Loss Reserve Changes for Insurance Companies

In January 2019, the IRS published Revenue Procedure (Rev. Proc.) 2019-06 to prescribe unpaid loss discount factors for the 2018 accident year and earlier accident years. As part of Rev. Proc. 2019-06, IRS and Treasury announced that it would revise the unpaid loss discount factors as necessary after issuing final regulations.

In June 2019, final regulations under code section 846 were published, and in July 2019 Rev. Proc. 2019-30 and Rev. Proc. 2019-31 were published. Rev. Proc. 2019-30 provides guidance on procedurally making the change in method of accounting and Rev. Proc. 2019-31 provides final discount factors for the 2018 and earlier accident years.

Below are impacts of the various guidance.

Background

Tax reform passed in 2017, commonly referred to as the Tax Cuts and Job Act (TCJA), caused sweeping change to US tax law, and insurance companies are among those feeling the effects. One of the most significant changes applicable to insurance companies was the shift to the discounting rules for unpaid losses.

Section 13523 of the TCJA amended Section 846 of the Internal Revenue Code, which covers discounted unpaid losses for the first taxable year beginning after December 31, 2017. As part of the amendment, the TCJA provided a transition rule for taxpayers in recognizing the resulting income from the change.

For the first taxable year beginning after December 31, 2017, the discounted unpaid losses at the end of the preceding taxable year are determined as if the amendments made by section 13523 had applied to such unpaid losses in the preceding taxable year, and by using the annual rate and loss payment patterns applicable to accident years ending with calendar year 2018.

The resulting adjustment between the end of year discounted unpaid losses as calculated on the taxpayer's 2017 tax filing and the beginning of year unpaid losses as calculated on the taxpayer's 2018 tax filing (using the annual rate and loss payment pattern as applicable to accident years ending with calendar year 2018) is then included in the company's taxable income ratably over an eight-year period. For many taxpayers, the change in discount rate has a significant impact on the unpaid losses.

Tax Return Impact

At the time the regulations were finalized in June 2019, and the accounting method change guidance and revised discount factors were published in July 2019, some companies had already filed their 2018 tax returns using the earlier discount rates that had been released in January 2019.

For taxpayers that filed with the proposed rates, Rev. Proc. 2019-30 offers guidance for dealing with the change, providing two options:

  1. Amend the 2018 tax return for the updated rates, or
  2. Calculate a separate Remainder Adjustment to include over the remaining seven-year period (2019—2025)

Note, similar rules apply for taxpayers who used the proposed factors to discount their salvage and subrogation.

Tax Provision Impacts

The loss reserve changes also impact the presentation of the deferred tax assets and liabilities (DTAs/DTLs), most notably for admissibility purposes. A separate deferred tax liability should be established for the transition adjustment.

This deferred related to the transition adjustment shouldn’t be netted with the traditional loss reserve DTA for purposes of admissibility, and the statutorily mandated transition period should be used to determine the reversal pattern.

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To learn more about how these changes might impact your company, please contact your Moss Adams professional.

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