Treasury Department Report on Tax Treatment of Life Insurance Inside Buildup
In September 2016, the Treasury Department released a report titled The Tax Expenditure for Life Insurance Inside Buildup (the “Report”). According to the Report, the Joint Committee on Taxation (JCT) recently changed its position to no longer include the deferral or exclusion of life insurance inside buildup as a tax expenditure. Treasury disagrees with this position.
In addition to describing its view that inside buildup is a tax expenditure and providing a simplified economic example, the Report included the following observations that we consider noteworthy:
- Cost Basis – The Report takes the position that the Internal Revenue Code provisions that determine a policyholder’s basis in an insurance contract measure basis “incorrectly.” Treasury believes that basis should be reduced for mortality charges.
- Proposals to Eliminate the Tax Expenditure – The Report states that proposals to eliminate the tax expenditure could allocate the income to either individuals, insurance companies or some combination of the two. The Report acknowledges administrative challenges with respect to any of the approaches.
While it remains unclear whether or to what extent Treasury’s position will influence the Administration’s or Congress’ ultimate policy position, understanding Treasury’s long-held views seems noteworthy.
IRS Private Letter Ruling – Variable Contracts (for Individuals) Satisfy Investor Control Rules
On February 3, the IRS published Private Letter Ruling (PLR) 201705003. The structure and analysis by the IRS in this PLR are very similar to the analysis in PLRs 201651002 and 201651012, which we discussed in the December 2016 Monthly LRA update.
In this PLR, the variable contract holders are individuals. The structure describes three distinct Portfolios that are existing series of a trust.
Federal Reserve Board Releases Scenarios for CCAR and Dodd-Frank Stress Tests
On February 3, the Federal Reserve Board (“FRB”) released the 2017 scenarios for the Comprehensive Capital Analysis and Review (“CCAR”) and Dodd-Frank Act stress tests.
On February 10, the FRB revised the 2017 scenarios to correct a data series error for the historical values for the BBB corporate yield in 2016.
The summary of the 2017 stress test scenarios from the FRB is as follows:
For the 2017 cycle, the severely adverse scenario is characterized by a severe global recession in which the U.S. unemployment rate rises by about 5.25 percentage points to 10 percent, accompanied by a period of heightened stress in corporate loan markets and commercial real estate markets. The adverse scenario features a moderate recession in the United States, as well as weakening economic activity across all countries included in the scenario. The adverse and severely adverse scenarios describe hypothetical sets of events designed to assess the strength of banking organizations and their resilience.
The CCAR and Dodd-Frank stress tests require covered institutions to project earnings across the entire balance sheet (including BOLI programs), as well as risk-weighted assets and capital ratios.
Executive Order on Core Principles of Financial Regulation
On February 3, President Trump signed an Executive Order promulgating “Core Principles for Regulating the United States Financial System.”
The Core Principles are as follows:
- empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;
- prevent taxpayer-funded bailouts;
- foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry;
- enable American companies to be competitive with foreign firms in domestic and foreign markets;
- advance American interests in international financial regulatory negotiations and meetings;
- make regulation efficient, effective, and appropriately tailored; and restore public accountability within Federal financial regulatory agencies and rationalize the Federal financial regulatory framework.
COI Litigation – Proposed Class Action Against Lincoln National
On February 22, a class action complaint was filed in the Eastern District of Pennsylvania against Lincoln National alleging that Lincoln’s recent COI increases on certain universal life insurance policies originally issued by Jefferson-Pilot (which Lincoln acquired in 2006) were improper.
The following excerpt from the complaint (paragraph 5) conveys the general premise:
The Policies contain an express contractual provision that states “The monthly cost of insurance rates are determined by us. Rates will be based on our expectation of future mortality, interest, expenses, and lapses.” This provision does not permit Defendants to increase COI rates for reasons other than those stated forward looking factors. For example Lincoln cannot increase the COI rate to cover for improper dividends paid by LNIC to its parent company LNC, past losses on the particular book of business, or miscalculations concerning past mortality assumptions, interest rates, expenses or lapse rates. Likewise, Lincoln is not permitted, pursuant to the policy terms, to increase COI charges to earn future profits above the level at the time the Policies were priced.
The complaint alleges that “the [COI] rate increases were imposed to improperly shift to the policyholders Lincoln’s own obligation to pay interest at the guaranteed minimum rate of 4% and to recoup past losses and spread deficiencies or reduced profits on the Policies, and therefore constituted a breach of Lincoln’s contractual obligations under the Policies.”
The complaint also indicates that the Plaintiffs submitted a complaint to the North Carolina Department of Insurance prior to commencing this litigation.
Lincoln has not yet filed a response to this complaint.
Separate from this litigation, Lincoln National raised COI rates on certain existing BOLI policies (formerly issued by Jefferson-Pilot) to the contractual maximums in April 2016.
Case Citation: 2:17-cv-00837 (PA-E.D.)
Ongoing BOLI-Related Litigation – Procedural Updates
FNB PA v. Transamerica and Clark Consulting
In February, the parties filed additional materials with respect to Transamerica and Clark Consulting’s Motion for Summary Judgment. At this point, the Court appears to be fully briefed, and we will expect a ruling on the Motion for Summary Judgment in the coming months.
BB&T v. MassMutual
As a brief reminder, BB&T first filed a complaint against MassMutual in 2009 (“BB&T I”). On May 1, 2015, BB&T voluntarily dismissed BB&T I and filed a new, substantially similar complaint (“BB&T II”). This litigation stems from investment losses realized in conjunction with BB&T’s allocation to a fixed income hedge fund (the Falcon Fund) within a MassMutual separate account policy.
On February 2, the Court approved an updated Case Management Order which included the following deadlines:
- The parties have until June 12, 2017 to conduct fact discovery;
- All expert discovery shall be completed on or before September 13, 2017;
- A final mediation must be conducted by September 29, 2017; and
- Post-discovery dispositive motions must be filed by October 13, 2017.