Even for instance, if we assume a fact that Anchor would dispute; namely, that we are on the same playing field with banks, differences in the regulatory climate, both State and Federal outside of the tax laws, would render any action by this committee solely in the tax area ineffective to remedy the complaint.

The list of regulatory disparities is long. Permit me to offer just a few short examples.

Banks enjoy certain exemptions from securities' laws which permit them to offer CD's without registration of the product or the salesperson. Insurers cannot offer CD's under present law without a securities registration. State law would prevent it in any event. Fixed annuities need not be registered if they are not sold as investment products. Under guidelines set down by the SEC there are certain things which we can and cannot do in our advertising. Investments of insurance company premiums are restricted by State code. The limit on real estate loans is more stringent for life insurers than for banks.

Savings deposits at banks and S&L's are protected by FSLIC and FDIC. Although comparable protection has been considered for insurers, it is just not as effective.

Insurance guarantee funds do not provide universal coverage since some States have not adopted them. Other areas of disparity exist which cannot be ignored if a level playing field is to result. We submit, however, that we are not like banks and should not be compared to them; that the annuity program should be allowed to continue and be studied as provided in the 1984 act. Thank you. [The prepared statement follows:]

STATEMENT Of Anchor NATIONAL LIFE INSUARNCE CO.

Anchor National Life Insurance Company ("Anchor National") is a life insurance company organized under the laws of the State of California and admitted to conduct an insurance business in the District of Columbia and all states except New York. Anchor National has over $5 billion of life insurace in force and has approximately 17,500 insurance agents appointed and licensed to sell life insurance policies and annuity contracts.

At the end of 1984, Anchor National had written almost 125,000 deferred annuity contracts. As of July 1, 1985, the average cash value of the Company's policies was under $11,500, and the average cumulative preimium received for each policy was approximately $8,100.1 The average age of annuity purchasers was 51.7 years.

Anchor National opposes the Administration proposal to tax the year-by-year increase in the cash value (internal build-up) of nonqualified, deferred annuities and cash value life insurance. Because many other interested parties have addressed the issues concerning the taxation of life insurance, this statement will concentrate on the issues relating to annuities.

In summary, Anchor National submits that the Administration Proposal is ill-conceived for the following reasons:

Taxation of inside build-up would thwart the desirable goal of encouraging individuals to save for retirement. The burden of this change would fall not on the wealthy but on the middle class; as noted above, the average cash value of an Anchor annuity is less than $11.50 while the average policyholder investement is only about $8,100.

Contrary to its stated purpose, the Proposal would not insure a "level playing field" among comparable financial institutions and products, due to the fundamental differences in function and product design, and the disparate federal and state regulation of the various types of financial institutions and products.

1 Unlike IRA contributions, annuity premiums are not deductible by the policyholder.

Congress has examined the taxation of annuities twice in the last three years, and has changed the tax treatment to discourage the use of annuities as short/term investment vehicles. Further changes at this time are unwarranted and unnecessary. Taxation of inside build-up is contrary to the principle that tax is not imposed on amounts that cannot be received without sacrificing substantial rights and benefits. Taxation of inside build-up would inhibit economic growth.

Historically, deferred annuities have served a valuable and moritorious purpose. That purpose-to encourage thrift and independent planning for a financially adequate retirement income-deserves the continued encouragement afforded by present law. The Administration tax reform proposals would reverse the historical tax deferral treatment accorded to the internal build-up in annuities since 1913.2 If enacted, the proposals regarding the internal build-up in deferred annuities will not promote fairness, will restrict growth, and will destroy the simplicity of tax result that is a cornerstone of the President's Proposal.

A brief review of the purpose, features and current tax treatment of deferred annuities is in order. Unlike life insurance, which protects against the risk of early death, the annuity contract protects against the risk of outliving one's life expectancy and thereby exhausting one's means of support in retirement. Due to their unique function of providing a guaranteed lifetime income, deferred annuities join with social security, employer provided pension programs and IRAs to provide a safety net of retirement income. If continued and adequate encouragement is provided, deferred annuities will serve to lessen dependence upon and the ultimate pressure for ever-increasing levels of social security benefits.

The deferred annuity permits the contractholder, on the basis or premiums paid during his working years, to accumulate a fund to provide income after retirement. An annuity contract can be purchased for a single premium or on a periodic premium basis. A death benefit equal to the accumulated value of the contract is typically payable to a named beneficiary in the event of the death of the annuitant prior to the commencement of the contract benefit. A loan provision is usually available. Aside from any loan provision, funds may be withdrawn from the contract only by a surrender of the contract benefits. Surrenders are subject, in many instances, to the imposition of a surrender charge.

