4 threats to the insurance industry: tax reform (and 3 others)

Levies on the “inside buildup” of permanent life insurance, non-qualified deferred compensation and corporate-owned life insurance remain the principal threats to the life insurance industry as the House Ways and Means Committee draws up a “blueprint” for tax reform in advance of the Republican National Convention in July.

So warned participants at a widely attended session of the Association for Advanced Life Underwriting (AALU) 2016 annual meeting, held in Washington, D.C. May 1-3. A regular feature of the conference, the “Washington Update LIVE!” explored prospects for tax reform, repeal of the estate tax, as well as other legislative and regulatory changes that may go into effect this year or next.

Will tax reform happen?

Tax reform has been a top priority for the GOP and, in particular, House Speaker Paul Ryan, who oversaw tax policy as former chair of the Ways and Means Committee. Democrats also are pushing for tax reform, but the two parties part ways on an all-important question: How much revenue should a post-tax reform regime bring in?

Republicans, the panelists noted, want tax reform to be “revenue-neutral,” meaning that a tax bill should garner as much in tax receipts as under current law — no more, no less. Democrats believe that additional revenue is needed to reduce the national debt and cover rising entitlement costs, hence the need to increase income tax rates and broaden the tax base.

“Democrats believe that any conversation around tax reform has to include a conversation about additional revenue,” said Jeff Ricchetti, president of Ricchetti, Inc., and an outside counsel to AALU. “No prior tax reform proposal has paid for itself dollar for dollar. Unless the conversation is around having additional revenue, Democrats will not be involved in tax reform legislation.”

Few question, however, that a major overhaul of the current federal tax system is needed. Beyond its much derided complexity, the Internal Revenue Code suppresses economic growth, in part through misguided tax incentives and disincentives to engage productive, income-generating activities; and through tax policies that create inefficiencies and misallocate resources.

Political pressure for reform is rising. Since the 2007-2009 recession, wages have remained largely stagnant (a much discussed point in the 2016 presidential campaign), and growth rates have been declining. Under President Clinton, panelists noted, the average rate of growth, as measured by gross domestic product, was 3.5 percent. Under President Obama, the average GDP rate has dipped to 1.4 percent.

The decline has fueled a growing imbalance between revenues and spending. Federal outlays for the next decade are projected at $51.4 trillion, but the 10-year forecast for revenue is $42 trillion, a $10 trillion gap.

“That means that, in the absence of improved economic growth, we’re looking at threats to entitlements and pressure to raise revenues, which neither party wants to entertain,” said Kenneth Kies, managing director of Federal Policy Group LLC and an outside counsel to AALU. “That’s why people on both sides of the aisle view tax reform as key to improving economic growth, increasing revenue and avoiding horrible policy decisions.”

Or worsening some already taken. Example: slapping U.S. corporations with a 35 percent income tax rate — the highest among developed countries. Kies said the high tax rate places many businesses at a competitive disadvantage, among them U.S.-based multinationals that feel compelled to park their profits abroad, rather than reinvesting them in equipment and research.

The foundation of any new tax reform bill, said Kies, would be the last one: a proposal drafted under former House Ways and Means Committee Chair David Camp (R-Mich.). According to the congressional nonpartisan Joint Committee on Taxation, the draft bill would allow 95 percent of tax filers to get the lowest tax rate possible by claiming the standard deduction, create up to 1.8 million jobs, and increase gross domestic product by up to 1.4 percent in 2023.

These gains, however, will have come at a high cost to the insurance industry: $60.5 billion in new taxes on the sector’s products. These tax increases would result in $25 billion less of capital over the next 10 years.

Milliman, a provider of actuarial and related products and services, estimates that $1 of capital is required to support $170 of face amount in life insurance coverage. So $25 billion less of capital, multiplied by $170, would yield $4.2 trillion less of face amount coverage over the next 10 years.

Milliman also forecasts that, absent changes to current tax law, life insurance companies would sell $8.4 trillion of face amount coverage.

With the general election approaching, what are the prospects for tax legislation this year? Kies said that House GOP leaders will likely release a “blueprint” of a reform bill by end the end of June, before the Republican National Convention convenes July 18-21 in Cleveland. The proposal won’t be as detailed as the Camp draft, but also won’t be limited to “platitudes.”

A new bill could include any of what Ricchetti, dubbed the “dirty dozen” of tax threats. The three principal threats remain, as in prior tax reform proposals, levies on:

• the cash value component of permanent life insurance (taxation of this “inside buildup” could yield $300 billion over 10 years)

• non-qualified deferred compensation; and

• corporate or employer-owned life insurance (COLI/EOLI)

A reform bill, said Richetti, could also potentially target lesser threats. Among them: increases in taxes on:

• life insurers (in the form deferred acquisition costs or DAC tax)

• C-corporations

• life insurance death benefits; and

• grantor trusts.

Three additional legislative and regulatory threats explored by the AALU panelists begin on the next page.

See also: