[Federal Register Volume 59, Number 188 (Thursday, September 29, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-24012]


[[Page Unknown]]

[Federal Register: September 29, 1994]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8564]
RIN 1545-AR59

 

Computation of Equity Base

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
determination of the equity base for purposes of computing the 
differential earnings amount and recomputed differential earnings 
amount, which are used in determining the deduction for policyholder 
dividends of a mutual life insurance company. The final regulations 
provide that the equity base includes the amount of any asset valuation 
reserve and the amount of any interest maintenance reserve reported on 
the annual statement prescribed by the National Association of 
Insurance Commissioners (NAIC) for filing with the insurance regulatory 
authorities of a state. The regulations affect life insurance 
companies.

DATES: These final regulations are effective September 29, 1994.
    These final regulations are applicable for taxable years beginning 
after December 31, 1991.

FOR FURTHER INFORMATION CONTACT: Katherine Ann Hossofsky, (202) 622-
3477 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On September 7, 1993, temporary regulations (TD 8484) relating to 
the determination of the equity base of a life insurance company under 
section 809 of the Internal Revenue Code (Code) were published in the 
Federal Register (58 FR 47060). A notice of proposed rulemaking (FI-29-
93) cross-referencing the temporary regulations was published in the 
Federal Register (58 FR 47089) on the same day. The proposed and 
temporary regulations provide that the equity base includes the amount 
of any asset valuation reserve and the amount of any interest 
maintenance reserve reported on the annual statement prescribed by the 
NAIC for filing with the insurance regulatory authorities of a state.
    Three comments on the proposed regulations were received, and a 
public hearing on the regulations was held on December 3, 1993. After 
consideration of the comments, the proposed regulations are adopted 
without change by this Treasury decision.

