Insurance Tax Conference

42nd Annual Insurance Tax Conference Insurance Tax Conference Primer: Financial Reporting for Taxes - Accounting and Tax Risk Management

Agenda • GAAP tax accounting basics • ASC 740 general concepts • Valuation allowance • Uncertain tax positions • STAT tax accounting basics • SSAP101 overview • SSAP101 admissibility complications in consolidated return settings • Intricacies of tax reform • GAAP and STAT tax and accounting updates 42nd Annual Insurance Tax Conference

42nd Annual Insurance Tax Conference GAAP tax accounting basics

ASC 740 general concepts • U.S. GAAP — Accounting for the recognition of the tax consequences of a transaction or event in the same period that it is recognized in the enterprise’s financial statements (“Matching Principle”) • Computation and reporting of: • Income taxes currently payable • Tax effects of items treated differently for book and tax (permanent items) • Future tax effects of items recognized in different periods for book and tax purposes (temporary items) • Tax-only attributes (tax credits) • Assumption inherent in U.S. GAAP financial statements is that assets and liabilities will be recovered and settled, respectively, at their financial statement reported amounts 42nd Annual Insurance Tax Conference

ASC 740 objectives • ASC 740 addresses financial accounting and reporting for the effects of income taxes that result from an entity’s activities during the current and preceding years (ASC 740-10-05-1) • Objectives (ASC 740-10-10-1 and 10-2) • To recognize the amount of taxes payable or refundable for the current year. • To recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. • More specifically, to recognize the expected future tax consequences. 42nd Annual Insurance Tax Conference

Scope of ASC 740 • Establishes standards of financial accounting and reporting for income taxes that are currently payable and for the tax consequences of (ASC 740-10-05-1): • Revenues, expenses, gains, or losses that are included in taxable income of an earlier or later year than the year in which they are recognized in financial income • Other events that create differences between the tax bases of assets and liabilities and their amounts for financial reporting • Operating loss or tax credit carrybacks for refunds of taxes paid in prior years and carryforwards to reduce taxes payable in future years 42nd Annual Insurance Tax Conference

ASC 740: the balance sheet approach • Compute the current tax asset or liability (follows the same process as preparing the tax return) • Compute the deferred tax asset (DTA) or liability (DTL) on the difference between the book and tax basis of assets and liabilities and on tax attributes and carryforwards • Deferred tax is the future expected tax effect of temporary differences and carryforwards • Analyze and adjust general ledger accounts to computed balances • Measurement is based upon enacted tax laws and rates 42nd Annual Insurance Tax Conference

42nd Annual Insurance Tax Conference Uncertain tax positions

Uncertain tax positions • Scope — ASC 740 applies to income tax uncertainties (non‐income tax uncertainties are covered by ASC 450, Contingencies). • Recognition — benefit recognized only if a tax position is more-likely-than-not (MLTN) of being sustained based solely on its technical merits. • Measurement — benefit measured at the largest amount that is MLTN to be realized (cumulative probability analysis). • Tax positions include (1) deductions, (2) taxable income excluded or re-characterized, (3) conclusions to NOT file an income tax return, and (4) conclusions an entity or transaction is tax-free. • Steps • Identify tax positions and determine unit of account • Evaluate tax position for recognition • Measure benefit to be recognized • Determine classification • Accrue interest and penalties • Prepare disclosures 42nd Annual Insurance Tax Conference

42nd Annual Insurance Tax Conference Valuation allowance

Valuation allowance • All DTAs must be examined to determine their ultimate realization, whether the DTA is: • The tax effect of deductible temporary differences or • A tax attribute such as a carryforward of an NOL, loss or credit • If full realization is not more-likely-than-not, a VA is needed to reduce the net asset to the amount that more-likely-than-not will be realized. • Future realization of the tax benefit ultimately depends on the existence of sufficient taxable income. • Of the appropriate source and character of income • Within the allowable carryback period and carryforward period 42nd Annual Insurance Tax Conference

