Internal controls
14. In accordance with paragraph 35 of FAS 109, a reporting entity’s unrealized gains and losses shall be recorded net
13.8 A tax-planning strategy would not be considered prudent or feasible if use of the strategy would be inconsistent with assumptions inherent
in statutory or other accounting basis financial statements. For
instance, a tax-planning strategy to sell securities identified as “held to maturity” for GAAP-basis financial statements at a loss would not be prudent or feasible. Additionally, if a potential tax planning strategy were to involve selling debt securities at a loss, it would not be prudent or feasible if the securities had not been identified as impaired and the loss recognized for statutory-basis financial statements. Additionally, a tax-planning strategy that could not be implemented within twelve months of the balance sheet date or is inconsistent with management’s business plan objectives, would not be prudent and/or feasible.
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Appendix D
PricewaterhouseCoopers summary of the revised SSAP 10R Introduction
On December 7, 2009, the NAIC voted to approve SSAP No. 10R, the revised statutory income tax accounting standard. The new standard, effective for the 2009 and 2010 years only, presents opportunities and challenges for filers and their advisors.
The Standard
The revised standard contains three major departures from, and additions to, SSAP No. 10.
1. The new standard adds a valuation allowance criterion that is applied before the admissibility test is performed.
2. If the relevant Risk-Based Capital (RBC) threshold is met, a company may avail itself of an expanded admissibility test.
3. Significant additional disclosures apply to all insurers filing statutory statements.
Valuation Allowance
The valuation allowance concept is new to the world of Statutory Accounting Principles (SAP). Only gross deferred tax assets (DTAs) that will more likely than not (defined as a likelihood of more than 50 percent) generate a tax benefit are potentially admissible. Once the valuation allowance hurdle is cleared, the adjusted gross deferred tax asset is then subjected to the admissibility test. This SSAP No. 10R provision applies to all filers, whether or not they qualify for the expanded admissibility test.
Many commentators believe that this GAAP-like requirement is not an
obstacle for most companies. The second part of the current admissibility test under paragraph 10.b. requires filers to perform a with and without calculation to determine the estimated reduction in cash taxes resulting from reversing deductible temporary differences. This calculation requires projections of future taxable income and reversing deductible temporary differences. Similar information is required in assessing the need for a valuation allowance. Thus, most companies are already considering some of the valuation allowance type factors (positive and negative evidence) in determining DTA admissibility.
Therefore, this change may not have a major impact on most companies.
There is no separate reporting in the financial statements of the valuation allowance or the movement in the valuation allowance during the year.
However, certain disclosures are required.
PwC Observes: An insurer that is a member of a consolidated group of companies for which a valuation allowance is required on a consolidated basis does not necessarily have to establish a valuation allowance on a separate company, SAP basis. The key will be the supporting documentation and the tax sharing agreement among the consolidated group members.
Expanded Admissibility Test
Qualification: For companies subject to RBC or that file an RBC report with their domiciliary state (see paragraph 10.d.), an expanded admissibility test is potentially available. Insurers with RBCs that exceed the relevant threshold or trend test may elect to use this more generous standard. Companies that do not want to go through the exercise can choose to calculate their admitted DTAs under the existing standard of paragraphs 10.a. through 10.c., subject, however, to the valuation allowance test described above.
PwC Observes: Filers may have to complete the admissibility test twice. First, the admissibility test under paragraphs 10.a. through 10.c. must be performed to calculate a tentative admitted DTA. An interim RBC calculation is then made to determine eligibility for the expanded admissibility test. Once the expanded admissibility test is performed, the final RBC calculation is made.