Interest is guaranteed on the accumulated contract value at a rate specified in the contract. Additional interest amounts are guaranteed in advance on a yearly or other periodic basis. Those additional interest guarantees are possible due to the generally higher yields currently available in the money markets, efficiencies in the conduct of the life insurance business, and a willingness on the part of those insurers to accrue to their contractholders a greater portion of the interest earnings on their premiums. Presently Anchor's periodic guaranteed interest rates range from 8.25% to 9.25%.

Periodic income is guaranteed for the life of the annuitant commencing on the retirement date (usually age 65 or 70). The insurer assumes the risk that the annuitant may outlive his or her life expectancy. The insurer is thus obligated to provide the guaranteed income in a periodic amount fixed at retirement for however long the annuitant lives. Often the policy permits the holder to specify a period certain, during which the Company will guarantee to pay benefits for a fixed number of years, in addition to the life annuity. In this way the purchaser can protect against the early death of the annuitant by the selection of a beneficiary to receive the balance of the period certain payments.

Under present law, premiums on nonqualified deferred annuities are paid with after-tax income. That is, unlike IRAS, no deduction of the purchase price is allowed to the individual. The interest portion of the annuity value is taxed as payments are made to the annuitant. Thus, taxation of the internal build-up is merely deferred, not eliminated: when the accumulated value is paid out in the form of annuity payments, the recipient is subject to tax on the deferred income. Death benefits payable by reason of the death of the annuitant during the deferral period are taxable to the extent of deferred income. In short, in no instance does any income from a deferred annuity contract escape taxation.

Changes made by Congress in 1982 and 1984 refine the taxation of annuities, with a view toward ensuring that the deferred annuity will be used only as a long-term

2 The formulae for taxing annuity payments had changed periodically, but the bedrock of tax policy respecting deferred annuities has remained throughout-no taxation while the value is accumulating in the annuity.

3 The insurance industry generally has been criticized in recent years for its low rates of return on the cash value of life insurance policies. Staff Report to the Federal Trade Commissioner. Life Insurance Cost Disclosure (July, 1979).

retirement income vehicle. In the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Congress sought to "level the playing field" to ensure that deferred annuities were not used as short-term vehicles in substitution for bank deposits and CDs. TEFRA reversed the ordering rules relating to partial contract surrenders, requiring that income withdrawn be treated first as taxable income to the extent of such income in the contract. Loans were effectively eliminated by treating them as taxable withdrawals. Additionally, a penalty tax of 5% was assessed against taxable interest income withdrawn or borrowed prior to age 59% or 10 years from the date of the contract, whichever occurred earlier.

The Tax Reform Act of 1984 further restricted the owner's ability to borrow against or surrender the contract by imposing a penalty tax on such activity at any time prior to age 592 regardless of how long the premiums were invested in the contract. Additionally, new definitional language requires a distribution of contract values within a specified period upon the transfer of the contract by reason of the death of the owner. The Technical Corrections Act to the 1984 Tax Reform Act, now pending as H.R. 1800, would expand these forced distribution rules to include transfers by gift as well as by reason of death.

It is submitted that the re-examination of the annuity issues within the broader context of the 1985 tax reform proposals is untimely and seeks to correct alleged abuses in a product that has been examined in great depth by this Committee no less than three times in the last eight years and twice in the last three years. In these past considerations, the Committee has examined arguments that tax deferred annuities are tax shelters, that they unduly benefit the rich, and that they create an "uneven playing field," unfair to other financial institutions. In 1978, the concept of tax deferral of internal build-up was found to have merit and the "tax shelter" and "benefit the rich theories" were rejected. In 1982, legislation eliminated unduly favorable elements of the program and "leveled the playing field" with changes that made the use of the deferred annuity as a possible replacement for CDs and other short-term instruments undesirable. Indeed, the Joint Committee concluded its discussion of the changes enacted by TEFRA with the statement that "the use of deferred annuity contracts to meet long-term investment and retirement goals [is] still a worthy ideal." Joint Committee of Taxation, General Explanation of the Revenue Provisions of the Tax Equity and Fiscal Responsibility Act of 1982, 361 (1982).

