The Tax Reserve Method Should Be PBR Once It Is Adopted by the NAIC

Notice 2008-181 outlines tax issues and concerns of Treasury and the Internal Revenue Service (IRS) in the event the National Association of Insurance Commissioners (NAIC) adopts AG VACARVM and/or principle-based reserves (PBR). Comments on the Notice were filed by the American Council of Life Insurers (ACLI), the NAIC and the American Academy of Actuaries (AAA). One of the questions in Notice 2008-18 addressed by the ACLI relates to whether Treasury and the IRS are required by the Internal Revenue Code to accept AG VACARVM and PBR as the tax reserve methods under I.R.C. § 807(d). Specifically, the Notice asks:

. . . if Proposed AG VACARVM and Proposed Life PBR are characterized as CARVM or CRVM, respectively, for regulatory purposes, could the Treasury Department and IRS nevertheless conclude they do not constitute CARVM or CRVM as Congress envisioned those terms to apply in 1984; alternatively, if Proposed AG VACARVM and Proposed Life PBR were not characterized as CARVM or CRVM, respectively, for purposes of applying section 807, could Proposed AG VACARVM and Proposed Life PBR nonetheless be required as the appropriate tax reserve method under the authority of section 807(d)(3)(A)(iv).

As to the first question, the ACLI responded that, by enacting I.R.C. § 807(d), Congress deferred to the NAIC to determine the tax reserve method and contemplated that the method could be changed from time to time. As to the second question, the ACLI pointed out that it is rhetorical because the Code defers to the applicable NAIC reserve method regardless of how it is labeled. Because the ACLI’s comments are somewhat conclusory, it may be useful to provide more detailed background to demonstrate why the trade association correctly summarized the law.

What is the “Tax Reserve Method?”

I.R.C. § 807(d)(3)(A) provides a general rule that the “tax reserve method” for a life insurance contract is CRVM and for an annuity contract is CARVM. CRVM and CARVM are further defined in I.R.C. § 807(d)(3)(B) to mean CRVM and CARVM prescribed by the NAIC which is in effect on the date of the issuance of the contract. This general rule applies only to contracts covered by CRVM or CARVM. Thus, for example, the general rule does not apply under current law to certain group contracts for which the Standard Valuation Law does not prescribe CRVM or CARVM. For contracts that are not covered by CRVM or CARVM, one of two rules applies under I.R.C. § 807(d)(3)(A)(iv). The reserve method prescribed by the NAIC which covers the contract at the date of issue is required to be used, or, if no reserve method has been prescribed by the NAIC, a reserve method consistent with CRVM or CARVM must be used.