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because the investment earnings of a noninsured qualified pension or profitsharing trust are completely exempt from tax while they are accumulated in the trust.
Thus, an attempt was made at that time to treat qualified pension or profitsharing contracts, handled through an insurance company, in the same manner as tax-exempt qualified pension and profit-sharing trusts. This result was not obtained, however, because the current earnings rate of a life insurance company is based on items of investment yield and assets of the company as a whole and not on those items as they relate to qualified pension plan contracts alone. Moreover, under present law the capital gains of all assets relating to these pension contracts remain subject to tax. Noninsured pension trusts, on the other hand, account separately for all assets attributable to qualified pension plans and pay no tax on either the investment income of the capital gains on such assets.
This difference in tax treatment may well be an important factor in the loss of pension business which has occurred in the case of life insurance companies in the last few years. In 1960 the premiums and other consideration they received for insured pension plans, for example, were $145 million lower than in 1959. This difference in tax treatment is damaging, however, not only to the life insurance companies but also to the smaller employers who generally cannot assume the risk or administrative expense of establishing a small pension trust.
In the last few years a number of States have authorized the use of segregated account pension contracts to enable life insurance companies to meet the competition of the pension trusts. These States are Arkansas, Colorado, Connecticut, Florida, Indiana, Iowa, Kentucky, Massachusetts. Nebraska, Nevada, New Jersey, New York, and the District of Columbia. However, to provide tax equality for these segregated pension accounts with the tax-exempt pension trusts, it is necessary that the investment income and capital gains credited to policyholders in these segregated accounts be free of tax in the same manner as is already true in the case of the noninsured pension trusts.
Your committee's amendment is designed to remove this competitve discrimination. First, it provides that the full current earnings rate on assets held in segregated accounts, less any amounts retained by the company in excess of allowable expenses, are to be deducted in computing the life insurance company's investment income tax base. This is provided in the amendment by specifying that in computing the policy and other contract liability requirements of the life insurance company with respect to life insurance reserves on segregated asset accounts, the current earnings rate with respect to these segregated accounts is to be substituted for the use of the adjusted reserve rate and the rate of interest assumed by the taxpayer. However, this current earnings rate is to be reduced for amounts retained by the life insurance company from gross investment income on segregated assets to the extent these retained amounts exceed the investment deductions otherwise allowable. Similarly, with respect to reserves based on segregated asset accounts other than life insurance reserves, the current earnings rate on the segregated assets is to be considered as the interest paid.
Second, capital gains and losses specifically allocated to segregated asset accounts are no longer to be subjected to the flat 25-percent capital gains tax. This treatment is provided, however, only in the case of qualified pension contracts. This is accomplished by adjusting the basis of the segregated assets upward or downward to the extent of the amount of the gain or loss which would otherwise occur.
Third, in determining the "phase two” tax base, or net gains from operation, increases or decreases in reserves for the contracts which would otherwise occur because of appreciation or depreciation in the value of assets is not to be taken into account. This, like the first adjustment described above, applies to qualified and nonqualified pension contracts alike.
Fourth, in determining the "phase one” tax base, namely, the taxable investment income, a completely separate computation is made for the investment income attributable to the segregated account business.
5. Effective date
All of the amendments ,made by your committee relating to life insurance companies apply with respect to taxable years beginning after December 31, 1961.
B. TECHNICAL EXPLANATION
Section 3 of the bill, which is a new section added to the bill as passed by the House, amends part 1 of subchapter L of chapter 1 of the Internal Revenue Code of 1954 (relating to the taxation of the income of life insurance companies).
(a) Variable annuities and other segregated asset accounts.-Subsection (a) of section 3 of the bill revises section 801 (g) of the Internal Revenue Code of 1954, relating to variable annuities.
Subparagraph (A) of paragraph (1) of the new section 801 (g) provides that, for purposes of part I of subchapter L, an “annuity contract” includes a contract which provides for the payment of a variable annuity that is computed on the basis of recognized mortality tables and the investment experience of the company issuing the contract. The language of the new section 801 (g) (1) (A) is identical with the language of section 801 (g) (1) in existing law.
Subparagraph (B) of paragraph (1) of the new section 801 (g) is a new provision which provides that, for purposes of part 1 of subchapter L, the term “contract with reserves based on a segregated asset account” means a contract,
(i) which provides for the allocation of all or part of the amounts received under the contract to an account which, pursuant to State law or regulation, is segregated from the general asset accounts of the company;
(ii) which provides for the payment of annuities; and
(iii) under which the amounts paid in, or the amounts paid as annuities reflect the investment return and the market value of the segregated asset
account. A pension contract written on the basis of the so-called new money concept, i.e., whereby reserves are credited on the basis of the company's new high yield investments, is not included within the meaning of such term. However, the fact that a contract provides for the payment of an annuity computed on the basis of recognized mortality tables does not cause it to be excluded from the meaning of such term.