First Part—Carryback Potential: The first part of the admissibility test looks to hypothetical loss carrybacks (net operating losses and capital losses) created by deductible temporary difference reversals. Under SSAP No. 10R, paragraph 10.a., companies look to differences reversing within the one year period following the balance sheet date and calculate the amount of taxes paid in the carryback period that could be recovered through a loss carryback claim. For companies meeting the RBC thresholds, SSAP No. 10R expands the reversal period (see paragraph 10.e.i.) to mirror the loss carryback provisions of the Internal Revenue Code (IRC). For non-life companies, net operating losses are carried back two (2) years; thus, non-life companies with deductible temporary differences that are ordinary in character would apply a two (2) year reversal period in this part of the expanded admissibility test.
Non-life companies with deductible temporary differences that are capital in character, and life companies with ordinary and capital differences, would all apply a three (3) year reversal period.
Filers may be able to significantly increase the amount of deductible
temporary differences reversing in the short-term period (expanded from one to three years). This applies equally to the second part of the admissibility test as well.
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expected to reverse in the short-term. For example, some companies employ a rolling average of one year reserve development to apply against the temporary difference as support for their reversal assumptions. The support for reversal assumptions would need to be adjusted to accommodate the expanded reversal period.
Example 1: ABC Insurance Company, a property/casualty insurer with an RBC well in excess of the paragraph 10.d. threshold, has a single temporary difference at December 31, 2009, of $3,000, that generates a gross adjusted DTA of $1,050 (assume no valuation allowance for SAP). ABC paid tax (at a tax rate of 35%) in 2009 of $840 and paid no tax in 2008. ABC estimates that the loss reserve difference will reverse ratably over the next three years (2010–2012). ABC is a non-life company subject to a 2 year carryback for ordinary losses and the single temporary difference is ordinary in character;
accordingly, only the portion of the temporary difference reversing within 2 years ($2,000) can be considered in paragraph 10.e.i.. ABC will be able to admit a DTA of $700. The other $350 can be considered for admissibility in paragraph 10.e.ii..
Example 2: Assume the same facts as in Example 1, except that ABC paid
$840 in taxes in 2008 and no taxes in 2009. Only the deductible temporary difference reversing in 2010 can be considered for admissibility in paragraph 10.e.i. ($1,000). The portion reversing in 2011 can only be carried back to 2009, a year in which no taxes were paid. The admitted DTA is $350, and the remaining $700 DTA will be considered for admissibility in paragraph 10.e.ii..
Example 3: Assume the same facts as in Example 1, except that the deductible temporary difference is capital in nature or that ABC is a life company. In either case, the entire 3 year reversing deductible temporary difference can be considered. However, the character of taxes paid (ordinary vs. capital) must be considered and further consideration must be given to the actual recoverable taxes by year as highlighted in Example 2.
Second Part—Reversals and the With and Without Test: Under SSAP No. 10R, paragraph 10.b.i., companies also apply a one year reversal period to any DTAs not admitted in the first part of the admissibility test. One year reversals can be admitted to the extent they reduce cash taxes otherwise due. Paragraph 10.b.ii. limits the admitted asset under this part of the test to 10% of adjusted surplus as of the most recently filed statutory financial statement. For companies meeting the RBC thresholds, the reversal period is three (3) years and there is no reference to IRC carryback provisions (see paragraph 10.e.ii.(a)). Thus, all insurers can employ a three-year reversal period in this part of the test. Also, the surplus limitation is expanded to 15%
of adjusted surplus.
Care must be taken to ensure that projections of pre-tax and taxable income used in the with and without calculation are reasonable. Further, any tax planning strategies, now subject to a more liberal three year reversal window, must continue to meet the “prudent and feasible” standard. One-year
projections of income used in the admissibility test under paragraph 10.b.i.
are often subject to a high degree of scrutiny, particularly if a company has had a trend of losses in recent years. Thus, it seems reasonable to assume that three-year projections would be subject to an even higher degree of scrutiny, especially if negative evidence exists.
