Jason Parker, CPA, is a Tax Manager for Larson & Company. Jason specializes in tax provision work for insurance companies.

With falling interest rates exacerbated by the pandemic environment, life insurance companies faced a sustainability problem. Rates on investments held by insurers were no longer keeping up with the rates the same insurers were required to guarantee on permanent life insurance and other long-term life insurance policies. Thus, Internal Revenue Code §7702 was amended by the Consolidated Appropriations Act (CAA).

For a policy to be treated as life insurance for income tax purposes, §7702 utilizes the Cash Value Accumulation Test (CVAT) and the Guideline Premium Test, both of which used a defined interest rate assumption of 4% to calculate the target limits for cash value and premiums. The CAA changed that interest rate assumption from a fixed rate to allow a change in the rate once per year. The Act also cut the rate for contracts issued in 2021 from 4% to 2% for CVAT and guideline level premium calculations.

The change will allow permanent and long-term life insurance policies to continue to receive tax-advantaged treatment. The design of permanent life insurance policies and the funding requirements was strained to a breaking point by COVID’s impact on interest rates. This update to reflect current conditions was desperately needed for the life insurance industry to continue to provide products consumers use for financial and retirement security.

What’s Next for Insurance Companies?

This piece of the CAA made it easier for insurance companies to continue to offer long-term life insurance policies. If products like permanent life insurance are a part of your business plan, then this will be a welcome change. If you have moved away from such products, then this may be an opportunity to consider offering them again. This adjustment to the rates used in CVAT and the Guideline Premium Test should have a positive impact on the insurance industry moving forward.

 

Sources:

Investopedia: https://www.investopedia.com/small-tax-law-change-may-have-big-impact-on-life-insurance-sales-and-values-5097046

Bankingtruths.com: https://bankingtruths.com/7702-changes-life-insurance-caa/?utm_source=GooglePPC&utm_campaign=7702&gclid=CjwKCAjw1uiEBhBzEiwAO9B_HQAENMCrEQMEcJ2xNkaIyNjPGTPApIeYQUnlRheckoTSNzeuTXP4GBoCtQYQAvD_BwE

Lincoln Financial Group: https://www.lfg.com/public/regulatoryroundup/section7702