In addition to further restricting the use of annuities as short-term investment vehicles, the 1984 Act specifically requires the Treasury (in consultation with the Joint Committee on Taxation, the Ways and Means Committee and the Senate Finance Committee) to conduct "a full and complete study" of the taxation of life insurance. Section 231 of the Act provides that the study "shall also include an analysis of life insurance products and the taxation thereof." Treasury is to submit interim reports to the Ways and Means Committee and the Senate Finance Committee on July 1, 1986, 1987 and 1988. A final report is to be submitted on January 1, 1989. Congress mandated these studies to determine whether the 1984 Act changes to annuity taxation were effective and appropriate in light of subsequent industry experience. Yet the ink was scarcely dry on the 1984 Act-with even the first of the interim reports almost two years away-when the Treasury, in November 1984, proposed to change the taxation of annuity contracts once again. Viewed against this legislative background, reconsideration of the annuity issues at this time is simply premature.

A brief analysis of the Administration proposals to tax internal build-up in deferred annuities and life insurance reveals their devastating effect on the contractholder, on the life insurance industry and on the thousands of small businessmen and women who make up the professional insurance sales force in the United States. The loss of tax-deferred internal build-up would require that the industry find a public acceptance for cash value policies that in the deferral period produce taxable income without any corresponding cash that can be used to pay taxes. The willingness of the public to accept and to purchase a vehicle generating current taxable income without corresponding cash flows is untested and highly questionable. Alternatively, the industry will be confined to the sale of term insurance and cash value qualified plan products. As one of the leading companies in the movement to provide greater rates of return to the consuming public, it is Anchor National's experience that a viable agency force cannot be maintained on commissions generated solely from the qualified plan and term insurance markets. Thus, the predictable result of the Proposal is a massive contraction in the size of the industry and a reconcentration on qualified plan and term insurance markets.

Tax reform in itself is a laudable goal. Abuses and special preferences could be eliminated in the pursuit of such reform, however, without the wholesale destruction of any industry.

Appendix C to the Administration proposal projects income to the Government from the repeal of deferral of inside build-up on annuities at approximately $1 billion over five years through fiscal year 1990. While this amount appears de minimis in connection with a $600 billion proposal, we do not believe that this amount or any significant amount of revenue at all will be collected if the proposals are adopted. The more likely scenario is that the elimination of tax deferral of internal buildup will result in the elimination of the product line entirely, producing no net tax effect.

One argument advanced by the Administration is that the tax deferral of annuities favors wealthy individuals. Contrary to this assertion, however, the experience of Anchor National demonstrates that the primary appeal of the deferred annuity is to the middle class. This is demonstrated by the company's average current policy cash value as of July 1, 1985, of approximately $11,500 (considered on the basis of accumulated premiums plus interest), and the average cumulative premium received per policy of approximately $8,100. Further, the average age of purchasers of 51.7 years (determined in a special study of annuity production during June of 1985) demonstrates that the funds are being invested for retirement purposes and remain in the policy until the retirement years. The 1982 and 1984 Tax Act changes effectively have eliminated the use of annuities by younger individuals as short-term investment vehicles.

The middle class marketing orientation is evident in the current range of minimum annual premiums which will be accepted by the company for an annuity. That range is between $240 (payable at $20 per month) and $1,500. Thus, a purchaser of relatively modest means is able to afford an annuity. It is precisely this group that should be encouraged to plan for long-term retirement savings, and it is this group that, if forced by the adoption of the Administration's proposals to pay a tax on funds that will not be withdrawn for many years, would be most inclined to stop purchasing annuity contracts. The wealthy, who are capable of affording greater risks, can achieve much better rates of return and tax benefits through more elaborate means, such as the purchase of municipal bonds or tax shelter programs. The reform proposals cannot be said to promote fairness when they will result in the elimination of a valuable savings vehicle of particular use to those of limited financial opportunities.

Further, the life insurance industry has uniquely provided a massive source of capital for growth in this country. In 1983, for example, net investments in U.S. capital markets by life insurance companies totaled $56.6 billion, placing life insurance companies third among all private domestic institutions as a source of funds. Taxation of the internal interest build-up on annuity contracts and life insurance would significantly curtail the availability of such funds for long term investment and therefore would impede capital formation.

The life insurance industry in the past has been an especially efficient collector of small amounts of premiums. Its performance of this role has enabled the average working class American over the years to create an estate by the concentration of those premiums and cash values into retirement and death benefits. The loss of the tax deferral of the cash value of annuity and life insurance products will mean the destruction, both on an individual basis and on a macro-economic basis, of an important engine for economic growth in America.