Example 4: Assume the same facts as in Example 2. The $2,000 of reversing deductible temporary differences (generating a $700 DTA) not considered in the first part of the admitted asset test consists of projected reversals in 2011 and 2012. If ABC can reasonably support the assertion that projected cash taxes in those two years will be reduced by virtue of these reversals, and further assuming no surplus limitation applies, an additional DTA may be admitted in paragraph 10.e.ii. of the test. If ABC is projected to be subject to AMT in 2011 and 2012 (in both the “with” and “without” calculations), this paragraph would only yield an admitted DTA of $400 (20% of $2,000).
PwC Observes: The three-year reversal period may give companies more time to implement a tax planning strategy. Some companies have been unable to consider tax planning strategies that may take considerable time to implement (for instance, a sale/leaseback of a significant amount of real property). The expanded window under paragraph 10.e.ii.(a) provides an additional two years to potentially make such strategies feasible.
Second Part—The Surplus Limitation: The expanded admissibility test also provides, in paragraph 10.e.ii.(b), a more generous surplus limitation than paragraph 10.b.ii. (15% versus 10%, respectively).
PwC Observes: Several companies assume that the more generous surplus limitation means an automatic 5% surplus increase. However, companies must be disciplined in their approach to SSAP No. 10R. The valuation allowance test must be considered, the RBC threshold cleared, and the with and without calculations performed before the surplus limitation comes into play.
Third Part—The DTL Offset: The third part of the admissibility test (under both paragraphs 10.c. and 10.e.iii.) retains the ability to offset otherwise nonadmitted DTAs against existing DTLs. Additional language was added to both paragraphs to emphasize that character must be considered in this part
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Example 5: Assume the same facts as in Example 2, except that the $2,000 of deductible temporary differences not admitted in the first part of the admissibility test are capital in nature and no amount is admitted in the second part of the admissibility test. ABC also has a taxable temporary difference of $2,000 that is ordinary in character for which a DTL of $700 has been established. Because capital losses cannot offset ordinary income, no offset is allowed and the potential DTA of $700 is nonadmitted.
Disclosure
Character: The character of DTAs and DTLs must be disclosed, regardless of whether or not the filer has availed itself of the expanded admissibility test.
Also, the results of both admissibility tests, by paragraph, must be shown by character.
Valuation Allowance: Filers must make GAAP-like disclosures concerning the valuation allowance, if any. Additionally, disclosure of adjustments to DTAs caused by changes in judgment as to the realizability of DTAs must also be made (see paragraph 20.f.).
Risk-Based Capital: Companies must also disclose the risk-based capital used in paragraph 10.d. to determine eligibility for the expanded admissibility test. If a company opts out of the expanded admissibility test, it is not clear as to whether or not this disclosure applies.
Other Disclosures: An additional disclosure requires a further break-down of DTAs into the following categories:
• Gross DTAs
• Adjusted Gross DTAs (after valuation allowance)
• Admitted DTAs
• Nonadmitted DTAs
The additional surplus generated by applying the expanded admissibility test, and the change in such additional surplus during the year, should be disclosed as “aggregate write-ins” on the balance sheet and income statement (via the “Capital and Surplus” rollforward). The change in gross deferred tax assets (without regard to unrealized gains/losses and before the admissibility test) that becomes part of the effective tax rate reconciliation will now be recorded in two places in the surplus reconciliation.
PwC Observes: SSAP No. 10R requires additional disclosures, but no illustrations. As such, filers may be “on their own” in drafting appropriate disclosures. Working with their advisors at the earliest opportunity is advised.
Final Thoughts
• Although the expanded admissibility test is optional, SSAP No. 10R is not optional; thus, the valuation allowance regime and much of the expanded disclosures will apply to all filers.
• The RBC section of the standard has been expanded to allow more companies to avail themselves of the expanded admissibility test, but read the standard (paragraph 10.d.) to be absolutely certain it applies to your entity.
• Take a look at GAAP guidance on valuation allowances and familiarize yourself with the more likely than not standard and examples of positive and negative evidence supporting DTA realizability.
• Start the process now by looking at recoverable taxes, reversal patterns, tax planning strategies, and character (ordinary vs. capital) issues.
