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Life Health > Life Insurance

What Is The Administration Thinking?

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Exactly what are they thinking?

That is the question those in the insurance industry are asking as they evaluate counter-attacks to and the potential impact of several revenue-raising proposals affecting the industry that have been unveiled over the last several weeks by the Obama administration.

First, the administration proposed to increase revenue by barring businesses from deducting the cost of financing their offshore subsidiaries unless they repatriated the profits they earned on those subsidiaries at the same time.

The offshore provision will have great impact on all financial firms, including insurers, who finance their overseas business with borrowed money, although it will be hard to measure.

But it is the second set of proposals that will weigh most heavily on companies and agents.

One of these proposals would effectively end the sale of corporate-owned life insurance–widely believed to be among the industry’s most profitable products. Another would modify the rules that apply to “certain life insurance contracts,” change the dividends-received deduction for certain life insurance company separate accounts and expand the pro-rata interest expense disallowance.

Industry officials acknowledge they anticipated an administration faced with huge budget deficits would certainly seek to raise revenue by increasing taxes on an industry that sells tax-advantaged products. That was a no-brainer.

And, the industry also realized that Treasury Department staffers see COLI as a loophole.

But the timing and scope of these proposals is raising eyebrows.

What jumps out is that while the Obama administration moves to raise almost $13 billion over 10 years from one of the industries most directly impacted by the devastating financial downturn, it is pulling out all the stops to help another one–the banks.

In fact, one of the reasons the life insurance industry is struggling is that the administration is keeping interest rates low to help the banks–even though such a policy is contributing to the life insurance industry’s woes.

One industry argument against wiping out the tax benefits corporate customers gain through purchase of COLI is that it is an indirect attack on inside buildup. It would do so by disallowing a proportionate amount of deductible interest expenses for unrelated borrowing, they argue.

And there are many other arguments. As noted in a recent letter signed by all industry trade groups and sent to congressional leadership objecting to the proposed tax provisions, “…the life insurance industry, like many other industries in this country, is weathering an economic downturn not seen since the Great Depression.”

Further, in recent testimony before a subcommittee of the House Financial Services Committee, Patricia Guinn, managing director for risk and financial services at Towers Perrin, said that “without a doubt, the financial crisis has had a significant adverse impact on insurer balance sheets and profitability.”

For life insurers, she said, “2008 was among the poorest on record for operating performance, largely because of significant realized and unrealized losses on investment portfolios, large reserve increases to support product guarantees, higher costs of capital and a declining revenue base.”

In an investment note, Keefe Bruyette & Woods analysts project the cost of the dividends-received deductions provisions at 5% to 10% of annual earnings for some life insurers, depending on the percentage of income gained from separate accounts in annuities. It is also believed that the worst impact will be among insurers left most vulnerable by the devastating economic downturn.

Equally galling to the industry is that the proposals targeting DRD and COLI have a lot of dust on them. They were first suggested by the Clinton administration in 1997.

The DRD provisions were rejected by Congress 1997, and it was not until 2006, in the Pension Protection Act, that bipartisan language codifying COLI best practices, and limiting the product’s use, was enacted.

“It was a targeted, thoughtful approach that eliminated abuses in the sale and use of the product,” notes one industry official.

Now, instead of being targeted, the changes suggested would affect the body shop owner as well as the top corporate executive, industry officials say.

They also note that COLI, in practice, is used as a tool to fund healthcare benefits for employees, as well as retirement benefits and buyouts of key shareholders.

In the final analysis, the Obama administration does have legitimate reasons to seek revenue increases.

But wouldn’t it be better to think through the potential collateral damage on affected industries before plowing ahead with a barrage of changes?


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