Finally, the proposal to eliminate tax deferral of internal build-up violates the fundamental principle of the Internal Revenue Code that income is recognized and therefore taxable only at the time of its receipt or accrual to the taxpayer. The Administration proposals would be inconsistent with the doctrine of constructive receipt, which is inapplicable where a taxpayer can receive funds only by giving up valuable rights. In essence, the proposal would require the taxation of the unrealized appreciation in annuity and life insurance contracts. This result is the same as taxing the appreciation in the value of a home, even though the owner will not receive the proceeds of such appreciation until the house is sold.

The Administration proposal indicates that the reason for the elimination of the tax deferral of internal build-up is that such deferral results in a major distortion of savings flows from other financial institutions to the life insurance industry. This allegation is not supported by any significant studies of which the Company is aware. Further Congress examined and rejected this argument in the proceedings on the Revenue Act of 1978.

Perhaps most important, the "level playing field" argument is an attempt to compare apples and oranges. Bank deposits and certificates of deposit are essentially dif

ferent than deferred annuities, both in nature and ultimate purpose. Bank deposits and certificates of deposit provide short-term liquidity and a degree of flexibility not present in annuities. A deferred annuity represents a long-term vehicle for the accumulation and payment of retirement income.

Even if one were to accept that banks and insurance companies are in direct competition for the same type of consumer savings, a proposition with which the Company disagrees, it does not follow that the elimination of tax deferral of the internal build-up on annuities is either desirable as an end in itself, or would create the desired "level playing field". The regulatory climate outside the tax law is much more favorable to banks and other savings institutions. For instance, banks are exempt from SEC regulation on certificates of deposit and other evidence of indebtedness that if issued by an insurance company would require registration of both the salesperson and the product itself. Federal deposit insurance for banks and savings and loans has no real counterpart in the life insurance area. Further, seventy percent of the average dollar expended by the insurance industry in the annuity line of business goes to reserves. American Council of Life Insurance, 1984 Life Insurance Fact Book 62 (1984). In contrast, banks must hold in reserve a maximum of only about twelve percent of their transaction accounts (checking accounts, demand deposits), and some small banks may set aside a little as three percent. 12 C.F.R. 204.9(a)(1) (1985). Moreover, banks need not set aside any reserves on late-muturing institutional time deposits (long-term CDs sold to institutions rather than individuals). Id. In view of these differences, the passage of these proposals would not promote a level playing field; to the contrary, it would leave the insurance industry structurally uncompetitive.

In conclusion we believe that the deferred annuity policy, with deferral of taxation on the interest accumulation until such time as benefit payments result, is a valid and necessary component of the larger national retirement income policy. It is demonstrable that this product is purchased largely by persons of middle income and modest means, generally at later ages, for the primary purpose of providing an additional income source during requirement. The social and economic benefits supporting the present tax policy are increasingly compelling due to the need to provide supplemental benefits in addition to the basic minimum benefits provided by social security. The proposals if adopted will not demonstrably add even the de minimis amounts assigned to it as future tax revenues and is likely to result in greater expense to the government than revenues gained due to the anticipated ecomomic dislocations. In short, the elimination of the tax deferred internal build-up on deferred annuities does not fulfill any of the tax reform objectives of fairness, simplicity or the promotion of economic growth.

Mr. STARK. Thank you, Mr. Deer, and Tom. I know that I have talked with your committee, and I think that my views on how we should approach this bill are well known. And I won't burden you with reviewing those at this point.

I might ask both of you if the objectionable insurance provisions were taken out of the proposal, could you recommend to the committee of annuity insurers and your customers that you endorse the remainder of the President's proposal?

Mr. ANDERSON. That is a sweeping question. I think you are asking for comment on a lot of different things, and I think there are a lot of problems in the bill. This is a matter of survival for the life insurance industry.

Mr. STARK. Unfortunately, we haven't heard a witness in 3 weeks who hasn't had a matter of survival. If we took all the matters of survival out of the bill there would be no bill.

I thank you both for your patience and suggest that it was the luck of the draw, and not the importance of your testimony that brought you to us this late in the afternoon. Thank you both for your contribution.

I would like at this point to call the last panel.

I would ask the reporter if we could go off the record for a moment.

[Discussion off the record.]