Federal budget negotiations that increase tax rates for higher income consumers could be good for U.S. life insurers, securities analysts say.

John Nadel and Dennis Zavolock, analysts in the New York office of Sterne, Agee & Leach Inc., write about the possibility in a comment on the release of an Obama administration deficit-reduction proposal.

The proposal calls for lowering the estate tax personal exemption to the 2009 level, increasing the maximum estate tax rate to the 2009 level, increasing taxes on corporate-owned life insurance (COLI) arrangements, making the dividends-received deduction (DRD) for life insurers’ separate accounts less favorable to insurers, and making it clear that taxpayers who buy life insurance policies through life settlement arrangements must pay income taxes on the death benefits.

The proposal is supposed to save a total of about $3 trillion over 10 years, with $1.5 trillion coming from spending cuts and $1.5 trillion from tax increases.

The COLI provision is supposed to raise about $6 billion over 10 years, but, in the real world, the main effect on life insurers likely would be a dramatic reduction in demand for the product, the analysts say.

The DRD change is supposed to raise about $5.5 billion over 10 years, and the life insurers that Sterne, Agee follows took about $650 million to $700 million in DRD deductions in 2010, the analysts say.

The deduction may have contributed about 2% to 10% of earnings per share at the life insurers the firm tracks, the analysts estimate.

A sharp reduction in the DRD deduction would add another potential headwind to earnings growth.

But, in the long run, “we view higher taxes on the wealthy as positive for the industry,” the analysts say. “While the near-term impact of the president’s proposals appear to be a cause for some concern for the sector’s earnings outlook, over the longer-term, we generally view higher taxes on the upper-income consumer as a positive stimulus for growth for our sector. Among the biggest demand-drivers for protection and retirement-oriented products offered by the life insurance industry is the tax-deferred/tax-advantaged nature of most of the products. Assuming tax rates on upper-income Americans do indeed rise over time, we would expect the life insurance industry to expand its marketing efforts around the benefits of its products/services, which could, over time, generate better organic growth for life insurance and annuity products primarily.”

- Allison Bell

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