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Appendix E
ABC Insurance Company Statutory Footnote December 31, 2009
Note 9 - Income Taxes
ABC Insurance Company
Inventory of DTAs and DTLs Recoverable Taxes and Reversal Patterns
Deferred Tax Assets Taxes Recoverable
UPR $200,000 2008 Ordinary $220,000
Loss Reserves $500,000 2008 Capital $110,000
Unrealized Losses $300,000 2009 Ordinary $70,000
Deferred Tax Liabilities Reversal Patterns
Fixed Assets $450,000 UPR $200,000 all in 1 year
Loss Reserves $100,000 / year over 5 years Unrealized Loss $100,000 in 1 year (1) (1) Assume the company adopts a planning strategy to sell certain securities in the one-year reversal
period; generally considered in 10.b. of the admissibility test unless there is an actual plan to sell.
Admissibility Test
Paragraph 10.a. Paragraph 10.b. Paragraph 10.c.
1-Year reversals $300,000 Ordinary Remaining 1-year
reversals 0 Ordinary Remaining DTAs $400,000 Ordinary 1-Year reversals 0 Capital Remaining 1-year
reversals $100,000 Capital(3) Remaining DTAs $220,000 Capital Recoverable taxes $290,000 Ordinary Assumed surplus
limitation $80,000 DTLs $450,000
Recoverable taxes $110,000 Capital(2) Admitted asset $80,000 Admitted Asset $400,000(4) Admitted asset $300,000
Paragraph 10.e.i. Paragraph 10.e.ii. Paragraph 10.e.iii.
1-Year reversals
(2010) $300,000 Ordinary Remaining 3-year
reversals $130,000 Ordinary Remaining DTAs $310,000 Ordinary 2-Year reversals
(2011) $100,000 Ordinary(5) Remaining 3-year
reversals $100,000 Capital Remaining DTAs $200,000 Capital 3-Year reversals
(2012) 0 Capital Assumed surplus
limitation $120,000 DTLs $450,000
Recoverable taxes -
2008 $220,000 Ordinary Admitted asset $120,000(6) Admitted asset $310,000(7)
Recoverable taxes
- 2008 $110,000 Capital Recoverable taxes
- 2009 $ 70,000 Ordinary(5) Recoverable taxes
- 2009 0 Capital
Admitted asset $ 370,000 (2) Ordinary losses can offset capital gains
(3) Assumes adequate income in the with/without calculation
(4) The DTLs are ordinary in character and cannot be offset by DTAs that are capital in character
(5) The additional $100,000 of loss reserves reversing in 2011 and considered in 10.e.i. can only be carried back to 2009, a year in which only
$70,000 of taxes were paid
(6) There is no definitive guidance as to how the surplus limitation should be allocated among the ordinary and capital DTAs; this example assumes that the surplus limitation is first applied against the capital DTAs with the balance applied against ordinary DTAs
(7) The DTLs are ordinary in character and cannot be offset by DTAs that are capital in character
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Summary
Paragraph 10.a. $300,000 Paragraph 10.e.i. $370,000 Paragraph 10.b. $80,000 Paragraph 10.e.ii. $120,000
Paragraph 10.c. $400,000 Paragraph 10.e.iii. $310,000
Admitted DTA $780,000 Admitted DTA $800,000
DTL $(450,000) DTL $(450,000)
Net Admitted
DTA $330,000 Net Admitted DTA $350,000
Nonadmitted
DTA $220,000 Nonadmitted DTA $200,000
Q&A 12.23 states that “[s]ome of the disclosure paragraphs of SSAP 10 are not specific as to whether the entity should disclose the nature of certain items or whether the entity should disclose specific amounts.
...The NAIC encourages a format that provides the information in the most understandable manner in the specific circumstances.” The attached footnote highlights in blue the sections of the footnote that arguably may not be required, but are included to make the disclosure more understandable and meaningful.
