Tax Accounting for Insurance Companies

Agenda 

• Tax Provision Background
• Steps of Tax Provision
• Permanent vs. Temporary Tax Adjustments
• Valuation Allowance vs. Admissibility Test
• 15% Second Admissibility Test (SSAP10R)

Tax Provision Background

Overview of ASC 740, ASC 740-10, SSAP 10R

ASC 740 General Overview 

Issued in 1992.

ASC 740 (f/k/a FAS 109) applies to:

• Domestic federal (national) income taxes (U.S. federal income taxes for U.S. entities) and foreign, state, and local (including franchise) taxes based on income.
  
   
• An entity’s domestic and foreign operations that are consolidated, combined or accounted for by the equity method.
  
   
• Foreign entities preparing financial statements in accordance with U.S. GAAP.
  
   
• Non-public and Public entities.

Objectives of Accounting for Income Taxes under ASC 740:

1. To recognize the amount of taxes payable or refundable for the current year.
2. To recognize deferred tax assets (“DTA”) and liabilities (“DTL”) for future tax consequences of events that have been recognized in an entity’s tax returns or financial statements.

The Tax Provision Formula 

Current income tax based on corporate tax return

+/-

Change in the DTA or DTL from the beginning to end of the period

=

Total income tax expense or benefit

Basic Principles of ASC 740 

Current Portion of Taxes
Payable (Liability)
Prepaid/Refund (Asset)

Future Portion of Taxes
Deferred Tax Liability
Deferred Tax Asset

Profit and Loss Accounts
Current Expense/Benefit
Deferred Expense/Benefit

ASC 740 Computations 

Computation of Income Tax Provision

1. Identify permanent and temporary differences
2. Compute current income tax payable or receivable
3. Calculate tax provision to tax return true up
4. Analyze deferred taxes and compute deferred income tax expense or benefit
5. Analyze need for ASC 740-10 reserves
6. Analyze need for ASC 740 valuation allowance
7. Compute total income tax provision
8. Reconcile income tax accounts
9. Prepare rate reconciliation
10. Prepare financial statement disclosures

ASC 740 General Overview, Continued 

The following basic principles are applied for income tax purposes at the date of the financial statements:

1. A current tax liability is recognized for current year estimated tax liability
2. A deferred tax asset/liability is recognized for future year estimated tax effects related to temporary differences
3. Measurement is based on provisions of enacted tax laws.
4. Deferred tax assets are reduced by the amount of any tax benefits that are not expected to be realized.

Effective for all fiscal years beginning after December 15, 2006

ASC 740-10 (formerly FIN 48) consists of two main points:

1. A tax benefit/expense may be reflected in the F/S only if it is “more likely than not” that the company will be able to sustain the uncertain tax positions based on its technical merits
   
    
2. A tax benefit/expense should be measured as the largest amount of benefit/expense that is cumulatively greater than 50% likely to be realized

SSAP 10R – Statutory Tax Provision 

Effective 2009, 2010.

• Temporarily approved in order to provide some relief to insurance companies that have suffered a reduction in their surplus due to the current economic conditions

What’s new?

1. Similar to FAS 109, a statutory valuation allowance should be considered
2. Risk Based Capital (RBC) requirements may limit additional availability

What changed?

1. Additional 15% of Admitted DTA (Optional)
2. Admissibility test is increases the loss carry back allowance from 1 year to 3 years

AP 10 vs. SSAP 10R 

 

Description	SSAP 10	SSAP 10R
Valuation allowance	No	Yes, more likely than not criteria
Reversal period for timing differences	1 year	3 Years
Capital & Surplus limit	10%	15%
Additional DTA’s dependent on RBC Result (TAC/ACL)	N/A	Yes, have to pass trend test of 300% for P&C Co. & 250% for Life Co.
Recognition of Additional DTA’s	N/A	Optional

 

SSAP 10R 

• Adopts ASC 740 with the following modifications:
• State income taxes - included as “taxes, licenses and fees”. No deferred state income taxes are provided.
• Changes in DTA’s and DTL’s - are recognized as a separate component of gains and losses in surplus, except to the extent allocated to changes in unrealized gains and losses.

