[Federal Register Volume 83, Number 216 (Wednesday, November 7, 2018)]
[Proposed Rules]
[Pages 55646-55653]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-24367]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-103163-18]
RIN 1545-BO50


Modification of Discounting Rules for Insurance Companies

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking; notice of public hearing.

-----------------------------------------------------------------------

SUMMARY: This document contains proposed regulations providing guidance 
on new discounting rules for unpaid losses and estimated salvage 
recoverable of insurance companies for Federal income tax purposes. The 
proposed regulations implement recent legislative changes to the 
Internal Revenue Code (Code) and make other technical improvements to 
the derivation and use of discount factors. The proposed regulations 
affect entities taxable as insurance companies. This document invites 
comments and provides notice of a public hearing on these proposed 
regulations.

DATES: Written or electronic comments must be received by December 7, 
2018. Requests to speak and outlines of topics to be discussed at the 
public hearing scheduled for December 20, 2018, at 10 a.m., must be 
received by December 7, 2018.

ADDRESSES: 
    Comments: Send submissions to: CC:PA:LPD:PR (REG-103163-18), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
103163-18), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW, Washington, DC 20224, or sent electronically via the Federal 
eRulemaking Portal at http://www.regulations.gov (REG-103163-18).
    Public hearing: The public hearing will be held in the IRS 
Auditorium, Internal Revenue Service, 1111 Constitution Avenue NW, 
Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Kathryn M. Sneade, (202) 317-6995; concerning submissions of comments 
and requests to speak at the public hearing, Regina L. Johnson, (202) 
317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains proposed amendments to 26 CFR part 1 under 
section 846 of the Code. Section 846 was added to the Code by section 
1023(c) of the Tax Reform Act of 1986, Public Law 99-514 (100 Stat. 
2085, 2399). Final regulations under section 846 were published in the 
Federal Register (57 FR 40841) on September 8, 1992 (T.D. 8433). See 
Sec. Sec.  1.846-0 through 1.846-4 (1992 Final Regulations).
    This document provides guidance on discounting rules under section 
846 of the Code, which were amended on December 22, 2017 by section 
13523 of ``An Act to provide for reconciliation pursuant to titles II 
and V of the concurrent resolution on the budget for fiscal year 
2018,'' Public Law 115-97, title 1, 131 Stat. 2152 (2017) (TCJA) for 
taxable years beginning after December 31, 2017. The discounting rules 
of section 846, both prior to and after amendment by the TCJA, are used 
to determine discounted unpaid losses and estimated salvage recoverable 
of property and casualty insurance companies and discounted unearned 
premiums of title insurance companies for Federal income tax purposes 
under section 832, as well as discounted unpaid losses of life 
insurance companies for Federal income tax purposes under sections 
805(a)(1) and 807(c)(2). These rules are discussed in greater detail in 
parts A and B of this Background section.
    Section 13523(a) of the TCJA amended section 846(c) to provide a 
new definition of the ``annual rate'' to be used by taxpayers for 
discounting purposes. Section 13523(b) of the TCJA amended the 
computational rules for determining loss payment patterns under section 
846(d). Section 13523(c) of the TCJA repealed the election under former 
section 846(e) to use the taxpayer's own historical loss payment 
pattern instead of the pattern published by the Secretary. These 
changes are effective for taxable years beginning after December 31, 
2017. The proposed regulations implement these changes in the law.
    Part C of this Background section discusses smoothing adjustments, 
and part C of the Explanation of Provisions section of this preamble 
describes a proposed regulation authorizing the Secretary to adopt a 
methodology to smooth the loss payment patterns derived from the annual 
statement loss payment data to avoid negative payment amounts and to 
otherwise produce a stable pattern of positive discount factors less 
than one. Part A of the Other Discounting Considerations section of 
this preamble provides additional detail on the proposed methodology 
that the Department of the Treasury (Treasury Department) and the IRS 
anticipate developing under the authority provided in this proposed 
regulation. The Treasury Department and the IRS intend to describe the 
methodology used under the rules set forth in the proposed regulations 
in each revenue procedure that publishes discount factors for a 
determination year.
    Part D of this Background section describes the existing procedures 
for discounting unpaid losses with respect to accident years not 
separately reported on the National Association of Insurance 
Commissioners' (NAIC) annual statement, including the method described 
in section V of Notice 88-100, 1988-2 C.B. 439 (composite method). Part 
B of the Other Discounting Considerations section of this preamble 
describes proposed new procedures for discounting such unpaid losses. 
These procedures would simplify the discounting of unpaid losses by 
eliminating the need for a second set of discount factors to be used 
with respect to accident years not separately reported on the NAIC 
annual statement.
    Part C of the Other Discounting Considerations section of this 
preamble describes an approach that the Secretary intends to adopt for 
discounting estimated salvage recoverable by applying the unpaid loss 
discount factors in each line of business to the estimated salvage 
recoverable in that line of business.

A. Discounted Unpaid Losses, Estimated Salvage Recoverable, and 
Discounted Unearned Premiums

    Under section 832, the taxable income of a property and casualty 
insurance company (non-life insurance company), including a title 
insurance company, is the sum of its underwriting income and investment 
income (as well as gains and other income items), reduced by allowable 
deductions. Under section 832(b)(3), a non-life insurance company's 
``losses incurred'' is a

[[Page 55647]]

component of the company's underwriting income. Under section 
832(b)(5)(A), the change over a taxable year in the company's 
``discounted unpaid losses'' (as defined in section 846) is a component 
of its losses incurred for the taxable year. Discounting of unpaid 
losses is required to take into account the time value of money. See H. 
Rept. 115-466, at 470 (2017) (Conf. Rep.). Under section 832(b)(3), 
(4), and (8), a title insurance company's ``discounted unearned 
premiums'' is a component of the company's underwriting income. Under 
section 832(b)(8), a title insurance company must discount its unearned 
premiums by using the applicable interest rate and the applicable 
statutory premium recognition pattern. The applicable interest rate for 
purposes of section 832(b)(8) is the annual rate determined under 
section 846(c)(2).
    Section 832(b)(5)(A) also requires that the change in discounted 
estimated salvage recoverable be taken into account in computing the 
losses incurred component of underwriting income. Under section 
832(b)(5)(A), the amount of discounted estimated salvage recoverable is 
determined in accordance with procedures established by the Secretary. 
Section 1.832-4(c) provides that, except as otherwise provided in 
guidance published by the Commissioner in the Internal Revenue 
Bulletin, estimated salvage recoverable must be discounted either (1) 
by using the applicable discount factors published by the Commissioner 
for estimated salvage recoverable; or (2) by using the loss payment 
pattern for a line of business as the salvage recovery pattern for that 
line of business and by using the applicable interest rate for 
calculating unpaid losses under section 846(c). In prior years, 
guidance published by the Commissioner in the Internal Revenue Bulletin 
has always directed taxpayers to discount estimated salvage recoverable 
for each line of business using the applicable discount factors 
published by the Commissioner for estimated salvage recoverable and has 
not allowed the use of the second option provided for by regulations. 
These discount factors were determined using the salvage recovery 
pattern for the line of business and the applicable interest rate for 
calculating unpaid losses under section 846. See, e.g., Rev. Proc. 
2018-13, 2018-7 I.R.B. 356, and Rev. Proc. 2016-59, 2016-51 I.R.B. 849.
    The section 846 discounting rules are also relevant for life 
insurance companies. Section 807(c) provides that, for life insurance 
companies, the amount of unpaid losses (other than losses on life 
insurance contracts) is the amount of discounted unpaid losses as 
defined in section 846 for purposes of both sections 805(a)(1) and 
807(c)(2). Section 805(a)(1) provides life insurance companies with a 
deduction for losses incurred during the taxable year on insurance and 
annuity contracts. Section 807(c)(2) provides that unpaid losses 
included in total reserves under section 816(c)(2) are taken into 
account under section 807(a) and (b) by a life insurance company. In 
general, section 807(a) provides that a decrease in discounted unpaid 
losses over the taxable year is included in life insurance company 
gross income under section 803(a)(2), while section 807(b) provides 
that an increase in discounted unpaid losses over the taxable year is 
deductible under section 805(a)(2).

B. Discounting Rules for Unpaid Losses

    Section 846(a)(1) provides that the amount of discounted unpaid 
losses as of the end of any taxable year is the sum of the discounted 
unpaid losses, as of such time, separately computed with respect to 
unpaid losses in each line of business for each accident year. The 
amount of discounted unpaid losses in a line of business that is 
attributable to a specified accident year is calculated by multiplying 
that accident year's undiscounted unpaid losses at the end of each 
taxable year by a published discount factor associated with that line 
of business, accident year, and taxable year. Discount factors are 
published annually by the IRS. See, e.g., Rev. Proc. 2018-13 and Rev. 
Proc. 2016-58, 2016-51 I.R.B. 839. These discount factors are derived 
using the applicable loss payment pattern, determined under section 
846(d) using aggregate industry loss payment data, and the applicable 
interest rate determined by the Secretary under section 846(c).
1. Modification of the Applicable Rate of Interest Used To Discount 
Unpaid Losses
    The ``applicable interest rate'' used to determine the discount 
factors associated with any accident year and line of business is the 
``annual rate'' determined under section 846(c)(2).
    Before amendment by section 13523(a) of the TCJA, section 846(c)(2) 
provided that the annual rate for any calendar year was a rate equal to 
the average of the applicable Federal mid-term rates (as defined in 
section 1274(d) but based on annual compounding) effective as of the 
beginning of each of the calendar months in the most recent 60-month 
period ending before the beginning of the calendar year for which the 
determination is made. The applicable Federal mid-term rate is 
determined by the Secretary based on the average market yield on 
outstanding marketable obligations of the United States with remaining 
periods of over three years but not over nine years. See section 
1274(d)(1).
    As amended by section 13523(a) of the TCJA, section 846(c)(2) 
provides that the annual rate for any calendar year will be determined 
by the Secretary based on the corporate bond yield curve (as defined in 
section 430(h)(2)(D)(i), determined by substituting ``60-month period'' 
for ``24-month period'' therein). Section 430, which relates to minimum 
funding standards for single-employer defined benefit pension plans, 
includes other rules for determining an ``effective interest rate,'' 
such as segment rate rules. The term ``effective interest rate'' along 
with these other rules, including the segment rate rules, do not apply 
for purposes of property and casualty insurance reserve discounting. 
See H. Rept. 115-466, at 471, fn. 979. The corporate bond yield curve 
is published on a monthly basis by the Treasury Department and consists 
of spot interest rates for each stated time to maturity. See, e.g., 
Notice 2018-60, 2018-31 I.R.B. 275. The spot rate for a given time to 
maturity represents the yield on a bond that gives a single payment at 
that maturity. For the stated yield curve, times to maturity are 
specified at half-year intervals from 0.5 year through 100 years. 
Section 846(c)(2) does not specify how the Secretary is to determine 
the annual rate for any calendar year based on the corporate bond yield 
curve.
2. Modification of Computational Rules for Loss Payment Patterns
    Under section 846(d)(1), the Secretary determines a loss payment 
pattern for each line of business by reference to the historical 
aggregate loss payment data applicable to that line of business for 
each determination year. Under section 846(d)(4), the determination 
year is the calendar year 1987 and each fifth calendar year thereafter. 
Any loss payment pattern determined by the Secretary applies to the 
accident year ending with the determination year and to each of the 
four succeeding accident years. Section 846(d)(2)(A) and (B) provide 
that the determination of a loss payment pattern for any determination 
year is made using the aggregate experience reported on the annual 
statements of insurance companies on the basis of the most recent 
published aggregate data relating to loss payments available on the 
first day of the determination year. For instance, the payment data 
used to determine the loss payment patterns for 2017 (the most recent 
determination year) were

