Sunday, September 12, 2010

Deferred Tax Issue Still On Radar

Deferred Tax Assets are getting discussion again in preparation for the release of a report by the American Academy of Actuaries, Washington, on Sept 15.

DTAs are differences between GAAP tax accounting and statutory accounting that are reflected on company balance sheets. They are used in the calculation of company risk-based capital ratios. DTAs are also used generally in accounting by taking prior losses and using them as a tax offset against current company income.

The issue is one that state insurance regulators have been addressing for a year-and-a-half. At the height of the financial meltdown, regulators dealt with a request from life insurers that included relaxing capital and surplus requirements so companies could more efficiently use capital. Part of that discussion included treatment of DTAs.

The preliminary report states that DTAs are not volatile in isolation but rather is a function of the underlying assets and liabilities. It continues that risks associated with DTAs are:

--Inability to generate taxable income of the right character to realize the DTA,
--Extension risk, i.e., the inability to generate taxable income soon enough to realize the DTA, and
--The risks that federal legislative or regulatory tax changes could impact the value of the DTAs before they are realized.

The Academy writes that “the first of these risks is the only one of major significance.”

The results of the review, according to the Academy, will be considered for implementation in the RBC formulas for year end 2011 or later for life, property-casualty and health lines of business. However, it continues, the review will not address the temporary change to statutory DTA for 2009 and 2010.

Among the preliminary recommendations that Academy is making are that the RBC charge should reflect the company’s level of capitalization, as measured by the RBC ratio calculated without the Admitted DTA in Adjusted Capital. And, it continues in its report, “If current (or similar) capping procedures are maintained, it is recommended there should be no charge in the RBC formula for reasonably well capitalized companies given the resulting implicit ‘RBC charge’ of the capping procedures. Weakly capitalized companies should still be subject to a 100% RBC charge of the admitted DTA.”

During the discussion among regulators of the National Association of Insurance Commissioners, Kansas City, Mo., several points were raised by Academy representatives:

--the Academy working group found no concerns with the current way tax sharing is done among company groups;
--in response to a question about whether tax credits should be allowed for weaker insurers with lower RBC, the Academy noted that “RBC should be appropriate for weak companies. If you can’t make use of tax credits, they shouldn’t be used…” The Academy says that it has decided that the particular question relates to the broader RBC formula and would require significant changes that are out of the scope of the Academy’s charge from regulators.
--Fraternals don’t pay taxes so there are no DTA considerations; and,
--the Academy noted that as an insurer’s RBC position becomes weaker, the portion of DTAs that are included in non-admitted assets grows.

Regulators listening to the report raised questions that need further examination. Denis Luzon, a New York regulator, asked whether both the DTA is competing with other tax offsets for the same gains the insurer is reporting.

And, Peter Medley, a Wisconsin regulator expressed concern that the report may not be taking into account the credit risk of the holding company and whether the insurer in a holding company structure will actually receive the DTA.

No comments:

Post a Comment