Recent Guidance Addresses Discounting Rules for Insurance Companies

| 8/1/2019
The U.S. Department of the Treasury and the IRS recently released final regulations and two revenue procedures that reflect changes made by the Tax Cuts and Jobs Act of 2017 (TCJA) to the discounting rules under IRC Section 846. Those rules are used to determine discounted unpaid losses and estimated salvage recoverable of property and casualty insurance companies and discounted unearned premiums of title insurance companies under IRC Section 832, as well as discounted unpaid losses of life insurance companies under IRC Sections 805(a)(1) and 807(c)(2). The TCJA changes are effective for taxable years beginning after Dec. 31, 2017.

Final regulations

The final regulations address the following:
  • Applicable annual rate. The applicable interest rate used to determine the discount factors associated with any accident year and line of business is the annual rate. The final regulations provide that the annual rate for any calendar year is the average of the corporate bond yield curve’s monthly spot rates with a maturity range from 4½  to 10 years. The maturity range in the final regulations is more favorable than the maturity range in the proposed regulations. Based on these rules, the current applicable interest rate for 2018 is 2.94%.
  • Composite method. Taxpayers generally use the composite method to discount loss reserves for accident years that are 10 years and older. The proposed regulations would have eliminated the use of the composite method. Many commenters stated that if the composite method were eliminated, compiling data required to compute discounted unpaid losses with respect to accident years not separately reported on the National Association of Insurance Commissioners’ annual statement would be unnecessarily difficult, especially given the limitations of company data for older accident years and legacy information systems. In response to these comments, the final regulations continue to permit the use of the composite method. Accordingly, the IRS will continue to publish composite discount factors annually.
  • Smoothing adjustment. The smoothing adjustment allows the IRS to adjust the loss payment pattern for any line of business if necessary to avoid negative payment amounts and produce a stable pattern of positive discount factors less than one. The final regulations adopt the proposed rules for the smoothing adjustment. Specifically, Section 1.846(d)(1) of the final regulations provides that the loss payment pattern determined by the secretary for each line of business generally is determined by reference to the historical loss payment pattern applicable to such line of business.
  • Discounted salvage recoverable. The preamble to the proposed regulations requested comments regarding whether the estimated salvage recoverable should be discounted by using the published discount factors applicable to unpaid losses, which is permitted under IRC Section 832. This proposed change was met with general support from commenters, and the preamble to the final regulations confirmed the change. Accordingly, the estimated salvage recoverable will be discounted using the published discount factors applicable to unpaid losses.
  • Reinsurance and international lines of business. IRC Section 846 no longer explicitly provides for the determination of loss payment patterns for nonproportional reinsurance and international lines of business extending beyond three calendar years following the accident year. The final regulations reflect this change by removing Sections 1.836-1(b)(3)(iv) and (b)(4).

Simplified change of accounting method revenue procedure

Effective for changes made for taxable years beginning after Dec. 31, 2017, and ending on or before Dec. 31, 2019, Revenue Procedure 2019-30 provides simplified procedures for taxpayers to change their method of accounting for discounting unpaid loss reserves to comply with the tax reform changes under IRC Section 846. One major simplification is a waiver of the requirement to file Form 3115 to obtain consent to change a method of accounting under this revenue procedure.

Revised discounting rates revenue procedure

Revenue Procedure 2019-06 provided the unpaid loss discount factors for the 2018 accident year and earlier accident years for use in computing discounted unpaid losses based on the proposed IRC Section 846 regulations. In light of the final regulations, Revenue Procedure 2019-31 provides revised discounting rates for discounting 2018 loss reserves and for revaluation of loss reserves for 2017 and prior years.

Revenue Procedure 2019-30 also allows a taxpayer to use the revised discounting rates provided in Revenue Procedure 2019-31, or the rates provided in Revenue Procedure 2019-06 for the 2018 tax return, as long as the taxpayer is consistent with using the proposed or revised rates for both the 2018 discounting and for revaluation for 2017 and prior tax years. Regardless, taxpayers must use the revised discount factors in Revenue Procedure 2019-31 for tax years after 2018. Fiscal year filers must use the revised factors for tax years ending on or after June 17, 2019.

In addition, if the proposed factors are used, the revised discount factors in Revenue Procedure 2019-31 must be used when computing any supplemental adjustment to account for the difference between the discount factors determined under the two revenue procedures. The taxpayer has the option to take this supplemental adjustment into account in 2018 or to spread the adjustment over the remaining six years (after 2017 and 2018) of the eight-year spread.

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