[[Page 55648]]

reported on annual statements filed for the year 2015.
    The loss payment pattern for each line of business is determined in 
accordance with the computational rules of section 846(d)(3). These 
rules determine different loss payment patterns for ``long-tail'' lines 
of business (any line of business reported in the schedule or schedules 
of the annual statement relating to auto liability, other liability, 
medical malpractice, workers' compensation, and multiple peril lines) 
and ``short-tail'' lines of business (all lines of business other than 
long-tail lines of business).
    For short-tail lines of business, section 846(d)(3) provides that 
losses unpaid at the end of the first year following the accident year 
are treated as paid equally in the second and third years following the 
accident year. For long-tail lines of business, section 846(d)(3) 
provides that unpaid losses remaining after ten years are treated as 
paid in the tenth year following the accident year, except as otherwise 
provided in that section.
    Before amendment by section 13523(b) of the TCJA, section 846(d)(3) 
provided for the extension of the ten-year payment period specified for 
long-tail lines by not more than five years provided certain conditions 
were met.
    As amended by section 13523(b) of the TCJA, section 846(d)(3) 
provides for the extension of the ten-year payment period for a maximum 
of fourteen additional years if the amount of losses that would have 
been treated as paid in the tenth year after the accident year exceeds 
the average of the loss payments treated as paid in the seventh, 
eighth, and ninth years after the accident year. In that case, the 
amount of losses that would have been treated as paid in the tenth year 
after the accident year are treated as paid in such tenth year and each 
subsequent year in an amount equal to the average of the loss payments 
treated as paid in the seventh, eighth, and ninth years after the 
accident year (or, if less, the portion of the unpaid losses not 
previously taken into account). To the extent such unpaid losses have 
not been treated as paid before the twenty-fourth year after the 
accident year, they are to be treated as paid in such twenty-fourth 
year.
    In addition to extending the ten-year payment period, section 
13523(b) of the TCJA repealed section 846(d)(3)(E) through (G). Former 
section 846(d)(3)(G) is discussed in part C of this Background section. 
Former section 846(d)(3)(F) provided for the Secretary to make 
appropriate adjustments if annual statement data with respect to 
payment of losses was available for longer periods after the accident 
year than the periods assumed under section 846(d). The annual 
statement requires the reporting of ten years of loss payment data for 
the international line of business and the three lines of business for 
non-proportional reinsurance, as it does for long-tail lines of 
business. Losses from proportional reinsurance are reported in the 
annual statement schedules related to the underlying line of business, 
which may be short-tail or long-tail. Under section 846(d)(3), 
proportional reinsurance unpaid losses are discounted using the 
discount factors published for the underlying line of business. Former 
section 846(d)(3)(E) provided special rules for determining loss 
payment patterns for the international line of business and for 
reinsurance lines of business based on the combined losses for all 
long-tail lines of business and provided explicit authority to the 
Secretary to override these special rules.
    The repeal of section 846(d)(3)(E) and (F) means that the statute 
no longer explicitly provides for the determination of loss payment 
patterns for non-proportional reinsurance and international lines of 
business extending beyond three calendar years following the accident 
year. Non-proportional reinsurance and international lines of business 
are not included in the list of long-tail lines set forth in section 
846(d)(3)(A)(ii). The Treasury Department and the IRS request comments 
regarding the length of the loss payment patterns for non-proportional 
reinsurance and international lines of business to be determined under 
section 846, as amended, and the legal basis for limiting the loss 
payment patterns for these lines of business to three calendar years 
following the accident year or extending the loss payment patterns 
beyond those years.
    Section 846(f) (as redesignated by section 13523(c) of the TCJA) 
provides the Secretary with authority to prescribe such regulations as 
may be necessary or appropriate to carry out the purposes of section 
846, including an explicit grant of authority to prescribe regulations 
for providing proper treatment of allocated reinsurance. The 1992 Final 
Regulations provide special rules for the determination of discount 
factors for proportional and non-proportional reinsurance lines of 
business and the international line of business. Section 1.846-1(b)(3) 
of the 1992 Final Regulations provides rules for the determination of 
discount factors for reinsurance lines of business. Section 1.846-
1(b)(3)(i) provides that, with respect to proportional reinsurance 
lines of business (for accident years after 1987), unpaid losses are 
discounted using discount factors applicable to the line of business to 
which those unpaid losses are allocated as required on the annual 
statement. Section 1.846-1(b)(3)(ii)(A) provides that unpaid losses for 
non-proportional reinsurance (for accident years after 1991) are 
discounted using the discount factors published by the IRS for the 
appropriate reinsurance line of business, subject to an exception set 
forth in Sec.  1.846-1(b)(3)(iv) (if more than 90 percent of the 
unallocated losses of a taxpayer for an accident year relate to one 
underlying line of business, the taxpayer must discount all unallocated 
reinsurance unpaid losses attributable to that accident year using the 
discount factors published by the IRS for the underlying line of 
business). Section 1.846-1(b)(3)(ii)(B) provides rules for unpaid 
losses for non-proportional reinsurance for accident years 1988 through 
1991, and Sec.  1.846-1(b)(3)(iii) provides rules for certain 
reinsurance unpaid losses for accident years before 1988.
    Section 1.846-1(b)(4) of the 1992 Final Regulations provides rules 
for the determination of discount factors for the international line of 
business. Section 1.846-1(b)(4) provides that unpaid losses 
attributable to the international line of business are discounted using 
the discount factors determined for a ``composite'' long-tail line of 
business, unless more than 90 percent of such losses for that accident 
year are related to a single line of business, in which case the 
international unpaid losses are discounted using that accident year's 
published discount factors for the underlying line of business.
3. Repeal of Historical Loss Payment Pattern Election
    Before amendment by section 13523(c) of the TCJA, section 846(e) 
permitted a taxpayer to elect to use its own historical loss payment 
pattern with respect to all lines of business rather than the industry-
wide loss payment pattern determined by the Secretary under section 
846(d), provided that applicable requirements were met. Section 
13523(c) of the TCJA repealed that election.
4. Transition Rule
    The transition rule set forth in section 13523(e) of the TCJA 
provides that, for the first taxable year beginning after December 31, 
2017, the unpaid losses and expenses unpaid (as defined in section 
832(b)(5) and (6)) at the end of the preceding taxable year, and the 
unpaid losses (as defined in sections

[[Page 55649]]

805(a)(1) and 807(c)(2)) at the end of the preceding taxable year, are 
determined as if the amendments made by section 13523 of the TCJA had 
applied to such unpaid losses and expenses unpaid in the preceding 
taxable year and by using the interest rate and loss payment patterns 
applicable to accident years ending with calendar year 2018. Any 
adjustment resulting from this transition rule is taken into account 
ratably in such first taxable year and the seven succeeding taxable 
years. For subsequent taxable years, such amendments are applied with 
respect to unpaid losses and expenses unpaid for accident years ending 
with or before calendar year 2018 by using the interest rate and loss 
payment patterns applicable to accident years ending with calendar year 
2018.