Valuation allowance • ASC 740-10-30-18 provides four possible sources of taxable income that should be considered to realize a tax benefit for deductible temporary differences and/or tax attributes. • Future reversals of existing taxable temporary differences • Future taxable income exclusive of reversing temporarydifferences and tax attributes • Taxable income in prior carry back year • Tax planning strategies • Source 1 and 3* can be “objectively verified” as they represent the financial accounting/ tax consequences of past transactions. Sources 2 and 4 are “subjective” as they represent future events. 42nd Annual Insurance Tax Conference

Valuation allowance • Cumulative losses in recent years represents significant objectively verifiable negative evidence. • While "cumulative losses" is deliberately not defined, common starting point is cumulative pre-tax results of the current and two preceding years adjusted for permanent items (e.g., nondeductible goodwill impairments) and not tax losses. • Better illustration of the economic reality (i.e., deductions might be delayed for tax even when an asset like property has no value and has been impaired for book) • Note: A three-year cumulative loss test is NOT in ASC 740 because FASB did not want a bright line test. However, it was in the SFAS 109 exposure draft and many entities use this standard in analyzing losses for purposes of VA. Sources 2 and 4 are “subjective” as they represent future events. 42nd Annual Insurance Tax Conference

42nd Annual Insurance Tax Conference STAT tax accounting basics

Statutory Accounting – Basic Principles • The basic objective of statutory accounting is to monitor and maintain insurance company solvency in order to protect its policyholders. If the insurance company were liquidated, what assets would be available to pay policyholder claims. • Statutory accounting focuses more on cash liquidity than GAAP accounting • Nonadmitted assets (page 2, col. 2)- Assets that cannot be readily converted to cash include impaired investments, receivables over 90 days old, deferred taxes, and furniture and fixtures. • The focus on solvency is also demonstrated on the income statement: policy acquisition expenses are immediately expensed, rather than capitalized, as they are for GAAP purposes. 42nd Annual Insurance Tax Conference

An Overview of Statutory Accounting and SSAP 101 • Statutory Accounting Principles (SAP) require the recognition of current and deferred taxes similar to GAAP • SAP generally applies the principles of GAAP accounting with some modifications • The primary difference in accounting for deferred income taxes for Statutory Accounting in comparison to GAAP is that Statutory Accounting employs an admissibility test with respect to deferred tax assets (DTAs) • Aligns with SAP’s primary solvency consideration – what portion of an entity’s DTA may actually be monetized in the near future (future operations tax carryback benefit) • Has similar impact as GAAP valuation allowance; creates an additional layer of realizability evaluation • The Admissibility Test of SSAP 101 determines the amount of DTAs that an insurer may admit for financial reporting purposes • “Nonadmitted” deferred tax assets are computed by the admissibility test components prescribed by SSAP 101 • Deferred tax assets which are determined to be non admitted are charged directly to surplus 42nd Annual Insurance Tax Conference

SSAP 101 Admissibility Testing Preparation of SSAP 101 admissibility calculation can be broken out into five steps: • Identification of future deductible temporary differences (DTAs) and future taxable temporary differences (DTL) • Scheduling of DTA reversals (separately for ordinary and capital DTAs) • Identification of federal income taxes paid in prior years that can be recovered through loss carrybacks for existing temporary differences (Paragraph 11.a) • Two year carryback for nonlife ordinary, three year carryback for life ordinary (capital is 3 years for both) • Comparison of DTAs reversing in three years, not admitted under Paragraph 11.a, to the allowable portion of the entity’s risk-based capital and admit the lesser of the two Realization Threshold Limitation Tables (“Tables”) for RBC and Non-RBC reporting entities (Paragraph 11.b) • Applicable realization period and capital and surplus limitation percentage are determined based on the Realization Threshold Limitation Tables (“RBC Tables”) discussed in further detail later in this section. • Admit lesser of remaining b.i) DTAs reversing in 3 years or b.ii) surplus limitation based on realization schedule • Comparison of remaining DTAs not admitted under 11.a or 11.b to the total population of DTLs (Paragraph 11.c) 42nd Annual Insurance Tax Conference

