with the following protections:
AGL was granted an extension until March 9 to file its response to Bancorp’s amended complaint.
As we’ve reported in prior LRA updates, several insurers have announced increases in their COI rates for diverse blocks of universal life policies. Many discretionary rate increases have been met with stiff opposition, including several judicial challenges. In February, the Consumer Federation of America sent a letter to state insurance regulators encouraging the regulators to block COI rate increases. The author, a former Insurance Commissioner of Vermont, suggests that COI rate increases may have the effect of voiding the guaranteed minimum crediting rate (i.e., if the COI rate increase is only an action to respond to the low interest rate environment). He suggests that the carrier should be required to demonstrate that the mortality of the block of policies has deteriorated. His letter makes various other observations about retail universal life products.
In December 2013, the Seventh Circuit Court of Appeals affirmed two separate district court rulings in favor of the insurance companies regarding the insurers’ respective rights to increase the COI rates.
Exacerbated by the current interest rate environment, this topic continues to receive considerable attention.