C. Smoothing Adjustments

    As described in part B(2) of this Background section, section 
846(d)(1) requires the Secretary to determine, for each determination 
year, a loss payment pattern for each line of business by reference to 
the historical aggregate loss payment data applicable to that line of 
business. The Secretary makes such determination using the aggregate 
experience reported on the annual statements of insurance companies on 
the basis of the most recent published aggregate data from such annual 
statements relating to loss payment patterns available on the first day 
of the determination year. Because historical loss payment patterns 
change from accident year to accident year, the annual payment amounts 
determined on the basis of data taken from a single year's annual 
statements are not always non-negative and may vary significantly from 
year to year. Accordingly, use of the annual statement payment data to 
determine the loss payment pattern without any adjustment to compensate 
for changes from year to year may produce discount factors that vary 
widely from one year to the next or discount factors for a particular 
year or years that are negative or greater than one. See Rev. Proc. 
2003-17, 2003-1 C.B. 427.
    Former section 846(d)(3)(G), prior to its repeal by section 13523 
of the TCJA, provided guidance on one aspect of smoothing. Former 
section 846(d)(3)(G) provided that, if the amount of losses treated as 
paid in the ninth year after the accident was negative or zero, the 
average of the losses treated as paid in the seventh, eighth, and ninth 
years after the accident year would be used instead to determine the 
amount of losses treated as paid in the following years. Section 
846(d)(3)(B)(ii)(II), as amended by section 13523(b) of the TCJA, 
provides that the average of the loss payments treated as paid in the 
seventh, eighth, and ninth years after the accident year is used to 
determine the amount of losses treated as paid in the following years. 
Section 846, as amended, provides no additional specific guidance 
regarding smoothing of the loss payment patterns.
    In section 2.03(4) of Rev. Proc. 2003-17 and section 3.04 of Rev. 
Proc. 2007-9, 2007-3 I.R.B. 278, comments were requested as to whether 
a methodology should be adopted to smooth the annual statement payment 
data, and thus produce a more stable pattern of discount factors. The 
Treasury Department and the IRS received comments that agreed that such 
a methodology should be adopted and suggested specific methods that 
could be used.

D. Composite Method

    Rules for discounting unpaid losses with respect to accident years 
not separately reported on the NAIC annual statement are described in 
section V of Notice 88-100 and in Rev. Proc. 2002-74, 2002-2 C.B. 980.
    After the enactment of section 846 in 1986, the Treasury Department 
and the IRS published Notice 88-100 to provide guidance with respect to 
several issues that were expected to be addressed in then forthcoming 
regulations under section 846. Section V of Notice 88-100 stated that 
regulations under section 846 would provide that taxpayers may not use 
information that does not appear on their NAIC annual statements to 
allocate aggregate unpaid losses among several accident years, but 
rather must use a composite discount factor for such aggregated unpaid 
losses. The notice set forth a method for computing a composite 
discount factor to be used to compute discounted unpaid losses with 
respect to accident years not separately reported on the NAIC annual 
statement, referred to as the ``composite method.'' The notice provided 
a simplified example to illustrate the operation of this method.
    The 1992 Final Regulations provided guidance on several issues 
addressed in Notice 88-100, rendering portions of Notice 88-100 
obsolete. However, the 1992 Final Regulations did not adopt the rule 
anticipated by section V of Notice 88-100 requiring that taxpayers use 
a composite discount factor for the aggregate unpaid losses from 
accident years not separately reported on the NAIC annual statement, 
and therefore section V of Notice 88-100 was not rendered obsolete.
    The 1992 Final Regulations adopted a rule requiring taxpayers to 
use composite discount factors with respect to any line of business for 
which the IRS has not published discount factors. See Sec.  1.846-
1(b)(1)(ii) and (5) of the 1992 Final Regulations. Composite discount 
factors determined on the basis of the appropriate composite loss 
payment pattern are published annually by the IRS for use with respect 
to such lines of business. However, these composite discount factors 
are unrelated to the composite discount factors of Notice 88-100 that 
relate to discounting unpaid losses from accident years not separately 
reported on the NAIC annual statement.
    Section 3.01 of Rev. Proc. 2002-74 clarifies that the composite 
method described in section V of Notice 88-100 is permitted but not 
required to be used by insurance companies. Section 3.01 also provides 
that the Secretary will publish composite discount factors annually for 
use by taxpayers that have not elected under section 846(e) to use 
their historical loss payment patterns, and such factors have been 
published annually since 2002, along with the Secretary's tables 
containing the section 846 loss payment patterns and discount factors 
and the section 832 salvage discount factors. See, e.g., Rev. Proc. 
2016-58. Section 3.02 of Rev. Proc. 2002-74 provides, in part, that 
taxpayers who do not use a composite method described in section 3.01 
of Rev. Proc. 2002-74 should instead use the discount factors for the 
appropriate year in the Secretary's table for the appropriate line of 
business. Sections 3.01 and 3.02 of Rev. Proc. 2002-74 also provide 
instructions for taxpayers that have elected under section 846(e) to 
use their historical loss payment patterns. However, as discussed in 
part B(3) of this Background section, section 13523(c) of the TCJA 
repealed section 846(e).

