Under earlier U.S Tax Law, insurers were able to use statutory reserves. The 1984 act changed this practice, generally resulting in a decrease in tax reserves. Under current law, a reserve for any contract shall be the greater of (1) the net cash surrender value of the contract or (2) the reserve for the contract as computed under federally prescribed standards. In no event may this amount exceed the statutory annual-statement figure. The reserve computed under federal standards uses the same methods and assumptions used for calculating statutory reserves but modified to take account of the following five federal standards:
• The Commissioners’ Reserve Valuation Method must be used for life insurance contracts.
• The minimum valuation interest rate to be used is the greater of (a) a federal interest rate determined using the average of the yields of midterm government bonds over the previous five years for the year in which the contract was issued or (b) the prevailing state interest rate, defined as the highest assumed interest rate that at least 26 states permit to be used in computing reserves for the particular insurance or annuity contract.
• The mortality tables to be used must be the most recent standard tables for mortality and morbidity prescribed by the NAIC that at least 26 states permit to be used in computing reserves for the type of contract involved at the time of issue.
• Reserves for any amounts in respect of deferred and uncollected premiums must be eliminated, unless the gross amount of these premiums is included in gross income.
• Reserves for excess interest (i.e., interest exceeding the prevailing state assumed interest rate) and guaranteed beyond the end of the taxable year must be eliminated.
Another deduction peculiar to the life insurance business is policy owner dividends. This term is in the law as any dividend paid or payable to a policy owner in his or her capacity as such, and it includes any distribution to a policy owner that is economically equivalent to a dividend. Accordingly, it includes excess interest, premium adjustments, and experience-rated refunds, as well as any amount paid or credited to policy owners (including an increase in benefits) in which the amount is not fixed in the contract but depends on the insurer’s experience or the discretion of management. Stock life insurers are allowed unlimited deductions for policy owner dividends paid or accrued during the taxable year. Mutual life insurers, however, may be subject to a limitation on the deductibility of its policy owner dividends.
The third major deduction allowed is the so-called small life insurance company deduction. This deduction, which was included primarily for political reasons and is consistent with the general congressional policy of encouraging small business, equals 60 percent of the tentative Life Insurance Company Taxable Income (LICTI), up to a maximum of $3 million. Thus, the small company deduction can never exceed $1,800,000 (i.e., .60 x $3,000,000). If a life insurance company’s tentative LICTI exceeds $3 million, the amount of the small company deduction is phased out by an amount equal to 15 percent of tentative LICTI in excess of $3 million. Thus, for an insurer with tentative LICTI of $15 million or more, no small company deduction is allowed.