March 19, 1999
Honorable Secretary Robert Rubin
Department of Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220
RE: Administration’s FY 2000 Budget
Dear Secretary Rubin:
The National Alliance of Life Companies (NALC)
is a national trade association of more than 200 life and health insurance
companies which do business in all 50 states and the District of Columbia.
By way of background, the NALC was formed in
1992 immediately after the merger of the National Association of Life Companies
with the American Council of Life Insurance (ACLI). The NALC is primarily
composed of small and medium size insurers. When the merger occurred, a number
of the smaller companies decided that the life insurance industry could not be
adequately represented by one voice. Therefore, those members decided to form
the current NALC.
The primary reason for the separation of
interests is simply stated in one word: "Survival." While most issues
such as taxation and the cost of doing business impact the bottom line of larger
companies, those same taxes and costs could put many of our companies out of
business. In fact, a number of these small companies are still owned by the
families that started them. They may be the largest employer in the small town
in which they are located. They are vital links in the American economic system.
It is with this view that we consider taxation and other important issues.
We have reviewed the Administration’s FY 2000
Budget. Please accept these comments on behalf of our members.
Smaller insurance companies suffer under the
current system of taxation. Specifically, the following Tax Code provisions and
proposals are of concern to the small and medium size companies.
Deferred Acquisition Cost (Section 848)
The Deferred Acquisition Cost (DAC Tax) is a
clear example of how a tax can unfairly burden smaller insurers. In 1990,
Congress adopted a change in the tax treatment of deferred acquisition costs
which was reportedly intended to act as a proxy for amortization of a portion of
such costs. Congress determined that a certain percentage of net premiums must
be amortized for either 60 or 120 months, depending on the size of the company.
This differs from the method of accounting
utilized by state regulators, statutory accounting.
Statutory accounting is a modified cash basis of
accounting. Expenses are written off when paid, whether the asset is admitted or
not. For instance, computer software is an example of a non- admitted asset in
most states. Federal Income Tax payments that apply to future income are a
similar example.
The DAC Tax does not allow insurers to deduct
expenses incurred in putting business on the books, even though these are actual
expenses. These expenses often exceed the premiums paid in the early years of
any policy. Therefore, insurers are taxed on the premiums paid before any
profits are made. This is a phantom tax on nonexistent money. The formula
artificially inflates the taxable income of insurers for the current year by
deferring expenses to future years. In theory, after an insurer starts to recoup
the deferred expenses, a credit is issued toward the current year’s tax bill,
which is inflated as a result of the current year’s DAC. However, the only way
for the insurer to even approach break even is to cease growth.
The operation of this tax is actually a double
hit to the insurer. The money is spent to acquire the business. Then, the
Federal Government requires payment of a tax bill which can only come from
surplus. Therefore, the surplus, which has been diminished by dollars already
spent, must be further depleted to pay the taxes. The dissipation of surplus
will restrict an insurer’s ability to write new business and reduces funds
needed for new product development.
The impact of this growth-inhibiting, regressive
tax on smaller companies is dramatic. This anti-growth tax policy has
disproportionately retarded the growth of the smaller insurers. These companies
have the ability and need for greater growth than the large companies. While
larger companies, which have mature surpluses, may opt for a slow growth or
no-growth strategy in order to counter the effects of the DAC Tax, this option
is not available to smaller companies. In fact, some small companies are paying
Federal Income Tax well in excess of 100% of statutory income.
Small insurance companies have traditionally
been the leaders in product innovation in the marketplace. These companies have
filled the niche markets and forged new channels of distribution that larger
companies have not traditionally pursued. These niche products are vital to many
consumers. Many of these consumers are not affluent and require, or can afford
only modest coverages to protect their families from loss. Therefore, the
inability of the smaller insurers to fill this vital role is a loss to these
traditionally under served consumers. The small insurers traditionally do not
lay off workers to trim budgets. As small as they are, they may even be the
largest employer in the town in which they are located. These smaller companies
should be encouraged by Federal tax policy to strengthen their balance sheets by
the growth of their businesses, rather than being prohibited from doing so by
the continued application of this regressive taxation. The disproportionate
application and impact of the DAC Tax runs counter to the American dream of
allowing the small, family-run company to grow and expand into new markets,
while providing employment for increasing numbers of citizens. Further, the
effect of the application of this tax is diametrically opposed to the stated
objective of this Administration to allow for economic growth, or at least not
penalize rapidly growing companies, by removing the barriers currently in place.
The DAC Tax does not allow for economic growth and actually penalizes the growth
of the smaller companies.
