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

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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:

5 ways to incur a big tax bill (and land you in arbitration)

5 House member health insurance tax ideas

AALU panelists fear unintended consequences of DOL rule

10 critical tax issues for 2016


A gift for the ultra-wealthy

Turning to the estate tax, Ricchetti said a proposal to repeal the tax passed the House last year. Spearheaded by the House Ways and Means Committee — currently chaired by Kevin Brady (R-Texas) — the legislation also calls for a step-up in basis: the readjustment of the value of an appreciated asset for tax purposes upon inheritance. With a step-up in basis, the value of the asset is calculated to be the higher market value of the asset at the time of inheritance, not the value at which the original party purchased the asset.

Ricchetti lambasted the bill, noting that, should it become law, it would create a class of ultra-rich individuals who will never pay tax on wealth-generating assets.

“Trillions of dollars in appreciation would move between generations without ever paying a single nickel in tax,” he said. [Estate beneficiaries] could liquidate a $70 billion estate and pay zero tax on it. [The bill] creates a set of people who would be entirely extricated from the federal tax system. It’s the most insane tax policy I’ve ever seen.”

And one likely, he added, to go into effect in 2017 or 2018 if the GOP takes the White House and secures majorities in both the House and Senate in November.

Kies suggested, however, that the estate tax bill should be viewed as a “negotiating position.” Much will depend on the make-up of the Senate in 2017, and whether Democrats retain a filibuster-proof minority. Assuming Republicans remain in the majority, he added, tax reform won’t move forward except on a revenue-neutral basis.


Rolling back the DOL rule

On April 28, The House passed H.J. Res. 88, a measure introduced by GOP lawmakers under the Congressional Review Act that would block the Department of Labor’s fiduciary rule. The 234-183 vote in favor of the resolution, “Protecting Access to Affordable Retirement Advice,” will now be put to a vote in the Senate.

During the panel debate, Ricchetti said he expected the resolution to pass in that chamber as well, albeit along a straight, party-line vote. But President Obama has indicated that he’ll veto the resolution, enabling the finalized DOL rule to go into effect as planned.

Ricchetti suggested that Republicans, with Democratic support, might still try to engineer a water-downed (and veto-proof) version of the rule.

“Some 15 to 20 Democrats in the Senate have expressed concerns with the DOL rule, and there remains an opportunity to make targeted fixes,” he said. “The unfortunate dilemma is that, as time passes, the industry and marketplace will respond to the rule as it is. And so enthusiasm for legislative fixes will diminish over time.”

Prospects for an SEC fiduciary rule

The Securities and Exchange Commission may release, as long feared, its own version of a fiduciary standard for broker-dealers and investment advisors. SEC Chairwoman Mary Jo White also warned lawmakers earlier this year that an SEC version may not align perfectly with the DOL’s rule because the two agencies have different mandates.

The AALU panelists deemed the unveiling of an SEC fiduciary rule unlikely, at least in the near-term. The reason: The agency is short two commissioners, forcing White to “backtrack” in recent statements on prospects for a proposal.

“Nonetheless, we need to be prepared by being proactive in shaping any proposal when it comes down the pike,” said Justin Brown, AALU’s vice president of legislative affairs.