Why Life Insurance Assets Might Still Be Safe From Congress

Congress could find new ways to tax the buildup of value inside cash-value life insurance policies this year, but it probably won't.

Carmi Margalit, the life insurance sector lead at S&P Global Ratings, made that prediction Thursday at an S&P Global insurance hot topics conference in New York.

Margalit and other speakers avoided the hottest topic of all — what U.S. insurance policy might look like if Donald Trump returns to the White House in 2025 — but Margalit did touch on why he thinks inside insurance buildup might continue to be safe, in spite of pressure on Congress to cut the federal budget deficit.

Once lawmakers look at how taxing inside buildup would really work, "it's not that attractive anymore," Margalit said.

What it means: The life insurance policies that ultra-high-net-worth clients use to pass on wealth and the life insurance in the arrangements that executive clients use to save for retirement are probably safe this year.

The backdrop: The United States is set to report a $1.8 trillion deficit for this year on $5 trillion in receipts, and the federal government's debt could increase to $25 trillion.

That compares with U.S. gross domestic product, or national income, of $27 trillion, and total national net wealth of $142 trillion, according to Federal Reserve Board analysts.

Life insurers have $9.1 trillion in financial assets.

Analysts at the White House Office of Management and Budget now estimate that the exclusion of life insurance death benefits from taxable income for federal income tax purposes will cost the Treasury $209 billion over the 10-year period from 2023 through 2032. The 10-year impact estimate is 31% higher than the 10-year impact estimate the analysts posted a year earlier for the period from 2023 through 2031.

The Congressional Budget Office predicted in 2013 that including life and annuity investment income in taxable income would add $210 billion in tax revenue over a 10-year period.

Tax policy considerations: An attendee asked about the status of inside buildup during a question-and-answer period.

"Congress really wants some tax revenue," the attendee said.

Interest in taxing life insurance inside buildup "is not new," Margalit said. 'It's a risk that's always been there."

Life insurers seem to think that proposals for taxing inside buildup could come from either Democrats or Republicans, he added.

What has protected inside buildup tax rules so far is that imposing new tax rules retroactively would be very difficult, Margalit said.

If an executive has put retirement savings in a life insurance policy under the current tax rules, "I would like to see the politician that's going to take that away from you," he said.

When lawmakers see that they can only tax inside buildup for new policies, and how low the increase in revenue from that would be, "that usually kills it," Margalit said. "All that doesn't mean it isn't going to happen, but I don't think it's necessarily just around the corner."

Other topics: Here's a look at other topics panelists and attendees at the conference discussed.

The overall outlook for life and annuity issuers: Right now, the life insurers S&P rates look strong and their outlook looks good, Margalit said.

He said factors that could change the S&P outlook include a deep recession, frenzied competition that leads to irrationally low pricing, and "disintermediation," or rapid moves by customers to drop fixed-rate products paying low rates and shift the cash into products paying higher rates.

But Margalit noted that life insurers have already faced a big, rapid spike in interest rates without facing a big surge in disintermediation.

The U.S. office price crash: Commercial mortgage-backed securities account for about 3% of life insurance compaies' adjusted assets.

Margalit said the effects of the work-from-home movement sparked by the COVID-19 pandemic will likely linger.

"We all know we're not going to back to work in the office five days a week," he said. "Over time, that means vacancies in offices are going to cause delinquencies and are going to cause defaults. There is going to be pain that is going to be felt."

But life insurers will probably benefit from the fact that they have been very careful about choosing their borrowers, he said.

Interest maintenance reserves: Life insurance regulation watchers have been talking excitedly for years about how the National Association of Insurance Commissioners might handle insurer concerns about IMRs, or accounting provisions that insurers can use to smooth out some of the statutory earnings changes caused by shifts in interest rates.

Statutory earnings are the financial results state insurance regulators use to measure how well insurers are doing.

Insurers complained that, in the real world, they could only use the IMR provision to adjust earnings when the provision would make their earnings look worse, never when using the IMR total would make their earnings look better.

The NAIC adopted IMR temporary flexibility guidance in mid-2023.

The new guidance will let life insurers use IMR assets to increase their capital and surplus by up to 10% until 2025, according to Anika Getubig, an S&P Global life ratings analyst.

But the rules are complicated, an insurer will have to analyze its situation carefully to see whether using the new NAIC guidance is worth it, and the overall impact on an insurer's performance may turn out to be modest, Getubig said.

Mary Pat Campbell, a prominent actuary who attended the conference, said an insurer's capital planning team will have to go through the insurers, bond by bond, to see which bonds could benefit much from using the temporary IMR flexibility.

She said that, because of the way using the guidance would affect reported earnings, the guidance could be more popular with policyholder-owned mutual insurers than with publicly traded life insurers.

Carmi Margalit. Credit: Allison Bell/ALM