Finally, the DAC Tax has forced insurers to
either acquire other insurers or be acquired in order to grow in the face of the
burden of this regressive tax. The operation of such this tax provision has
resulted in layoffs and closures of businesses which have long been the backbone
of the American insurance industry, the small companies.
The proposal to expand this regressive tax is
potentially fatal to smaller companies. Therefore, we urge the Administration to
reconsider the proposal to expand this regressive tax and further request that
the Administration help smaller companies to find relief from the current
regressive DAC Tax. We would respectfully request that the Administration
recommend a carve-out for small to medium size insurers from the DAC Tax burden.
The removal of the DAC Tax burden from these
insurers will save jobs, and encourage real growth for the first time since the
imposition of this burden. Therefore, over time, the relief would actually be
revenue positive, which would have the additional benefit of saving, as well as
creating jobs for Americans.
Proposal to Tax Policyholder Surplus Accounts
The Administration has proposed that life
insurance companies include policyholders surplus accounts (PSAs) into the
income calculation and pay tax on the PSAs over a period of ten years. Stock
life insurance companies established PSAs before the changes to the Tax Code in
1984. These accounts were to be taxed only under two circumstances: 1) If the
funds were distributed to shareholders; or 2) In the event that the company
ceased being a life insurance company.
In 1984, Congress changed the taxation of life
insurance companies to a method based on a comprehensive income calculation. At
the same time, Congress eliminate the ability of insurers to make any additions
to PSAs. At the same time, Congress also determined that the shareholder
distribution requirements in order to trigger taxation of PSAs would remain in
place.
The proposal to retroactively tax insurers by
reaching back, in some instances, as long as 40 years is overly burdensome and
unfair all insurers, but especially for smaller insurers. As stated above,
Congress addressed this issue in 1984. A review of the Committee Reports to the
1984 Tax Reform Act reveals that Committee recommended and Congress decided that
life insurance companies "will not be taxed on previously deferred amounts
unless they are treated as distributed to shareholders or subtracted from the
policyholders surplus account under rules comparable to those provided under the
1959 Act."
The burden on smaller insurers is greater
because the funds to pay the tax are not set aside. Any tax payments resulting
from the imposition of this new tax would come from the company’s surplus
account. As we have stated above, smaller insurers need their surplus to support
growth. If they do not grow, they will die, resulting in a loss of jobs and the
needs of their customers may no longer be served. This additional burden would
force smaller insurers already strapped due to Federal taxation policy into a
even deeper hole. Therefore, we urge the Administration to reconsider the
position that insurers must now pay this tax.
Subject Trade Association Investments to
Taxation The proposal to subject trade associations to taxation on investments
income is troubling. Trade associations fulfill a vital niche in America. These
organizations allow individuals and companies to work together for a common
goal, whether it be social, political or for any other reason. The NALC is very
small and we provide our members with a way to pool their resources.
While most trade associations charge dues
sufficient to fund their operations, as a result of mergers and acquisitions,
some trade associations cannot survive solely on the dues raised. This is
especially true for many trade associations that are smaller or regional. The
dues structures for these trade associations are more modest, in order to allow
those individuals and smaller companies to pool their resources to attempt to
accomplish what they cannot do alone. As a result, investment income may provide
the final resources that these trade associations require to sustain the voice
created by their members that cannot afford to retain expensive outside counsel
to represent their interests.
Congress created the current tax exemptions for
trade associations because of the recognition of the vital role that trade
associations play in America.
Therefore, we respectfully request that the
Administration reconsider this proposal.
Conclusion
As stated above, we urge that the Administration
recommend a carve-out for small to medium size insurers from the DAC Tax burden.
The NALC supports relief from the regressive DAC Tax and the other above
referenced tax provisions which have retarded the growth of the small life
insurers who have disproportionately shouldered these tax burdens. Further, we
also request that the Administration reconsider the proposals to tax
policyholder surplus accounts and subject trade associations to investment tax
burdens.
While these are not the only concerns the NALC
has with the Administration’s Proposed FY 2000 Budget, these issues are the
most pressing that we must address immediately. These and other issues are
technical in nature and may require additional discussion with tax specialists
in order to further analyze the pertinent data which may better illustrate the
problems presented by these tax provisions. Therefore, we would request the
opportunity to meet with your staff or other Administration staff to discuss
these matters in greater detail.
A member of the NALC once told me that forcing a
company out of business or into a forced acquisition is the death of someone’s
dream. We only ask that continuous excessive Federal taxation not be the
catalyst or cause of death.
Thank you again for the opportunity to submit
our views on these matters of vital concern to small and medium size companies.
Respectfully Submitted,
NALC
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The NALC held its 2008
Spring Conference April 2-5, at the Grand Hotel Marriott, Point
Clear, Alabama.