Insurance Income Tax

Study guide: Exam 6U

Insurance Income Tax for a U.S. property/casualty insurer is the federal corporate income tax — $21\%$ since the Tax Cuts and Jobs Act of 2017 (TCJA) — on taxable income computed under IRC §832. The computation starts from the underwriting and investment exhibit of the statutory NAIC Annual Statement and then departs from it in three places: unearned premium, loss reserves, and tax-exempt investment income.

$\begin{aligned} \text{Taxable UW income} = {} & \text{WP} - 0.8\,\Delta\text{UPR} \\ & - (\text{Paid} + \Delta\text{Discounted reserves}) \\ & - \text{Expenses incurred} \end{aligned}$

$\text{Proration add-back} = 25\% \times (\text{Exempt interest} + \text{DRD})$

Revenue offset. Tax premiums earned add $80\%$ of the prior year-end UPR and deduct $80\%$ of the current one, so $20\%$ of any increase in unearned premium is taxed now — a proxy for the acquisition costs statutory accounting has already expensed against premium not yet earned. A growing insurer pays tax sooner; a shrinking one gets it back.
Discounted reserves. Losses incurred use unpaid losses and LAE discounted under §846 at IRS-prescribed rates and payment patterns (Loss Reserve Discounting), not the undiscounted statutory reserves. The deduction for a reserve increase is smaller now and larger later.
Proration. Tax-exempt municipal interest and the dividends-received deduction (DRD) are sheltered, but losses incurred are reduced by $25\%$ of them. The TCJA replaced the former $15\%$ with $5.25\%$ divided by the top corporate rate, which at $21\%$ is $25\%$ . The exemption is therefore only partial for an insurer.
Other features. P&C insurers kept their two-year carryback and twenty-year carryforward of net operating losses after the TCJA; very large groups may also be subject to the $15\%$ corporate alternative minimum tax on adjusted financial statement income, enacted in 2022; reinsurance has its own rules (Tax Treatment of Reinsurance).
Book-tax differences. The revenue offset and reserve discounting are timing differences that create deferred tax assets under SAP (subject to admissibility limits) and GAAP; exempt interest and proration are permanent. So the effective rate on book income is not $21\%$ , and the actuary's reserve estimate directly changes the tax paid.

Computing a P&C Insurer's Taxable Income Statutory data for the year: written premium $\$1{,}000$ ; UPR rose from $\$400$ to $\$480$ ; paid losses and LAE $\$550$ ; undiscounted unpaid losses and LAE rose from $\$1{,}200$ to $\$1{,}300$ , which discount under §846 to $\$1{,}080$ and $\$1{,}165$ ; underwriting expenses incurred $\$280$ ; taxable bond interest $\$60$ ; tax-exempt municipal interest $\$40$ .

Compute statutory pre-tax income, taxable income and the tax.
Answer Statutory:
 $\begin{align*} \text{EP} &= 1{,}000 - 80 \\ &= 920 \\ \text{Losses incurred} &= 550 + 100 \\ &= 650 \\ \text{Pre-tax income} &= 920 - 650 - 280 + 60 + 40 \\ &= 90 \end{align*}$ 
Tax basis:
 $\begin{align*} \text{EP} &= 1{,}000 - 0.8(80) \\ &= 936 \\ \text{Losses incurred} &= 550 + (1{,}165 - 1{,}080) - 0.25(40) \\ &= 625 \\ \text{Taxable income} &= 936 - 625 - 280 + 60 \\ &= 91 \\ \text{Tax} &= 0.21 \times 91 \\ &= 19.11 \end{align*}$ 
Reconciling to book: $90 - 40 + 10 + 16 + 15 = 91$ — exempt interest out, proration back in, the $\$16$ revenue offset and the $\$15$ of reserve discount added. The tax is $21.2\%$ of statutory income even though $40\%$ of investment income was tax-exempt: the exemption saved $\$8.40$ , proration clawed back $\$2.10$ , and $\$6.51$ was prepaid on timing differences that will reverse, carried as a deferred tax asset.