Taxable Income vs. Actual Economic Income

QRA Method:

Original QRA Deduction is Equal to Pull Reserve
(and is, Therefore, Excessive" and Subject to Recapture)

Exhibit A-4

$1,000.00 premium received on 1/1/86 is fully earned on 12/31/86 $1,000.00 loss incurred on 12/31/86 is paid on 12/31/87

о

12% taxable interest rate (8.04% after tax)

and maintaining

the business of

Commissioners (NAIC) are responsible for supervising

the financial solvency of companies engaged in insurance in the United States; and

WHEREAS, The United States Treasury has proposed changes to the Internal Revenue Code which would alter the way insurers are taxed;

and

WHEREAS, after more than two years of study the Treasury and Congress agreed to the 1984 Life Insurance Company Tax Act provisions which affirmed the role of state regulatory authorities in safeguarding insurance company solvency by prescribing life insurance company tax reserves to be not less than those prescribed by the minimum standards of a majority of the states; and

WHEREAS, the proposal to limit

life insurance company reserves to

amounts solely equalling cash values is a disincentive for maintaining

adequate reserves for future

obligations

under life insurance

contracts; and

WHEREAS, proposals to tax insurers selling property and casualty, health insurance, and other non-life insurance products include a qualified reserve account method which fails to recognize minimum statutory reserves required by and established for those products; and

WHEREAS, the proposed changes in the Internal Revenue Code would act as strong disincentives for insurers to adequately reserve for losses

NOW BE IT THEREFORE RESOLVED that:

1.

The National Association of Insurance

Commissioners

opposes any

method of taxing insurers, such as the qualified reserve account

method, which would weaken the tax

laws '

recognition of state statutory accounting rules and their traditional methods of reserving for policyholder benefits, claims and losses, and

2.

To the extent any change in the system of taxing insurers 1S deemed necessary, the NAIC strongly urges Congress to pursue alternative methods of taxation which are consistent with the President's proposal for tax reform

simplicity and fairness, which contain incentives for adequate and sound loss reserving,

and which operate in harmony with state statutory accounting rules designed to preserve the safety and soundness of insurers.

Mrs. KENNELLY. Thank you, Mr. Mitchell.

Mr. Nutter?

STATEMENT OF FRANKLIN W. NUTTER, PRESIDENT, ALLIANCE OF AMERICAN INSURERS

Mr. NUTTER. Madam Chairwoman, I am Franklin W. Nutter, president of the Alliance of American Insurers. We are a national association of 175 property/casualty insurers, both stock and mutual, which provide insurance protection to millions of Americans' homes, autos, and businesses.

I speak in opposition to the proposals contained in the President's recommendations for tax reform. In accordance with the panel's understanding, my remarks will address only the President's proposal for a limitation on the policyholder dividend deduction, but we are submitting a statement for the record.

Mutual insurance has been a part of American commerce since the foundation of this country and payment of dividends to policyholders is a cornerstone of the mutual concept. But both mutual and stock companies pay dividends. Dividends are a return of a part of the premium paid for protection based upon loss experience. Unlike the issues facing this committee last year on the taxation of life insurers, this proposal to reduce an insurer's deduction for policholder dividends is not one that divides this industry. All segments are opposed to the proposal.

Under the current Tax Code, casualty insurance companies are allowed to deduct the dividends paid or declared to policyholders. Under the President's proposal, the deduction apparently would be reduced in a manner consistent with the way mutual life insurance deductions were limited by the 1984 Deficit Reduction Act proposed and adopted by this committee.

The administration proffers this proposal on the premise that the conditions which fueled the 1984 life insurance tax reform exist in this industry that is a competitive advantage for mutual versus stock companies resulting from policyholder dividends and a perception that mutual company policyholder dividends are a return on equity not on loss experience.

The administration's premise is completely unfounded. It is based upon an analysis which presumably demonstrates an inequity among policyholders as a result of the dividends.

Our industry is neither divided nor in conflict over the advisability of continuing the present deduction. Nevertheless, the Treasury proposal operates as a tax only on mutual insurance companies on this premise of a competitive advantage although indeed stock insurers in the property/casualty industry pay 50 percent of these dividends and account for nearly 75 percent of the premium volume.

It is truly notable that in a moment of self-doubt, the administration itself states that additional study of this proposal is needed. I suggest to you that sound public policy should be based on complete analysis, not conjecture and not transfer from tax negotiations from an industry with a tax structure totally unrelated to our

own.

We also disagree with the Treasury belief that policyholder dividends are in part a return of the ownership interest to policyholders and their proposed imputation of a dividend payment by disallowing a percentage of loss reserves that could be taken as a normal deduction.

Dividends are declared by a company based on a variety of factors, principally the loss experience on that line of insurance. Indeed, in some years it may be sound business practice to grant no dividends and it may be sound business practice to grant dividends on certain lines, but not on others.

The practical result of the Treasury proposal is to punish a mutual insurance company for exercising sound business judgment. Carried to an extreme, if no dividends were declared, all the surplus overtime could be disgorged by imputing income to the company out of policyholder surplus.

Current tax treatment recognizes the unique characteristic of casualty insurance where we do not know with any degree of complete certainty our costs until after a policy has been written.

Policyholder dividends and the deduction permitted by the code allow companies, stocks and mutual, to provide coverage, reward good loss experience and manage corporate growth through flexible pricing. Dividends paid to policyholders are an expense like any other business expense and should be allowed to be deducted in full.

Casualty insurance is not purchased as an investment such as occurs with certain life insurance products. Property casualty policyholders have no real expectation for a return on equity through policyholder dividends.

In summary and conclusion, Madam Chairwoman, we oppose the change in the deduction for policyholder dividends. They are not a share of company earnings. They are a return of premium by line of coverage. A valid distinction between policyholder dividends and the treatment of stockholder dividends should be noted.

The competitive advantage cited by the Treasury Department has not been demonstrated by the Treasury, nor asserted by any segment of the industry. Perhaps more importantly, the GAO studied this aspect of the property/casualty industry and did not make the same recommendation as Treasury. It will be a discrimination against the mutual form of insurance. Casualty insurance is not purchased as an investment.

Dividend payments are an ordinary and necessary business expense and should be allowed to be deducted in full. Thank you very much.

[The prepared statement follows:]