Explanation of Provisions

A. Modification of the Applicable Rate of Interest Used To Discount 
Unpaid Losses

    Proposed Sec.  1.846-1(c) provides that the applicable interest 
rate is the annual rate determined by the Secretary for any calendar 
year on the basis of the corporate bond yield curve (as defined in 
section 430(h)(2)(D)(i), determined by substituting ``60-month period'' 
for ``24-month period'' therein). The annual rate for any calendar year 
is the average of the corporate bond yield curve's monthly spot rates 
with times to maturity of not more than seventeen and one-half years, 
computed using the most

[[Page 55650]]

recent 60-month period ending before the beginning of the calendar year 
for which the determination is made.
    Consistent with the text of section 846, as amended by the TCJA, 
and the statutory structure as a whole, the proposed regulations 
provide for the use of a single annual rate applicable to all lines of 
business as was the case under section 846 prior to amendment by the 
TCJA. Under section 846(c)(2) prior to amendment by section 13523(a) of 
the TCJA, a single annual rate was used for all lines of business, and 
the amendments made by the TCJA do not clearly indicate an intent to 
change from the historical practice of applying a single rate to all 
loss payment patterns. The change from using the average of the 
applicable Federal mid-term rates to the averaged corporate bond yield 
curve, however, indicates that the annual rate should be determined in 
a manner that more closely matches the investments in bonds used to 
fund the undiscounted losses to be incurred in the future by insurance 
companies.
    An alternative approach would be the direct application of the 
corporate bond yield curve to the loss payment pattern for each line of 
business, which would result in a more accurate measure of the present 
value of the unpaid losses for each line of business. In light of the 
investment in corporate bonds to fund the unpaid losses to be paid in 
the future, the result is a more accurate reflection of the time value 
of money in the measure of income. Using this approach, for each 
taxable year, each future loss payment incurred in a line of business 
for an accident year (as determined by the loss payment pattern 
determined for that line of business) would be discounted using the 
spot rate from the corporate bond yield curve with a time to maturity 
that matches the time between the end of the accident year and the 
middle of the year of the loss payment.
    Although the proposed regulations do not adopt this approach in 
light of the text of section 846 and the statutory structure as a 
whole, the maturity range used to determine the single rate applicable 
to all unpaid losses for all lines of business (times to maturity of 
not more than seventeen and one-half years) was selected to minimize 
the differences in taxable income, in the aggregate, resulting from the 
use of a single discount rate for a given accident year versus the 
direct application of the corporate bond yield curve for that accident 
year. For this purpose, losses incurred for the accident year were 
assumed to be those reported for 2015, and loss payments for each line 
of business were assumed to follow the loss payment pattern for that 
line of business determined using aggregate data reported on annual 
statements filed for 2015. Each maturity range considered had a half-
year time to maturity as a lower bound, but had a different upper 
bound. Discount factors for all lines of business were calculated using 
the loss payment patterns and the discount rate applicable to the 2018 
accident year, and a different discount rate was used for each maturity 
range being considered. For each maturity range, discounted unpaid 
losses and taxable income effects were computed for each line of 
business for the accident year and for each following taxable year. A 
present value of the taxable income effects for each line of business 
was calculated and subtracted from the present value of the taxable 
income effects calculated for that line of business using a direct 
application of the applicable corporate bond yield curve. Each present-
value difference was expressed as a positive number, and these amounts 
were summed over all lines of business. The selected maturity range was 
the one that generated the smallest sum of present-value differences in 
taxable income effects.
    In addition to the approach underlying the proposed regulations, 
the Treasury Department and the IRS considered a number of other 
options for determining the annual rate on the basis of the corporate 
bond yield curve. The Treasury Department and the IRS considered other 
ranges of maturities that could be used to determine a single annual 
rate applicable to all lines of business, such as the range of 
maturities used to determine the applicable Federal mid-term rate (over 
three years but not over nine years), as well as different maturity 
ranges of the same width (five and one-half years). The Treasury 
Department and the IRS also considered the use of a variable maturity 
range. Under a variable maturity range approach, the annual rate for 
any calendar year would be the average of the corporate bond yield 
curve's monthly spot rates with times to maturity contained within the 
range that would minimize, for that calendar year, the sum of 
differences in taxable income effects, selected in the same fashion as 
was the range adopted in the proposed regulations. Additionally, the 
Treasury Department and the IRS also considered (1) the use of two 
rates, one for long-tail lines of business, and one for short-tail 
lines of business; (2) the use of a different annual rate for each line 
of business; and (3) the direct application of the corporate bond yield 
curve.
    The Treasury Department and the IRS request comments on the method 
of determining the annual rate on the basis of the corporate bond yield 
curve, including comments on whether a different option than the one 
incorporated in the proposed regulations should be adopted in the final 
regulations and, if so, the legal basis for that alternative option and 
explanation of how that option would more clearly reflect income.

