Authored by Carrie Small and Joe Vermeulen
In Revenue Procedure 2019-06, the Internal Revenue Service (IRS) released the unpaid loss discount factors for the 2018 accident year. These factors are to be used in the first taxable year beginning after Dec. 31, 2017, and for use in calculating the Tax Cuts and Jobs Act adjustment (TCJA adjustment or transitional adjustment). Insurance companies should use these factors for computing discounted unpaid losses and estimated salvage recoverable for each property and casualty line of business.
Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (TCJA), signed into law on Dec. 22, 2017, made several modifications to the discounting rules for non-life insurance companies for taxable years beginning after Dec. 31, 2017. These modifications include: 1) repealed the election permitting a taxpayer to use its own historical loss payment patterns; 2) amended the computational rules for determining loss payment patterns under section 846(d); and 3) modified how the Treasury will calculate its discount factors by using a corporate bond yield curve rather than applicable federal mid-term rates to determine the annual rate. A transitional rule exists for the first taxable year beginning in 2018 under which the amount of unpaid losses and expenses at the end of the preceding year (2017) are to be recalculated under the new provisions of the TCJA. Such adjustment is spread over eight years in the first taxable year beginning in 2018 and the seven succeeding taxable years. An example of this calculation is as follows:
|Dec. 31, 2017|
IRS Revenue Procedure 2018-13
|Dec. 31, 2017, Gross Loss and LAE, IRS Revenue Procedure 2019-06|
|Gross Loss and LAE Reserves (STAT/GAAP)||980,000,000||980,000,000|
|Discounted Loss and LAE Reserves (Tax)||915,000,000||893,000,000|
|Amount of Discount – EOY Gross DTA||65,000,000||87,000,000|
|1. Gross up to Dec. 31, 2017, DTA for Transitional Adjustment||22,000,000|
|2. DTL recorded for Transitional Adjustment with eight year spread:||(22,000,000)|
|Scheduled Reversal of DTL:||2,750,000|
|Dec. 31, 2018||2,750,000|
|Dec. 31, 2019||2,750,000|
|Dec. 31, 2020||2,750,000|
|Dec. 31, 2021||2,750,000|
|Dec. 31, 2022||2,750,000|
|Dec. 31, 2023||2,750,000|
|Dec. 31, 2024||2,750,000|
|Dec. 31, 2025||2,750,000|
Measurement period ending Dec. 22, 2018
To address concerns raised by companies regarding the enactment date of the TCJA and the limited timeframe available to accurately determine the impact of tax changes within their annual and quarterly reports filed with the Securities and Exchange Commission (SEC), the staff from the Office of the Chief Accountant and Corp Fin released Staff Accounting Bulletin (SAB) 118 on Dec. 22, 2017, to provide guidance on accounting and disclosures for the impact of the TCJA. The Financial Accounting Standards Board (FASB) released a Q&A in early 2018 indicating SAB 118 may be used for private companies and not-for-profit entities and the National Association of Insurance Commissioners (NAIC) quickly followed suit with the adoption of interpretation (INT) 18-01. As part of the guidance issued by the SEC, FASB and NAIC, companies were given a one-year measurement period to finalize the accounting for the impacts of the TCJA. The one-year measurement period ends on Dec. 22, 2018. One of the items of accounting for tax reform that has remained either incomplete for insurance companies, or as a provisional estimate, relates to the changes made to the discounting of loss reserves. With the release of the 2018 IRS discount factors in Revenue Procedure 2019-06, insurance companies can now finalize the accounting for this piece of tax reform and record the impact in the financials by the end of the measurement period.
Proposed regulations released on loss reserve discounting
On Nov. 7, 2018, the U.S. Treasury and the IRS released proposed regulations providing guidance on new discounting rules for unpaid losses and estimated salvage recoverable of insurance companies for federal income tax purposes. The proposed regulations implement recent legislative changes to the Internal Revenue Code as a result of the TCJA and make other technical improvements to the derivation and use of discount factors.
Per the proposed regulations, the U.S. Treasury and the IRS intend to describe the methodology used under the rules set forth therein in each revenue procedure that publishes discount factors for a determination year (see Revenue Procedure 2019-06). In addition, separate discount factors for estimated salvage recoverable would no longer be published by the IRS, and instead estimated salvage recoverable will be discounted using the published discount factors applicable to unpaid losses.
The U.S. Treasury and the IRS specifically request commentary on the following methodologies included within the proposed regulations:
- The length of the loss payment patterns for non-proportional reinsurance and international lines of business and the legal basis for limiting the loss payment patterns to three calendar years following the accident year or extending the loss payment patterns beyond those years;
- The method of determining the annual rate on the basis of the corporate bond yield curve, including comments on whether a different option than the one incorporated in the proposed regulations should be adopted in the final regulations; if another option is presented, the legal basis for that alternative option and explanation of how that option would more clearly reflect income.
A public hearing is scheduled for Dec. 20, 2018, to discuss these proposed regulations and any commentary received. However, it is not anticipated that the discount factors released in Revenue Procedure 2019-06 would be further updated. If revised unpaid loss discount factors for the 2018 accident year are published after final regulations are published in the Federal Register, the U.S. Treasury and the IRS propose guidance within Revenue Procedure 2019-06 on how insurance organizations should account for the change in factors.
For more information on this topic, or to learn how Baker Tilly’s insurance tax advisors can help you, contact our team.