SSAP101 admissibility – complications in a consolidated return setting • Tax Sharing Agreement (“TSA”) considerations • Modified separate company TSA • Separate company valuation allowance • Timely settlement of cash taxes from TSA • SSAP 101 paragraph 11a. • SSAP 101 Q&A #8 • “Furthermore, the admitted DTAs under paragraph 11.a. may not exceed the amount that the entity could reasonably expect to have refunded by its parent (paragraph 12.c.) The taxes paid by the reporting entity represent the maximum DTAs that may be admitted under paragraph 11.a., although the amount could be reduced pursuant to the group’s tax allocation agreement.” 42nd Annual Insurance Tax Conference

42nd Annual Insurance Tax Conference Intricacies of tax reform

Intricacies of tax reform GAAP impacts of tax reform • GAAP • Deferred taxes – reduction in tax rate could have unfavorable impact on net DTA position, favorable impact on net DTL position • 10 year DTA reversal scheduling exercise for any tax reform approved through reconciliation that is not budget neutral (10 year expiration window) • DTAs for specific tax attributes – foreign tax credits (i.e., future availability), AMT credits • Valuation allowance implications • Change in net deferred tax position • Future projections of income 42nd Annual Insurance Tax Conference

Intricacies of tax reform STAT impacts of tax reform • STAT • Surplus – haircut DTA by lower rate • Potential for reduction of admitted DTA due to tax law changes that may impact SSAP 101 admissibility calculation • No carryback or limited carryback of tax attributes • Cash Flow testing of reserves • Variable product pricing models and other models considering tax • Risk based capital calculations • Asset valuation reserve – reserve is computed based on post tax asset risk • Interest Maintenance Reserve – recorded net of tax 42nd Annual Insurance Tax Conference

42nd Annual Insurance Tax Conference GAAP and STAT tax and accounting updates

GAAP tax and accounting updates ASC 740 Income taxes • Tax technical • ASU 2016-16 Intra-entity asset transfers (effective 12/15/17) • Removes prohibition on recognition of income tax expense for taxes paid for intra-entity transactions • Removes prohibition on recognition of DTAs on intra-entity differences in tax basis and F/S cost • ASU 2016-01 Financial Instruments (effective 12/15/17) • Valuation Allowance considerations on Available-for-Sale debt securities • Historically able to provide representation that DTAs for AFS investments in unrealized loss positions can be held to maturity without Valuation Allowance • Cannot look to “holding to maturity” as a source of income in valuation allowance analysis 42nd Annual Insurance Tax Conference

GAAP tax and accounting updates ASC 740 Income taxes • Proposed income tax disclosures • Domestic and foreign components of pretax income or loss • Disaggregation of income tax expense/(benefit) by foreign/domestic • Disaggregation of income taxes paid by country • Indefinitely reinvested foreign earnings • Enacted tax law change • Attribute carryforwards detail • Reason for changes in realizability estimate of deferred tax assets • Government assistance 42nd Annual Insurance Tax Conference

STAT tax and accounting updates SSAP 101 and STAT considerations • SSAP No. 101—Income Taxes • Revisions reject ASU 2016-16: Intra-Entity Transfers of Assets Other Than Inventory that requires reporting entities to recognize the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. • SSAP No. 26R—Bonds and Issue Paper No. 156-Bonds (2013-36) • Certain bond ETFs may be identified for valuation under the system value approach. Otherwise, they are reported at fair value or net asset value. • Unrealized gain/loss DTA/DTL considerations • SSAP No. 35R—Guaranty Fund and Other Assessments (2017-01) • Discounting of guaranty assessments related to long-term care is allowed as of January 1, 2017 – consistent with GAAP • Generally see related STAT accrual related DTAs that may change as a result of updated STAT computation 42nd Annual Insurance Tax Conference

Insurance Tax Conference