Effective Date and Statutory Reserves Capping Issues Under Actuarial Guideline XLIII

This issue of TAXING TIMES includes an article which provides an excellent summary of tax issues that arise from the adoption of VACARVM by the National Association of Insurance Commissioners (NAIC)1 as well as an American Council of Life Insurer’s (ACLI) update of its dealings with the Treasury Department (Treasury) on the same issue.2 VACARVM is now designated as Actuarial Guideline XLIII (AG 43). The above referenced article makes the important point that, despite its retroactivity for statutory purposes, AG 43 probably will have only prospective effect for tax purposes. Both the article and the ACLI Update note that, regardless of whether the Stochastic Excess will be considered part of CARVM reserves for tax purposes, it may be included in the statutory reserves cap for purposes of the three-way test under I.R.C. § 807(d)(1). These points deserve some elaboration.

Does AG 43 apply to all contracts issued in 2009?

Under I.R.C. § 807(d)(3), the tax reserve method that must be used for variable annuity contracts is the Commissioners’ Annuities Reserve Valuation Method (CARVM) prescribed by the NAIC in effect on the date of the issuance of the contract. Implementation of this statutory rule has resulted in disputes between the Internal Revenue Service (IRS) and life insurance companies where the NAIC has adopted actuarial guidelines with retroactive effect. IRS auditors generally have taken the position that a newly-adopted actuarial guideline cannot apply for tax purposes to contracts issued prior to the year the guideline was adopted. As support for this position, IRS auditors cite a technical advice memorandum that currently is being challenged in the U.S. District Court in a tax refund suit.3 Life insurance companies have argued that an actuarial guideline should apply retroactively when the new method is used for statutory reserves and it was one of several permissible interpretations of CARVM at the time the contract was issued.4

There does not appear to be a major dispute on this issue as a result of the NAIC’s adoption of AG 43. The IRS is likely to take the position that AG 43 should not be used for contracts issued prior to 2009, and taxpayers are equally likely to accept this interpretation, at least for most pre-2009 contracts. This is because—prior to the adoption of AG 43—the NAIC had clear guidance on the interpretation of CARVM in AG 34 and AG 39 that was required to be used for the tax reserve method under I.R.C. § 807(d)(3). There is a lingering issue, however, relating to contracts subject to AG 43, but issued prior to the adoption of AG 34 or AG 39. It could be argued that AG 43 should be used for these contracts because there was no NAIC-prescribed interpretation of CARVM at the time they were issued, and AG 43, at least in theory, was one of several permissible interpretations. Therefore, because AG 43 will be used for statutory reserves for these contracts, it is arguable that it also should be used as the tax reserve method. Nevertheless, it appears from comments sent to the Treasury and the IRS by the ACLI on Oct. 24, 2008, that the industry does not intend to press this issue. Perhaps, this issue will be revisited after the pending litigation on the retroactive application of AG 33 is resolved.