A Components of Deferred Tax Assets (DTAs) and Deferred Tax Liabilities (DTLs):
(1) 2009 2008
Description Ordinary Capital Total Ordinary Capital Total
Gross deferred tax assets 18.a. 700,000 300,000 1,000,000 487,000 245,000 732,000
Statutory valuation allowance 0 0 0 0 0 0
Adjusted gross deferred tax assets 18.a. 700,000 300,000 1,000,000 487,000 245,000 732,000
Gross deferred tax liabilities 18.b. (450,000) 0 (450,000) (315,000) 0 (315,000)
Net deferred tax asset/(liability)
before admissibility test 250,000 300,000 550,000 172,000 245,000 417,000
Admitted pursuant to 10.a. 18.g. 300,000 0 300,000 700,000 0 700,000
10.b.i. N/A N/A (0) N/A N/A 10,000
10.b.ii. N/A N/A 0 N/A N/A 70,000
Admitted pursuant to 10.b.
(lesser of i. or ii.) 18.g. (0) 80,000 80,000 10,000 0 10,000
Admitted pursuant to 10.c. 18.g. 400,000 0 400,000 0 0 0
Additional admitted pursuant
to 10.e.i. 18.f. 70,000 (0) 70,000 N/A N/A N/A
10.e.ii.a.. N/A N/A 130,000 N/A N/A 0
10.e.ii.b. N/A N/A 20,000 N/A N/A 0
Additional admitted pursuant to
10.e.ii. (lesser of a. or b.) 18.f. 20,000 20,000 40,000 N/A N/A N/A
Additional admitted pursuant to
10.e.iii. 18.f. (90,000) 0 (90,000) N/A N/A N/A
Admitted deferred tax asset 18.a. 700,000 100,000 800,000 710,000 0 710,000
Deferred tax liability (450,000) 0 (450,000) (315,000) 0 (315,000)
Net admitted DTA or DTL 18.a. 250,000 100,000 350,000 395,000 0 395,000
Nonadmitted DTA 18.a.
18.d. (0) 200,000 200,000 22,000 0 22,000
(2) The Company has/has not elected to admit DTAs pursuant to paragraph 10.e..
Such election was not available in 2008. 18c.
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(3) The Company recorded an increase in admitted DTAs as the result of its election to employ the provisions of paragraph 10.e. as follows:
Change During 2009
Description Ordinary Capital Total
Gross deferred tax assets 213,000 55,000 268,000
Statutory valuation allowance 0 0 0
Adjusted gross deferred tax assets 213,000 55,000 268,000
Gross deferred tax liabilities (135,000) 0 (135,000)
Net deferred tax asset before
admissibility test 78,000 55,000 133,000
Admitted pursuant to 10.a. (400,000) 0 (400,000)
10.b.i. N/A N/A N/A
10.b.ii. N/A N/A N/A
Admitted pursuant to 10.b.
(lesser of i. or ii.) (10,000) 80,000 70,000
Admitted pursuant to 10.c. 400,000 0 400,000
Additional admitted pursuant
to 10.e.i. 18.f. 70,000 (0) 70,000
10.e.ii.a.. N/A N/A N/A
10.e.ii.b. N/A N/A N/A
Additional admitted pursuant to
10.e.ii. (lesser of a. or b.) 18.f. 20,000 20,000 40,000
Additional admitted pursuant to
10.e.iii. 18.f. (90,000) 0 (90,000)
Admitted deferred tax asset (10,000) 100,000 90,000
Deferred tax liability (135,000) 0 (135,000)
Change in net admitted DTA or DTL (145,000) 100,000 (45,000)
Change in nonadmitted DTA 18.e. (22,000) 200,000 178,000
(4) Description With¶ 10.a.-c. With¶ 10.e. Difference
Admitted DTAs 18.h. 330,000 350,000 20,000
Admitted assets 18.h. TBD TBD TBD
Statutory surplus 18.h. TBD TBD TBD
Total adjusted capital 18.h. TBD TBD TBD
Authorized control level used in
10.d. 18.g. TBD TBD TBD
B. Temporary differences for which a DTL has not been established: 19 N/A
C. Current Tax and Change in Deferred Tax
Current income taxes incurred consist of the following major components:
Description 2008 2009.