B. Proposed Removal of Regulations

    The proposed regulations propose to remove Sec.  1.846-1(a)(2) of 
the 1992 Final Regulations because the examples are no longer relevant. 
The proposed regulations propose to remove Sec.  1.846-1(b)(3)(ii)(B) 
and (b)(3)(iii) of the 1992 Final Regulations because these provisions 
apply only to accident years before 1992. The proposed regulations 
propose to remove Sec.  1.846-1(b)(3)(iv) and (b)(4) of the 1992 Final 
Regulations because section 13523 of the TCJA repealed section 
846(d)(3)(E). Section 1.846-1(b)(3)(i) and (b)(3)(ii)(A) of the 1992 
Final Regulations are retained (with Sec.  1.846-1(b)(3)(ii)(A) being 
redesignated as Sec.  1.846-1(b)(3)(ii)) because these rules continue 
to provide for the proper treatment of reinsurance unpaid losses. The 
proposed regulations also propose to make conforming changes to Sec.  
1.846-1(a) and (b) of the 1992 Final Regulations to reflect the removal 
of various Sec.  1.846-1 provisions, as well as the removal of 
Sec. Sec.  1.846-2 and 1.846-3 of the 1992 Final Regulations.
    Section 13523 of the TCJA repealed the section 846(e) election 
permitting a taxpayer to use its own historical loss payment pattern 
with respect to all lines of business rather than the industry-wide 
loss payment pattern determined by the Secretary under section 846(d), 
provided that applicable requirements were met. Section 1.846-2 of the 
1992 Final Regulations, which provides rules for applying the section 
846(e) election, is proposed to be removed.
    Section 1.846-3 of the 1992 Final Regulations provides ``fresh 
start'' and reserve strengthening rules applicable to the last taxable 
year beginning before January 1, 1987, and the first taxable year 
beginning after December 31, 1986. Because the rules in Sec.  1.846-3 
are no longer applicable, Sec.  1.846-3 is proposed to be removed.
    Section 1.846-4 of the 1992 Final Regulations provides 
applicability dates for Sec. Sec.  1.846-1 through 1.846-3 of the 1992 
Final Regulations. Under Sec.  1.846-4(a), Sec.  1.846-1 applies to 
taxable years beginning after December 31, 1986. Because Sec. Sec.  
1.846-2 and 1.846-3 are proposed to be removed, a separate 
applicability date section for Sec.  1.846-1 is no longer needed, and, 
therefore,

[[Page 55651]]

Sec.  1.846-4 is proposed to be removed. The applicability dates for 
Sec.  1.846-1 are proposed to be included in proposed Sec.  1.846-1(e), 
including the original applicability date for those portions of Sec.  
1.846-1 that are not proposed to be revised.
    Section 1.846-0 of the 1992 Final Regulations, which provides a 
list of the headings in Sec. Sec.  1.846-1 through 1.846-4 of the 1992 
Final Regulations, is proposed to be removed.
    On April 10, 2006, the Treasury Department and the IRS published in 
the Federal Register (71 FR 17990) a Treasury decision (T.D. 9257) 
containing Sec. Sec.  1.846-2T and 1.846-4T. On January 23, 2008, the 
Treasury Department and the IRS published in the Federal Register (73 
FR 3868) a Treasury decision (T.D. 9377) that finalized the rules 
contained in Sec.  1.846-2T in Sec.  1.846-2 and finalized the rules 
contained in Sec.  1.846-4T in Sec.  1.846-4. T.D. 9377, however, did 
not remove Sec. Sec.  1.846-2T and 1.846-4T from the Code of Federal 
Regulations (CFR). Because these sections are obsolete, the Treasury 
Department and the IRS intend to remove Sec. Sec.  1.846-2T and 1.846-
4T from the CFR when the proposed regulations in this document are 
finalized.

C. Smoothing Adjustments

    Section 846(d) instructs the Secretary to determine a loss payment 
pattern for each line of business for each determination year ``by 
reference to'' the historical loss payment pattern applicable to such 
line of business ``on the basis of'' the most recent published 
aggregate data from annual statements of insurance companies available 
on the first day of the determination year. Section 846 provides broad 
discretion to the Secretary to make needed adjustments when determining 
the loss payment patterns for each line of business. Use of loss 
payment patterns with negative payment amounts may produce discount 
factors that vary widely from year to year or discount factors that are 
negative or that exceed one. Commenters responding to prior requests 
for comments agreed that a methodology should be adopted to smooth the 
loss payment patterns. Proposed Sec.  1.846-1(d)(2) provides that the 
Secretary may, if necessary to avoid negative payment amounts and 
otherwise produce a stable pattern of positive discount factors less 
than one, adjust the loss payment pattern for any line of business 
using a methodology described by the Secretary in other published 
guidance.
    Part A of the Other Discounting Considerations section of this 
preamble provides additional detail on the methodology that the 
Treasury Department and the IRS anticipate using to adjust loss payment 
patterns.

Proposed Applicability Dates

    The rules in proposed Sec.  1.846-1(c) and (d) are proposed to 
apply to taxable years beginning after December 31, 2017.

Other Discounting Considerations

A. Smoothing Adjustments

1. Proposed Methodology
    The Treasury Department and the IRS intend to describe the 
adjustments made to the loss payment patterns produced using annual 
statement payment data and the methodology used to make such 
adjustments under the rule set forth in proposed Sec.  1.846-1(d)(2) 
for each determination year in the revenue procedure publishing 
discount factors for that determination year. The methodology that the 
Treasury Department and the IRS anticipate using to make adjustments to 
loss payment patterns for lines of business described in section 
846(d)(3)(A)(ii) is illustrated by the following computational steps.
    Step 1. Compute the yearly payment amounts and cumulative payment 
amounts for the accident year and the nine years following the accident 
year using the most recent published aggregate data from annual 
statements relating to loss payment patterns available on the first day 
of the determination year. If any of the payment amounts for the 
seventh, eighth, or ninth year following the accident year are 
negative, or if the sum of these amounts is zero (and the cumulative 
payment amount for the ninth year following the accident year is not 1 
(one)), go to Step 2 of this illustration. Otherwise, compute the 
average of the payment amounts for these three years for later 
reference in Step 3 and use in Step 7 of this illustration, and proceed 
to Step 3 of this illustration.
    Step 2. Average the payments for the seventh, eighth, and ninth 
years after the accident year. If that average is non-positive, include 
in the average the payment for the immediate prior year (that is, the 
sixth year following the accident year). If the average payment is 
still non-positive, continue including payments (from the fifth, 
fourth, etc. years after the accident year) until a positive average is 
produced. When a positive average payment amount is achieved, assign 
this payment amount to all years for which payment amounts were 
included in the average, and recalculate the cumulative payments for 
those years.
    Step 3. Identify the payment for the year immediately prior to the 
earliest year included in the average computed in Step 1 or Step 2 of 
this illustration. Call that year the ``current year,'' and go to Step 
4 of this illustration.
    Step 4. If the payment for the current year is negative, go to Step 
5 of this illustration. If it is non-negative, keep that payment amount 
for the current year, go to the next prior year, call it the ``current 
year,'' and repeat this Step 4. Repeat until all payments are non-
negative, then go to Step 7 of this illustration.
    Step 5. If the payment amount for the current year is negative, 
average that amount with the payment amounts from an even number of 
adjacent years, before and after the current year. Choose the minimum 
number of adjacent years necessary to achieve a non-negative average 
payment amount. This average may include amounts that were the result 
of a previous averaging calculation, but may not include any payment 
amount for a year following the sixth year after the accident year. If 
including payments for all prior years in the average does not achieve 
a non-negative average, include as many additional payments from years 
following the current year as necessary to achieve a non-negative 
average. Assign the non-negative average payment amount to all years 
for which payment amounts were included in the calculation of the 
average, and recalculate the cumulative payments for those years.
    Step 6. Identify the payment for the year immediately prior to the 
earliest year included in the average of Step 5 of this illustration. 
Call it the ``current year,'' and go to Step 4 of this illustration.
    Step 7. Apply the rules of section 846(d)(3)(B)(ii), using the 
average payment for the seventh, eighth, and ninth year after the 
accident year, to produce payment amounts for years following the ninth 
year after the accident year.
    For example, using this methodology, if the tentative payment 
amount for the fifth year following the accident year is negative, that 
amount is averaged with the tentative payment amounts for the fourth 
and sixth years following the accident year. If that average is 
negative, the tentative payment amount for the third year following the 
accident year is included in the average. If that average is non-
negative, it becomes the tentative payment amount for the third through 
sixth years following the accident year.

