Uncertainty Remains in Tax Reserve Assumptions for Guaranteed Renewable and Noncancellable Health Insurance

At the time the l984 Tax Act was developed, efforts were made to conform tax reserves to the statutory reserve environment at the time. The drafters of the Act seemingly presumed that the National Association of Insurance Commissioners (NAIC) and state law always would provide for deterministic minimum reserves computed using defined tables and discount rates. Since then, statutory reserve regulation has undergone substantial changes prompted by product innovation and technological advances, whereas section 807, which deals with deductible tax reserves, has remained relatively unchanged.

Consequently, it has become increasingly more difficult to fit statutory guidance (most recently Actuarial Guideline 43) and new product forms into the Code’s tax reserve regime. Principle-based reserves likely will exacerbate this problem. With all the activity surrounding reserving changes for life insurance and variable annuities, tax reserve issues relating to guaranteed renewable and noncancellable health insurance sometimes are overlooked. Certain reserves in these product lines are treated as “life insurance reserves” and thus subject to recomputation for tax purposes under section 807. Actuaries have been struggling for years to fit these reserves into the rules of that Code section.

By its nature, the health insurance product lines contain enormous variations in benefits,
and even within one product line, significant differences in benefit terms arise. Thus, standard tables do not function as effectively for health insurance as for life insurance. This additionally complicates the application of the provision for adjustment “as appropriate to reflect the risk.” Further, there is the matter of rapid table obsolescence in several health product lines, which undoubtedly caused the Treasury Department (Treasury), in its crafting of Treas. Reg. § 1.807-1 (described below), to prescribe the morbidity table for tax purposes in most health product lines. Interestingly, Treasury in its regulation, apparently acknowledging the difficulty in prescribing specific tables for health insurance, in most instances simply prescribes the table used for statutory annual statement purposes.