Current income tax expense 20.a. 70,000 407,958
Tax on capital gains/(losses) 20.a. 0 0
Foreign taxes 20.a. 0 0
Prior year underaccrual (overaccrual) 20.a. (77,958) (9,961)
Federal income taxes incurred 20.a. (7,958) 397,997
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are as follows:
DTAs Resulting From
Book/Tax Differences In December 31,
2009 December 31,
2008 Change Character
Unpaid losses and LAE 20.b. 500,000 357,000 143,000 Ordinary
Unearned premiums 20.b. 200,000 130,000 70,000 Ordinary
Unrealized losses 20.b. 300,000 245,000 55,000 Capital
Other than temporary impairments 20.b. 0 0 0 Capital
Fixed assets 20.b. 0 0 0 Ordinary
Nonadmitted assets 20.b. 0 0 0 Ordinary
Other 20.b. 0 0 0 Ordinary
Gross DTAs 20.b. 1,000,000 732,000 268,000
Nonadmitted DTAs (200,000) (22,000) (178,000)
DTLs Resulting From
Book/Tax Differences In December 31,
2009 December 31,
2008 Change Character
Bond market discount 20.b. 0 0 0 Ordinary
Unrealized gains 20.b. 0 0 0 Capital
Fixed assets 20.b. (450,000) (315,000) (135,000) Ordinary
Gross DTLs 20.b. (450,000) (315,000) (135,000)
The change in net deferred income taxes is comprised of the following (this analysis is exclusive of nonadmitted assets as the Change in Nonadmitted Assets is reported separately from the Change in Net Deferred Income Taxes in the surplus section of the Annual Statement):
December 31,
2009 December 31,
2008 Change
Total deferred tax assets 1,000,000 732,000 268,000
Total deferred tax liabilities (450,000) (315,000) (135,000)
Net deferred tax asset 550,000 417,000 133,000
Tax effect of unrealized [(gains)/
losses] 55,000
Change in net deferred income tax
[(charge)/benefit] 20.b. 78,000
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D. Reconciliation of Federal income Tax Rate to Actual Effective Rate
The provision for federal income taxes incurred is different from that which would be obtained by applying the statutory federal income tax rate to income before income taxes. The significant items causing this difference are as follows:
Description Amount Tax Effect Effective Tax
Rate Income Before Taxes
21 225,714 79,000 35.00%
Tax-Exempt Interest
21 (300,000) (105,000) -46.52%
Dividends Received Deduction
21 0 0 0.00%
Proration
21 45,000 15,750 6.98%
Meals & Entertainment
21 15,000 5,250 2.33%
Other, Including Prior Year True-Up
21 (231,308) (80,958) -35.87%
Total
21 (245,594) (85,958) -38.08%
Federal income taxed incurred
[expense/(benefit)] (7,958) -3.53%
Tax on capital gains/(losses) 0 0.00%
Change in net deferred income tax
[charge/(benefit)] (78,000) -34.56%
Total statutory income taxes (85,958) -38.08%
E. At December 31, 2009, the Company had net operating
loss carryforwards expiring through the year 2029 of: $0 22.a.
At December 31, 2009, the Company had capital loss
carryforwards expiring through the year 2014 of: $0 22.a.
At December 31, 2009, the Company had an AMT credit
carryforwards, which does not expire, in the amount of $0 22.a.
The following is income tax expense for 2008 and 2009 that is available for recoupment in the event of future net losses:
Year Ordinary Capital Total
2007 22.b 0 0 0
2008 22.b 220,000 110,000 330,000
2009 22.b 70,000 0 70,000
Total 22.b 290,000 110,000 400,000
Deposits admitted under IRC § 6603
Deposits admitted under IRC § 6603