Paragraph (1) further provides that, if a contract described in subparagraph (B) ceases to reflect current investment return and current market value, such contract is not to be considered as meeting the requirements of the new section 801 (g) (1) (B) (iii) after such cessation.
Thus, "a contract with reserves based on a segregated asset account” includes a contract under which the reflection of investment return and market value terminates at the beginning of the annuity payments, but such contract would qualify under the definition only for the period prior to such termination.
Paragraph (2) of the new section 801 (g) provides that, for purposes of section 801 (b) (1) (A), the reflection of the investment return and the market value of the segregated asset account shall be considered an assumed rate of interest. Thus, for purposes of determining whether reserves based on a segregated asset account qualify as life insurance reserves under section 801 (b), such reserves are considered as computed on the basis of an assumed rate of interest. Accordingly, such reserves constitute "life insurance reserves” if they fulfill the other requirements of section 801 (b).
Paragraph (3) of the new section 801 (g) provides that, for purposes of part I of subchapter L, a life insurance company which issues contracts with reserves based on segregated asset accounts is to separately account for the various income, exclusion, deduction, asset, reserve, and other liability items which are properly attributable to such segregated asset accounts. This paragraph further provides that, in those cases where such items are not directly accounted for, separate accounting is to be made
(A) in accordance with the method regularly employed by the company, if such method is reasonable; and
(B) in all other cases, in accordance with regulations prescribed by the Secretary of the Treasury or his delegate. Subparagraph (A) of paragraph (4) of the new section 801 (g) provides that, for purposes of part 1 of subchapter L, the policy and other contract liability requirements (as determined under sec. 805), and the life insurance company's share of investment yield (as determined under sec. 804 (a) or 809(b)), shall be separately computed
(i) with respect to the items separately accounted for in accordance with paragraph (3); and
(ii) excluding the items taken into account under clause (i) of this
subparagraph. Thus, for purposes of determining both taxable investment income and gain or loss from operations, a life insurance company is required to separately compute the life insurance company's share of the investment yield on the assets in its segregated asset account without regard to the policy and other contract liability requirements of, and the investment income attributable to, contracts with reserves that are not based on the segregated asset account.
Subparagraph (B) of paragraph (4) provides that, if the net short-term capital gain (as defined in sec. 1222(5)) exceeds the net long-term capital loss (as defined in sec. 1222(8)), determined without regard to any separate computations under subparagraph (A) of this paragraph, such excess shall be allocated between clauses (i) and (ii) of subparagraph (A). Such allocation shall be in proportion to the respective contributions to such excess of the items taken into account under each such clause. The allocation under this subparagraph shall be made before the separate computations prescribed by subparagraph (A).
Paragraph (5) of the new section 801 (g) provides that, for purposes of part I of subchapter L
(A) the adjusted reserves rate and the current earnings rate for purposes of section 805(b), and the rate of interest assumed by the taxpayer for purposes of sections 805(c) and 809(a) (2), with respect to life insurance reserves based on segregated asset accounts, shall be a rate equal to the current earnings rate determined under section 805 (b) (2) with respect to the items separately accounted for in accordance with paragraph (3), reduced by the percentage obtained by dividing
(i) any amount retained with respect to such reserves by the life insurance company from gross investment income (as defined in sec. 804 (b)) on segregated assets, to the extent such retained amount exceeds the deductions allowable under section 804 (C) which are attributable to such reserves, by
(ii) the means of such reserves; and (B) with respect to reserves based on segregated asset accounts other than life insurance reserves, an amount equal to the product of—
(i) the rate of interest assumed as defined in subparagraph (A) of this paragraph, and
(ii) the means of such reserves, is to be included as interest paid within the meaning of section 805(e) (1).
Paragraph (6) of the new section 801 (g) provides that, for purposes of section 810 (a) and (b) (relating to adjustments for decreases and increases in reserves), the sum of the items described in section 810(c) taken into account as of the close of the taxable year is, under regulations prescribed by the Secretary of the Treasury or his delegate, to be adjusted
(A) by subtracting therefrom an amount equal to the sum of the amounts added from time to time (for the taxable year) to the reserves separately accounted for in accordance with paragraph (3) by reason of appreciation in value of assets (whether or not the assets have been disposed of), and
(B) by adding thereto an amount equal to the sum of the amounts subtracted from time to time (for the taxable year) from such reserves by reason of depreciation in value of assets (whether or not the assets have been
disposed of). The deduction allowable for items described in section 809(d) (1) and (7) with respect to segregated asset accounts is to be reduced to the extent that the amount of such items is increased for the taxable year by appreciation (or is to be increased to the extent that the amount of such items is decreased for the taxable year by depreciation) not reflected in adjustments under the preceding sentence.
