Reproduced with permission from Jason Simkin, CPA | Simkin CPA, LLC – The Insurance Tax Advisory Firm
Just in time for the Government Shutdown, the IRS has issued the discount factor information necessary to run a calculation of the potential tax reform implications for Unpaid Loss, LAE, and Salvage/Subrogation reserves and recoverables. Up to this point companies have generally not updated their financials for the tax implications of this major item. Many of you have probably put a note in your 2017 financials stating that this and other aspects of the tax reform implementation would be accounted for in 2018. Thus, you are now faced with a decision for your year-end financials on if and how to use the specified factors to generate a tax reform adjustment for tax provision. A few important observations:
1) What types of Companies are affected?
All P&C companies, as well as Life & Health companies that write certain A&H products (ex. Group Health, Med Sup, other A&H products excluding guaranteed renewable/non-cancelable, etc.)
2) What was provided in the Revenue Procedure?
a) Estimated Discount Factors to apply to all lines of business for the 2018 accident year (based on concepts in the Proposed Regulations)
b) Estimated Discount Factors to apply to all lines of business for 2017 and prior accident years to calculate the tax reform implementation adjustment to be amortized beginning in 2018 (based on concepts in the Proposed Regulations)
3) Were there any surprises in the Revenue Procedure?
One area that may provide a significantly more material impact to your financials than many were expecting is the approach to computing the tax reform adjustment and future discount factors for all accident years prior to 2018. The approach may be significantly more material as the change covered more years and more aspects of the calculation methodology than many anticipated. These are the potential computations of the tax reform adjustment that were considered, as well as the IRS’ selection in the Revenue Procedure:
a) Not Selected – Follow the 2016 and prior IRS historical industry payment pattern/discount factors and continue to run off those accident years under historical IRS patterns. For the 2017 year the unpaid losses and LAE would be computed using historical industry payment patterns but with the 2017 corporate bond rate.
b) Not Selected – Follow the 2016 and prior IRS historical industry payment pattern but replace the discount factor for those years with a corporate bond rate for that vintage year. For the 2017 year the unpaid losses would be computed using IRS historical industry payment patterns but with the corporate bond rate.
c) IRS Revenue Procedure Selection – The following is the summary from our firm’s discussions with Kathryn Sneade, the principle author of the Regulation and Revenue Procedure, as you will find that some of the underlying assumptions are not explicitly discussed in the Revenue Procedure. Thus, the following may ultimately be changed/clarified in future IRS commentary. Kathryn explained that for 2017 and prior they basically discarded all vintaged historical payment patterns and discount rates for all accident years 2017 and prior. They replaced those payment patterns and discount factors with the 2018 payment pattern and 2018 corporate bond rate. Thus, all years 2017 and prior are not only recomputed with a new discount rate but also with a new payment pattern independent of the payment pattern for that vintage year. For future years (i.e. 2019 and forward) she stated that they would go back to each accident year being vintaged with respect to payment pattern and interest rate. However, the 2018 and prior accident years would continue to use the 2018 payment pattern and corporate rate. Depending on the lines of business you write and the specific accident years you have with unpaid losses the materiality of this approach may be substantially more than you anticipated.
4) Will the factors in the Revenue Procedure change and are the underlying concepts final or estimates?
The factors, which affect all accident years from 2018 and prior, were generally based on the IRS concepts and positions taken in the Proposed Regulations published in November. While unusual, the IRS released the Revenue Procedure with computational results of principles still open to change, and with the provision that it may revise them further after the Regulations are finalized.
5) Will the factors be finalized before company financials are issued?
A hearing for the public to comment on the Proposed Regulations took place on December 20th. The Comment period for the Revenue Procedure is open until February 6, 2019. It’s also not clear how long the Government Shutdown will last and whether it could cause a delay in this area. Thus, it’s possible that there will not be Final Regulations and a final Revenue Procedure until after many companies publish year-end 2018 IFRS/GAAP/STAT financials. This leaves you with a decision to make whether your applicable financial statement guidance (i.e. GAAP/IFRS/STAT) requires you to book a tax reform implementation adjustment based on the new Revenue Procedure, as well as how to account for any future change in the computations after the Regulation and Revenue Procedures are finalized.
Jason Simkin, CPA
Simkin CPA, LLC – The Insurance Tax Advisory Firm
5757 Alpha Road Suite 622, Dallax, TX 75240
The “IRS Tax Reform 2018 and Prior Disc Factors” and “Proposed Regulations – Discounted Unpaid Loss and Salvage and Sub” are provided as supplements in the corresponding PDF document.
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