June 2018

TAX DEVELOPMENTS

IRS Notice 2018-41 – Comments Submitted

As we reported previously, in April the IRS released Notice 2018-41 requesting comments on various aspects relating to implementing regulations for certain life insurance contract transactions under new IRC § 6050Y, which was added by the Tax Cuts and Jobs Act. We refer to the topic as the “reportable policy sales” rule. The comment period ran through June 13.

The Association for Advanced Life Underwriting (AALU) submitted a comment letter addressing the new law’s unintended potential impact on business-owned life insurance being treated as an “indirect reportable policy sale.” The AALU urged the IRS to issue proposed regulations better defining indirect reportable policy sales and clarifying that ordinary course M&A transactions would not constitute a reportable policy sale. To that end, the AALU recommended that the proposed regulations include the following clarification:

For purposes of [this rule], the term ‘indirectly’ applies to the acquisition of an interest in a partnership, trust, or other entity that holds an interest in the life insurance contract unless the interest in the partnership, trust, or other entity is acquired as part of a transaction involving a trade or business where the acquired trade or business (or any predecessor trade or business) had a substantial family, business, or financial relationship with the insured at the time the contract was issued.

The Life Insurance Settlement Association (LISA) submitted a lengthy comment letter addressing numerous issues. One topic potentially relevant to BOLI owners was a recommendation to clarify that a reportable policy sale would not include any transaction that qualifies for non-recognition of income under IRC § 1035.

A few commenters asked for additional clarification related to the statutory definition of reportable policy sale. In particular, the meaning of the emphasized words below:

Statutory Definition of Reportable Policy Sale: the acquisition of an interest in a life insurance contract, directly or indirectly, if the acquirer has no SUBSTANTIAL family, business, or financial relationship with the insured APART from the acquirer’s interest in such life insurance contract.

We will continue to monitor this topic closely and report on any developments as we learn about them.

REGULATORY DEVELOPMENTS

FRB Finalizes Single-Counterparty Credit Limits

On June 14, the Federal Reserve Board approved a final rule which implements the single-counterparty credit limits required by section 165 of the Dodd-Frank Act. Consistent with the proposed rule:

• A global systemically important bank holding company (“GSIB”) will be limited to a credit exposure of no more than 15 percent of the GSIB’s tier 1 capital to another systemically important financial firm; and
• A bank holding company with $250 billion or more in total consolidated assets will be restricted to a credit exposure of no more than 25% of its tier 1 capital to a counterparty.

Consistent with the recently passed Economic Growth, Regulatory Reform, and Consumer Protection Act, the limits in the final rule will apply only to GSIBs and bank holding companies with at least $250 billion in total consolidated assets.

The press release issued by the FRB notes that GSIBs will be required to comply by these rules by January 1, 2020. All other firms must be in compliance by July 1, 2020.

JUDICIAL DEVELOPMENTS

COI Litigation – Vogt vs State Farm Insurance Company

On June 6, a federal jury in Missouri returned a verdict in favor of the plaintiffs in a class action lawsuit against State Farm Life Insurance Company, awarding damages of roughly $34 million. The case was brought on the behalf of approximately 24,000 current and former policyowners of universal life insurance policies issued by State Farm in Missouri.

The plaintiffs alleged that State Farm used impermissible factors in setting the cost of insurance (COI) rates under the policies. The policies specified that COI rates would be based on age, sex and rate class and further disclosed that the rates would only be adjusted for “projected changes in mortality.” Below is the substantive language from the applicable policies (emphasis added):

These [cost of insurance] rates for each policy year are based on the Insured’s age on the policy anniversary, sex, and applicable rate class. … Maximum monthly cost of insurance rates will be provided for each increase in the Basic Amount. We can charge rates lower than those shown. Such rates can be adjusted for projected changes in mortality but cannot exceed the maximum monthly cost of insurance rates.

The complaint alleged that State Farm knowingly used non-specified factors (including, among others, expense experience, taxes, profit assumptions, and investment earnings) in determining COI rates, which caused rates to be higher than explicitly authorized. Interestingly, the complaint did not appear to allege that State Farm ever administered an increase to its COI rates.

According to plaintiffs’ counsel’s press release, this law firm has obtained settlements in excess of $2 billion on cases challenging insurers’ COI deductions.

OTHER DEVELOPMENTS

NAIC Statutory Accounting Principles (E) Working Group Focuses on Private Placement Variable Products – MBSA Comment Letter

As we reported last month, the NAIC’s Statutory Accounting Principles (E) Working Group continues to deliberate possible revisions to SSAP No. 21. In its latest exposure, insurers that own ICOLI policies would need to meet two requirements in order to continue the current practice of recognizing the values fully as admitted assets. The two requirements proposed are

1. The policies must comply with IRC §7702; and
2. The owner of the policy is not subject to investment risk (meaning the net realizable value does not change as a result of market fluctuations).

On June 22, MBSA submitted a comment letter to the NAIC recommending a more comprehensive review of ICOLI as an asset class owned by insurers. We drew several references to bank regulatory guidance and ultimately recommended that the NAIC evaluate both the risk-based capital framework as well as whether the products qualify as admitted or non-admitted assets for statutory accounting purposes.