New Tax Bill Changes Rules On Non-Qualified Deferred Comp Plans
New ground rules on the sale of non-qualified deferred compensation plans as contained in the huge tax bill passed by Congress last week are of enormous importance to the life and health insurance industry. Additionally, a 2-year suspension of the policyholder surplus tax imposed on stock life insurers is likely to spur changes in the business.
The first fallout from the 2-year suspension of the policyholder surplus provision was contained in an investors note by a Smith Barney analyst who said it may prompt either Aetna or United Health Group to acquire CIGNA, or, alternatively, for both Aetna and CIGNA to step up their M&A activity. The note spoke only to the managed care industry.
Regarding non-qualified deferred compensation plans, Stuart Lewis, a lawyer with Buchanan Ingersoll in Washington, D.C., who represents the Association for Advanced Life Underwriting, said the NQDC provisions in the bill constitute a “huge change.” Lewis said the provisions cover all the nominally covered deferred compensations plans other than qualified, “but also cover non-obvious deferral arrangements that people dont think are normally affected.”
And Gus Comiskey, president of the AALU, said the provisions constitute a huge relief, because non-qualified deferred compensation planning, commonly funded by corporate-owned life insurance, “has been paralyzed” not only because of the uncertainty created by Congress announcement that it planned to change the rules regarding deferred compensation, but also by its failure to act promptly to do so.
For example, he said, bills dealing with the issue as passed by the House and Senate contained different provisions. “Companies and individuals told us that they werent willing to consider changes in plan design or funding until the law becomes certain and they know what they were dealing with,” he said. Insurance agents who sell NQDC plans are involved heavily in executive benefit plans.
Another issue is that under the law, the IRS only has 60 days to establish a limited period during which plans may be amended to conform to the laws requirements. “It is our understanding that such guidance, among other things, will likely address the application of the effective date, provide a grace period for amendments to existing plans, and include rules under which employees can cancel elections and exit plans if they do not want to comply with the new rules,” the AALU said in an analysis of the NCDQ provisions.
The law gives the IRS 90 days to establish rules dealing with what constitutes a change in ownership.
According to Lewis, the NQDC provisions apply very broadly and any program “that delays compensation generally is swept in under this law.” This includes severance payments, stock options below fair market value, phantom stock plans, stock appreciation rights and supplemental employee retirement plans.
“There is a very long list,” Lewis said. “Any deferred compensation contract is potentially covered; in fact, most are.”
The rules codified by the provision in the law include those relating to distribution, acceleration of payments and the basic decision by the employee to defer payment of certain compensation.
Regarding distribution, the legislation says that a participant in a NQDC plan cannot begin to receive payment except under 6 specific events. These include when the participant leaves the company providing the plan; when the participant becomes disabled; death; a date specified when the plan is set up; a change in control of the company or in the ownership of a substantial portion of the assets of the company; or “the occurrence of an unforeseeable emergency.”
Regarding acceleration, the law says the plan cannot permit the speeding up of the timing or scheduling of any payment under the plan except under rules established by the IRS.
Regarding elections of when payment under the plan is to start, the new rules are more rigid than the current “flexible” election rules now used by most companies. “As a consequence,” the AALU analysis said, “these new rules will substantially change the election procedures that employers must follow in order to avoid adverse tax consequences.”
The law also contains specific funding rules designed to prevent the use of offshore rabbi trusts and to prevent certain types of trigger plans that are intended to protect the executive in the event an employer gets into financial trouble.
The bill, H.R. 4520, Americas Job Creation Act of 2004, was passed by the House on Oct. 8, and by the Senate in a holiday session Oct. 11.
The 2-year suspension of the policyholder surplus tax codified as Sec. 815 of the tax code will save the industry at least $132 million, according to Congress Joint Tax Committee, and more likely the 10-year cost could be $533 million, as companies move to release their policyholder surplus accounts off the books through mergers, acquisitions or other means.
On the Sec. 815 issue, the first fallout could be in the managed care industry. In an investors note, Smith Barney analyst Charles Boorady said Aetna could save $321 million in taxes as a result of the suspension and CIGNA, $158 million.
“Aetna and CIGNA life insurance subsidiaries will now have the ability to distribute out the capital in the surplus accounts to the parent company without generating the tax liability, allowing the parent company to deploy this capital toward share buybacks and mergers and acquisitions,” Boorady wrote. “We believe it also increases the likelihood that Aetna or United Health Group acquires CIGNA as CIGNA now appears to be a more attractive acquisition.”
Boorady said none of the recently demutualized insurers, namely Anthem, would stand to benefit from the suspension of Sec. 815, “given our analysis.”
Reproduced from National Underwriter Edition, October 14, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.