Explanation of Provision

    Section 809(a) of the Code provides that, in the case of any mutual 
life insurance company, the amount of the deduction allowable under 
section 808 for policyholder dividends is reduced (but not below zero) 
by the differential earnings amount. For purposes of the computations 
under section 809, a life insurance company must determine its equity 
base. The equity base of a life insurance company includes the capital 
and surplus of the company as well as any mandatory securities 
valuation reserve, deficiency reserve, and voluntary reserve or similar 
liability.
    The mandatory securities valuation reserve is the first reserve 
listed in section 809(b)(5). From the time section 809 was enacted 
through 1991, the mandatory securities valuation reserve was required 
to be reported on the NAIC annual statement filed by all life insurance 
companies. During these years, the NAIC annual statement required 
insurers to allocate surplus to fund the mandatory securities valuation 
reserve. Though shown as a liability account on the annual statement, 
the mandatory securities valuation reserve was not an actual liability 
in the sense of a debt to another party; rather, it represented a fund 
of allocated surplus, earmarked as a contingency reserve against 
fluctuations in the values of a company's investments in stocks and 
bonds.
    For NAIC annual statements covering 1992 and later years, the NAIC 
replaced the mandatory securities valuation reserve with the asset 
valuation reserve and interest maintenance reserve. This change 
reflected the recognition by the NAIC that life insurance companies 
need to protect against fluctuations in value in mortgages, real 
estate, and other investments as well as fluctuations in value in 
stocks and bonds and that interest-related changes in asset values 
might appropriately be differentiated from other changes. Accordingly, 
the new reserves cover an expanded class of assets and differentiate 
between (1) equity and credit-related capital gains and losses, and (2) 
interest-related capital gains and losses.
    The asset valuation reserve reflects changes in the value of equity 
investments and also changes in the value of debt investments where the 
changes are credit-related. Both realized and unrealized capital gains 
and losses are reflected in the asset valuation reserve.
    The interest maintenance reserve reflects realized capital gains 
and losses from bonds, mortgages, and other fixed-income obligations to 
the extent that they are interest-related. Because the value of U.S. 
Government securities, together with the value of securities of 
agencies backed by the full faith and credit of the U.S. Government, 
are safe from credit-related risks and are subject only to interest-
related risks, the capital gains and losses on those securities are 
allocated solely to the interest maintenance reserve.
    The proposed and temporary regulations provide that the equity base 
includes the amount of any asset valuation reserve and the amount of 
any interest maintenance reserve reported on the NAIC annual statement. 
Three comments were received on the proposed regulations.
    The first commentator agreed that inclusion of the asset valuation 
reserve and the interest maintenance reserve in the section 809 equity 
base is consistent with Congress' decision to include the mandatory 
securities valuation reserve in the equity base. The commentator stated 
that, by providing in section 809(b)(5)(A) that the equity base 
includes the amount of the mandatory securities valuation reserve, 
Congress determined that the allocation of surplus represented by this 
reserve, which included credit-related capital gains as well as 
interest-related capital gains, was properly part of the equity base. 
The commentator concluded that, absent a legislative change, allocated 
surplus should continue to be included in the equity base 
notwithstanding the change in the name of the reserve or the method of 
allocating surplus to the reserve. Alternatively, the commentator 
stated that the unaccrued market value increase or decrease in an 
insurer's liabilities as reflected in the interest maintenance reserve 
should be included in the equity base because the Conference Report 
underlying section 809 indicates that Congress intended the equity base 
to include any reserve for potential or unaccrued liabilities. H.R. 
Conf. Rep. No. 861, 98th Cong., 2d Sess. 1058 (1984).
    This commentator also requested that the final regulations clarify 
that both positive and negative interest maintenance reserves are 
included in computing the equity base. Finally, while noting that the 
proposed regulations do not address the treatment of interest-related 
capital gains and losses in computing the section 809 earnings of a 
life insurance company, the commentator indicated that for calendar 
years prior to 1992 interest-related capital gains or losses have been 
included in section 809 earnings no later than the year in which the 
gains or losses were realized for tax purposes. The commentator stated 
that this treatment should be continued in the absence of a legislative 
change.
    The second commentator did not take a position regarding the 
inclusion of the amount of any interest maintenance reserve in the 
section 809 equity base. Rather, this commentator noted that the 
regulations deal with the determination of the equity base but are 
silent on the extent to which interest-related capital gains are to be 
included in section 809 earnings. If the current inclusion approach of 
the proposed and temporary regulations is adopted in the final 
regulations, then this commentator indicated that interest-related 
capital gains and losses should be included currently in section 809 
earnings. In addition, the commentator stated that there should be 
consistency between the calculations of the equity base made on Form 
1120L, U.S. Life Insurance Income Tax Return, and on Form 8390, 
Information Return for Determination of Life Insurance Company Earnings 
Rate Under Section 809.
    The third commentator agreed that the interest maintenance reserve 
must be treated consistently for equity base and earnings purposes. 
However, this commentator urged that the interest maintenance reserve 
not be included in the section 809 equity base. Instead, interest-
related capital gains and losses would be amortized into equity and 
earnings over the remaining life of the asset sold. The commentator 
stated that inclusion of the interest maintenance reserve in equity: 
(1) Is inconsistent with the substance and theory of the interest 
maintenance reserve, which is to treat interest-related realized 
capital gains and losses as a substitute for future unearned income; 
(2) fails to reduce the volatility of the life insurance companies' 
earnings rates; (3) is inconsistent with the requirement under section 
809 that all determinations generally be made on the basis of the 
amounts required to be set forth on the annual statement; and (4) is 
inconsistent with Sec. 1.809-9(a), which provides that neither the 
differential earnings rate nor the recomputed differential earnings 
rate may be negative.
    No changes are being made to the regulations in response to these 
comments. Inclusion of the interest maintenance reserve in the equity 
base is consistent with the historical treatment of interest-related 
capital gains and losses under section 809. By providing in section 
809(b)(5)(A) that the equity base includes the amount of the mandatory 
securities valuation reserve, Congress demonstrated its intent to 
include interest-related capital gains and losses in the equity base. 
Modification of the annual statement by the NAIC to eliminate and 
replace the mandatory securities valuation reserve cannot override the 
specific inclusion that Congress required for these gains and losses. 
Section 809(g)(3) provides the regulatory authority to adjust under 
section 809(b)(5) amounts set forth on the annual statement to continue 
the inclusion of these gains and losses in the equity base. Since the 
interest maintenance reserve represents an allocation of surplus from 
interest-related capital gains and losses for which Congress made clear 
its intentions and provided regulatory authority to preserve its 
intentions, the inclusion of the interest maintenance reserve in the 
equity base is appropriate.
    The final regulations require any interest maintenance reserve 
(whether positive or negative) to be included in an insurer's equity 
base. The reduction of the equity base for any interest-related capital 
losses reflected in a negative interest maintenance reserve is 
consistent with the treatment of those losses prior to the replacement 
of the mandatory securities valuation reserve with the asset valuation 
reserve and the interest maintenance reserve. Before the change, any 
interest-related capital losses reduced the amount of net income added 
to capital and surplus. Thus, any negative interest maintenance reserve 
should be included as a reduction to the equity base, consistent with 
the treatment of interest-related capital losses prior to the change.
    Under the final regulations, the asset valuation reserve and the 
interest maintenance reserve must be included in the calculation of the 
equity base for purposes of section 809. This requirement is reflected 
on both Form 1120L and Form 8390. See Announcement 93-117, 1993-29 
I.R.B. 85. Thus, there is consistency between the calculations of the 
equity base on Form 1120L and on Form 8390. Finally, although the final 
regulations do not specifically address this issue, interest-related 
capital gains and losses continue to be included in section 809 
earnings by virtue of section 809(g)(1)(C).

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to 
these regulations, and, therefore, a Regulatory Flexibility Analysis is 
not required. Pursuant to section 7805(f) of the Internal Revenue Code, 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Small Business Administration for comment on its 
impact of small business.

Drafting Information

    The principal author of these regulations is Katherine Ann 
Hossofsky of the Office of the Assistant Chief Counsel (Financial 
Institutions and Products). However, other personnel from the IRS and 
Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *

    Section 1.809-10 also issued under 26 U.S.C. 809(b)(2) and (g)(3). 
* * *


Sec. 1.809-10T [Redesignated as Sec. 1.809-10]

    Par. 2. Section 1.809-10T is redesignated as Sec. 1.809-10 and the 
word ``(temporary)'' is removed from the section heading.
Michael P. Dolan,
Acting Commissioner of Internal Revenue .

    Approved: September 9, 1994.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 94-24012 Filed 9-28-94; 8:45 am]
BILLING CODE 4830-01-U