Steps of Tax Provision

Four Steps to the Tax Provision Process 

1. Current federal income tax expense
       (Annual Statement page 4, income statement)
2. Deferred federal income tax expense
       (Annual Statement page 4, surplus)
3. Gross deferred tax asset/liability
       (Annual Statement page 2, column 1/ page 3)
4. Nonadmitted deferred tax asset
       (Annual Statement page 2, column 2 and page 13, change in nonadmitted)

Current Taxes 

Current Income Taxes are defined as:

• Current year estimates of federal and foreign income taxes based on tax returns for the current year, and tax contingencies for current and all prior years to the extent not previously provided, computed in accordance with SSAP No. 5
  
   
• Amount incurred or received during the current year relating to prior periods, to the extent not previously provided, as such amounts are deemed to be changes in accounting estimates as defined in SSAP No. 3

Deferred Taxes 

• Usually deferred income taxes result when temporary differences exist between total income recorded on a company’s balance sheet and the amount of income the company must pay on taxes for a particular period
  
   
• Classified as either deferred income tax assets (DTAs) or deferred income tax liabilities (DTLs)

Permanent and Temporary Items / Adjustments

Permanent Items 

• Tax-Exempt Income
• Dividends Received Deduction
• Meals & Entertainment
• Fines & Penalties
• Lobbying Expenses/ Dues

Temporary Items 

Ordinary Investments

• Bond Discount Adjustments
• Change in Accrued Discounts

Capital Investments

• Other Than Temporary Impairments (“OTTI”)
• Sale of Discount Bonds
• Original Issue Discount (“OID”)

Other Ordinary Temporary Adjustments

• Loss Reserve Discounting (“LRD”)
• Unearned Premium Reserve (“UPR”)
• Guarantee Fund Assessments
• Nondeductible Premium Deficiency Reserves
• Depreciation
• Goodwill Amortization
• Accrued Expense and Compensation

Additional Temporary Deferred Items

• Unrealized Gain (Loss)
• Non-admitted Assets

DTA’s and DTL’s 

 

Item	Recorded Now	Recorded Later	Reported As	Example
Income	Books	Tax Return	DTL	Accrued Dividends
Income	Tax Return	Books	DTA	20% of unearned premiums
Expense	Books	Tax Return	DTA	Unpaid loss and LAE discounting
Expense	Tax Return	Books	DTL	Tax/Book Depreciation

 

Valuation Allowance vs. Admissibility Test

Valuation Allowance 

• Required as part of admissibility test – not reported in the financials
• Temporary differences are evaluated for realizability using "more likely than not criteria"
• Applies to all temporary differences not just those used in second admissibility test

First Admissibility Test 

• One year of temporary difference reversals
• Three components of admitted DTAs
  • Recovery of taxes paid
  • Future tax benefit in reversal period
    • Calculate total benefit of future reversals
    • Subtract the benefit based on taxes paid
    • Net remaining benefit limited to 10% capital & surplus
     
  • Amount offset against existing DTLs
   

15% Second Admissibility Test (SSAP10R)

Eligibility of Second Admissibility  

1. Must be subject to Risk Based Capital (“RBC”) filing requirements
2. If subject to RBC trend test — must pass
   • Ratio of Total Adjusted Capital (TAC) divided by Authorized control level RBC (ACL) is between 200% and 300%
   • Combined ratio is less than 120%
    
3. If not subject to RBC trend test — minimum RBC
   • P & C Companies = TAC 300% or greater than ACL
   • Life companies = 250% or greater
    

Steps of Second Admissibility Test 

• Three years of temporary difference reversals
• Three components of admitted DTAs
  1. Recovery of taxes paid
  2. Future tax benefit in reversal period
     • Calculate total benefit of future reversals
     • Subtract the benefit based on taxes paid
     • Net remaining benefit is limited to 15% capital & surplus
      
  3. Amount offset by existing DTLs
   

Contact: Paul Dougherty 

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