[[Page 55652]]

2. Comparison to Other Suggested Methods
    The methods suggested by commenters responding to the requests for 
comments in Rev. Proc. 2003-17 and Rev. Proc. 2007-9 can be described 
in general terms as follows:
    (1) Treat a negative estimated loss paid as zero.
    (2) Average the negative estimated loss paid with estimated losses 
from other years to yield a positive result. For instance, commenters 
suggested two different methods for eliminating a negative estimated 
loss paid in the ninth year after the accident year: Averaging the 
negative estimated loss with estimated losses from as many earlier 
years as needed to yield a positive result, and averaging the negative 
estimated loss with the estimated losses for all later years.
    (3) Adjust the negative estimated loss paid to equal the lesser of 
the value for the next younger year and the amount that brings the 
cumulative losses paid to 100 percent.
    (4) Adjust the negative estimated loss paid using a smoothing 
calculation that results in younger years having a lower ``Estimated 
Cumulative Losses Paid'' than more mature years.
    (5) Adjust the negative estimated loss paid by ensuring the percent 
paid in any year is no higher than the year before.
    The Treasury Department and the IRS considered the methods 
suggested by commenters responding to prior requests for comments, but 
anticipate using the proposed methodology to adjust loss payment 
patterns for several reasons. Among other things, the proposed 
methodology, to the extent possible, centers the average on the 
negative payment year and therefore should not display a bias towards 
increasing or decreasing discount factors. The proposed methodology 
ensures that the amount used to extend the loss payment pattern past 
the ninth year after the accident year is positive, and preserves the 
average for the seventh, eighth, and ninth years after the accident 
year when that average is initially positive.

B. Discontinuance of Composite Method

    This document proposes to eliminate the need to determine a second 
set of discount factors to be used with respect to accident years not 
separately reported on the NAIC annual statement by providing that, 
effective for taxable years beginning on or after the date the proposed 
regulations are published as final regulations in the Federal Register, 
a taxpayer that has unpaid losses relating to an accident year not 
separately reported on the NAIC annual statement must compute 
discounted unpaid losses with respect to that year using the discount 
factor published by the Secretary for that year for the appropriate 
line of business.
    The methods described in Rev. Proc. 2002-74, including the 
composite method described in section 3.01 of Rev. Proc. 2002-74 and 
section V of Notice 88-100, would not be permitted methods, effective 
for taxable years beginning on or after the date the proposed 
regulations are published as final regulations in the Federal Register. 
Section V of Notice 88-100 and Rev. Proc. 2002-74 would be obsolete for 
taxable years beginning on or after that date. The Treasury Department 
and the IRS anticipate providing rules applicable to taxpayers that 
seek to change a method of accounting to comply with these changes. The 
Treasury Department and the IRS anticipate that these rules will 
provide that a taxpayer seeking to change to the method of accounting 
prescribed must follow the applicable procedures for obtaining the 
Commissioner's automatic consent to a change in accounting method.

C. Determination of Estimated Discounted Salvage Recoverable

    In prior years, guidance published by the Commissioner in the 
Internal Revenue Bulletin has directed taxpayers to discount estimated 
salvage recoverable for each line of business using the applicable 
discount factors published by the Commissioner for estimated salvage 
recoverable. See, e.g., Rev. Proc. 2018-13 and Rev. Proc. 2016-59. 
These discount factors were determined using the salvage recovery 
pattern for the line of business and the applicable interest rate for 
calculating unpaid losses under section 846. Id. The Treasury 
Department and the IRS anticipate providing in similar future guidance 
published in the Internal Revenue Bulletin that estimated salvage 
recoverable is to be discounted using the published discount factors 
applicable to unpaid losses. This treatment of estimated salvage 
recoverable is equivalent to netting undiscounted unpaid losses with 
estimates of salvage recoverable and discounting the net amount using 
the unpaid loss discount factors. This method is permitted under 
section 832(b)(5)(A) and Sec.  1.832-4(c) and should reduce compliance 
complexity and costs. Separate discount factors for estimated salvage 
recoverable (including anticipated recoveries on account of subrogation 
claims) would no longer be published by the IRS. The Treasury 
Department and the IRS request comments on whether net payment data 
(loss payments less salvage recovered) and net losses incurred data 
(losses incurred less salvage recoverable) should be used to compute 
loss discount factors.

Effect on Other Documents

    Section V of Notice 88-100 and Rev. Proc. 2002-74 are proposed to 
be obsolete for taxable years beginning on or after the date the 
proposed regulations are published as final regulations in the Federal 
Register.

