IRS Actuaries Raising New Issues on AG 34 Tax Reserves
With the assistance of Internal Revenue Service (“IRS”) actuaries, IRS agents are routinely raising a new issue for tax reserves held under variable annuity (“VA”) contracts that provide guaranteed minimum death benefits (“GMDB”). Prior to being superceded by Actuarial Guideline XLIII
(“AG 43”) effective Dec. 31, 2009, statutory reserves for VA contracts with GMDB were required to be computed under Actuarial Guideline XXXIV “Variable Annuity Minimum Guaranteed Death Benefit Reserves” (“AG 34”). Under Notice 2010-29, AG 34 will continue to apply as the tax reserve method for most contracts issued prior to Dec. 31, 2009, because it is the applicable interpretation of CARVM prescribed by the NAIC in effect on the date of the issuance
of the contract.
AG 34 requires the calculation of an Integrated Reserve that combines GMDB with other contract benefits under various benefit streams. These benefit streams take into account an assumption that account values will grow by “a return based on the valuation rate less appropriate asset based charges.” Life insurance companies generally have recomputed their AG 34 tax reserves by starting with statutory AG 34 reserves and substituting the discount rate prescribed in section 807(d)(4) (generally the applicable federal interest rate or “AFIR”). Then, a conforming adjustment is made to the account value projection rate to comply with the CARVM requirements specified in AG 34. The audit adjustment currently being proposed by IRS actuaries is to eliminate the tax reserve adjustment for the projection rate and require the rate to remain at the statutory valuation rate less asset based charges. No adjustment is proposed by the IRS agents to the AFIR discount rate used for tax reserves. IRS agents have offered the following arguments to support the position that tax reserves should use the statutory rate for the earnings assumption while at the same time using the AFIR discount rate:
1. The reference in AG 34 is to the statutory valuation rate, not to the valuation rate prescribed for tax reserves;
2. The projected future benefits assumed in computing tax reserves should never exceed the future benefits assumed in statutory reserves;
3. An adjustment to the earnings rate is inconsistent with how tax reserves are computed for fixed annuities where no tax adjustment is made to the statutory earnings rate;
4. The interest rate adjustment required for tax reserves is intended to apply only to the discount rate, not for other interest rate assumptions; and
5. Congress could not have intended that tax reserves, as recomputed under section 807(d), exceed statutory reserves, which would be the case mathematically if the projection rate is adjusted to conform with the AFIR.
53 Taxing Times, Volume 6, Issue 3 (September 2010)