Is There Another Tax Reserves Solution for Pre-2010 Variable Annuities?

Life insurance companies and the Internal Revenue Service (IRS) are continuing to struggle with the tax reserve method to use for variable annuity contracts issued prior to Dec. 31, 2009. Since the adoption of Actuarial Guideline (AG) 43 effective on Dec. 31, 2009, statutory reserves for variable annuity contracts issued on or after Jan. 1, 1981, have been computed using that guideline. In Notice 2010-29, the IRS provided interim guidance on tax reserve issues that arise from AG 43. As to pre-2010 contracts, the IRS Notice states: “the tax reserve method under § 807(d)(2) (A) and (d)(3) is the method applicable to such contract when issued, as prescribed under relevant actuarial guidance in effect before the adoption of AG 43.” The IRS determined that this interim guidance for pre-2010 contracts was required by I.R.C. § 807(d)(3), which defines the tax reserve method as CARVM prescribed by the National Association of Insurance Commissioners (NAIC) in effect on the date of the issuance of the contract. Although the NAIC gave AG 43 “retroactive” effect for pre-2010 contracts, the IRS considered AG 43 to represent a change from the NAIC’s prior interpretation of CARVM. In such a circumstance, the IRS concluded that the Internal Revenue Code requires the NAIC’s interpretation at the date of the contract’s issuance to govern.

The problem with the IRS’s conclusion is that, in the absence of AG 43, there is no clear NAIC guidance regarding how to interpret CARVM for variable annuity contracts that have guaranteed living benefits (VAGLB) riders. And, the IRS has not provided any additional guidance to supplement Notice 2010-29.

In the absence of IRS guidance, life insurance companies generally have adopted one of two approaches to determine tax reserves for pre-2010 annuity contracts with VAGLB. Some companies use AG 39 to compute tax reserves on the basis that it applied to the contracts at the time they were issued—at least for contracts issued after the 2002 effective date of AG 39. Other companies take a different approach. These companies do not follow AG 39 for several reasons, but primarily because, by its terms, AG 39 (as amended) specified that it would sunset no later than Dec. 30, 2009. Therefore, the argument goes, although AG 39 was prescribed by the NAIC at the date the contracts were issued, it was only prescribed for pre-2010 years. Thereafter, the NAIC specified that other guidance would become applicable. The NAIC guidance that the second group of companies follows is the general provisions of AG 33, as well as by analogy AG 34, which applied to variable an- nuity contracts with guaranteed minimum death benefits. This second approach has been referred to as the “hybrid method,” and details of its application can be found in a TAXING TIMES article that this commentator co-authored.