Special Analyses

    This regulation is not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Treasury Department and the Office of Management 
and Budget regarding review of tax regulations. Because these 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ADDRESSES heading. 
The Treasury Department and the IRS request comments on all aspects of 
the proposed rules. All comments that are submitted by the public will 
be available for public inspection and copying at http://www.regulations.gov or upon request.
    A public hearing has been scheduled for December 20, 2018, at 10 
a.m., in the IRS Auditorium, Internal Revenue Service, 1111 
Constitution Avenue NW, Washington, DC 20224. Due to building security 
procedures, visitors must enter at the Constitution Avenue entrance. In 
addition, all visitors must present photo identification to enter the 
building. Because of access restrictions, visitors will not be admitted 
beyond the immediate entrance area more than thirty (30) minutes before 
the hearing starts. For more information about having your name placed 
on the building access list to attend the hearing, see the FOR FURTHER 
INFORMATION CONTACT section of this preamble.

[[Page 55653]]

    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit written or 
electronic comments and an outline of the topics to be discussed and 
the time to be devoted to each topic by December 7, 2018. Such persons 
should submit a signed paper original and eight (8) copies or an 
electronic copy. A period of ten (10) minutes will be allotted to each 
person for making comments. An agenda showing the scheduling of the 
speakers will be prepared after the deadline for receiving outlines has 
passed. Copies of the agenda will be available free of charge at the 
hearing.

Drafting Information

    The principal author of these regulations is Kathryn M. Sneade, 
Office of Associate Chief Counsel (Financial Institutions and 
Products), IRS. However, other personnel from the Treasury Department 
and the IRS participated in their development.

Statement of Availability of IRS Documents

    The IRS notices and revenue procedures cited in this preamble are 
published in the Internal Revenue Bulletin (or Cumulative Bulletin) and 
are available from the Superintendent of Documents, U.S. Government 
Publishing Office, Washington, DC 20402, or by visiting the IRS website 
at http://www.irs.gov.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the entry for Sec.  1.846-2(d), removing the entry for Sec. Sec.  
1.846-1 through 1.846-4, and adding an entry in numerical order for 
Sec.  1.846-1. The addition reads in part as follows:

    Authority:  26 U.S.C. 7805 * * *
* * * * *
    Section 1.846-1 also issued under 26 U.S.C. 846.
* * * * *


Sec.  1.846-0   [Removed]

0
Par. 2. Section 1.846-0 is removed.
0
Par. 3. Section 1.846-1 is amended by:
0
1. Removing ``section 846(f)(3)'' from the first sentence of paragraph 
(a)(1) and adding ``section 846(e)(3)'' in its place.
0
2. Removing ``and Sec.  1.846-3(b) contains guidance relating to 
discount factors applicable to accident years prior to the 1987 
accident year'' from the third sentence of paragraph (a)(1).
0
3. Removing the last sentence of paragraph (a)(1).
0
4. Removing paragraph (a)(2) and redesignating paragraphs (a)(3) and 
(4) as paragraphs (a)(2) and (3), respectively.
0
5. In the first sentence of paragraph (b)(1), removing ``section 
846(f)(6)'' and adding ``section 846(e)(6)'' in its place; and removing 
``, in Sec.  1.846-2 (relating to a taxpayer's election to use its own 
historical loss payment pattern)''.
0
6. Removing ``for accident years after 1987'' from the heading for 
paragraph (b)(3)(i).
0
7. Removing the designation ``(A)'' and the accompanying heading 
``Accident years after 1991'' after the heading of paragraph 
(b)(3)(ii).
0
8. Removing paragraphs (b)(3)(ii)(B), and (b)(3)(iii) and (iv).
0
9. Removing paragraph (b)(4) and redesignating paragraph (b)(5) as 
paragraph (b)(4).
0
10. Adding paragraphs (c), (d), and (e).
    The additions read as follows:


Sec.  1.846-1   Application of discount factors.

* * * * *
    (c) Determination of annual rate. The applicable interest rate is 
the annual rate determined by the Secretary for any calendar year on 
the basis of the corporate bond yield curve (as defined in section 
430(h)(2)(D)(i), determined by substituting ``60-month period'' for 
``24-month period'' therein). The annual rate for any calendar year is 
determined on the basis of a yield curve that reflects the average, for 
the most recent 60-month period ending before the beginning of the 
calendar year, of monthly yields on corporate bonds described in 
section 430(h)(2)(D)(i). The annual rate is the average of that yield 
curve's monthly spot rates with times to maturity of not more than 
seventeen and one-half years.
    (d) Determination of loss payment pattern--(1) In general. Under 
section 846(d)(1), the loss payment pattern determined by the Secretary 
for each line of business is determined by reference to the historical 
loss payment pattern applicable to such line of business determined in 
accordance with the method of determination set forth in section 
846(d)(2) and the computational rules prescribed in section 846(d)(3) 
on the basis of the annual statement data from annual statements 
described in section 846(d)(2)(A) and (B). However, the Secretary may 
adjust the loss payment pattern for any line of business as provided in 
paragraph (d)(2) of this section.
    (2) Smoothing adjustments. The Secretary may adjust the loss 
payment pattern for any line of business using a methodology described 
by the Secretary in other published guidance if necessary to avoid 
negative payment amounts and otherwise produce a stable pattern of 
positive discount factors less than one.
    (e) Applicability date. (1) Except as provided in paragraph (e)(2) 
of this section, this section applies to taxable years beginning after 
December 31, 1986.
    (2) Paragraphs (c) and (d) of this section apply to taxable years 
beginning after December 31, 2017.


Sec.  1.846-2   [Removed]

0
Par. 4. Section 1.846-2 is removed.


Sec.  1.846-2T   [Removed]

0
Par. 5. Section 1.846-2T is removed.


Sec.  1.846-3   [Removed]

0
Par. 6. Section 1.846-3 is removed.


Sec.  1.846-4   [Removed]

0
Par. 7. Section 1.846-4 is removed.


Sec.  1.846-4T   [Removed]

0
Par. 8. Section 1.846-4T is removed.

Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2018-24367 Filed 11-5-18; 4:15 pm]
 BILLING CODE 4830-01-P