Paragraph (7) of the new section 801 (g) provides that, in the case of contracts described in section 805(d) (1) (A), (B), (C), or (D) (relating to the definition of pension plan reserves), the basis of each asset in a segregated asset account shall (in addition to all other adjustments to basis) be increased by the amount of any appreciation in value, and decreased by the amount of any depreciation in value ; but only to the extent that such appreciation and depreciation are reflected in the increases and decreases in reserves, or other items described in paragraph (6), with respect to such contracts. The effect of this paragraph is to provide that there shall be no capital gains tax payable by the company on appreciation realized on assets to the extent such application has been reflected in reserves for qualified and certain other pension plan contracts based on segregated asset accounts.
Paragraph (8) of the new section 801 (g) provides that, under regulations prescribed by the Secretary of the Treasury or delegate, such additional separate computations (with respect to the items separately accounted for in accordance with par. (3)) are to be made as may be necessary to carry out the purposes of the new subsection (g) and part I of subchapter L.
GOVERNMENT OF THE DISTRICT OF COLUMBIA,
DEPARTMENT OF INSURANCE,
Washington, D.C., October 27, 1961. Rules and regulations pertaining to the issuance by life insurance companies of contracts providing for payments which vary directly according to investment experience, as provided by Public Law 86–520, 86th Congress, approved June 12, 1960.1
EFFECTIVE 12:01 A.M., NOVEMBER 1, 1961 1. No company will be authorized by the Superintendent to issue or deliver variable contracts in or from the District of Columbia until such company has satisfied the Superintendent that its condition and methods of operation in connection with the issuance of such variable contracts will not be such as to render its operation hazardous to the public or to its contract holders or to its policyholders. In determining the qualification of a company to issue or deliver such variable contracts in the District, the Superintendent will consider, among other things, the history and financial condition of the company, the character, responsibility, and general fitness of the officers and directors of the company; and, in the case of a foreign or alien company, whether the regulation provided by the laws of its domicile provides a degree of protection to the public and to its contract holders and policyholders substantially equal to that provided by the laws of the District of Columbia and by the rules and regulations issued by the Superintendent pursuant thereto.
2. No company which has been authorized by the Superintendent to issue variable contracts will be permitted to continue to conduct such business unless the actual management of such company is, in the opinion of the Superintendent, at all times capable by experience or otherwise of conducting the said business in the public interest and in such a manner as to safeguard the solvency of the company and the interests of its contract holders, policyholders, and creditors. · If the Superintendent finds that (a) the actual management of the company is not capable, or that (b) the business of the company is not being conducted so as to safeguard its solvency or the interests of its contract holders, policyholders, and creditors, or that (c) the company has not complied with the law or with these rules and regulations, the authority of the company to issue variable contracts may be withdrawn by the Superintendent by procedures which afford due process of law.
3. Written notice of the appointment or election by any company of any new officer, manager, director, or trustee, or, of the resignation, discharge, or death of any person while occupying such a position with the company, shall, within five days thereafter be submitted to the Superintendent.
4. The computation of the net investment factor shall be based exclusively upon the investment experience of the variable contract account, except as regards contracts issued prior to December 31, 1960, and specifying otherwise.
5. No person while serving as an elected or appointed officer or as a director or trustee of any company shall receive directly or indirectly any commission on the business transactions of the company.
6. The company will effect no transfer of assets or liabilities to or from the variable contract account except in making the adjustments necessitated by contract and the mortality experience adjustment specified in D.C. Code Sec. 35– 541 (a). Such adjustments shall be made by a cash transfer only.
7. The company will value assets of the variable contract account at market values, where possible, or, in the absence of a market value, by appraisal.
8. Each company will file with its annual statement the supplement included with the blank form.
9. All variable annuity contracts and the applications therefor will contain a prominent notice that payments by the company, when based on investment experience, are variable and are not guaranteed as to fixed dollar amount.
1 Rules 1, 2, 3, and 12 are new. 1960, except for editorial changes.
Rules 4 and 9 are the same as those issued Oct. 25,
10. The company will establish one or more separate bank accounts into which only and all variable contract premiums and considerations will be deposited. All amounts so deposited will be appropriately transferred periodically, consistent with the company's general accounting procedure.
11. For each variable annuity contract the company will maintain a history record card or ledger sheet showing, in addition to the usual premium or contract consideration information, each net annuity consideration applied and the increment and accumulated balance on either a unit or dollar value basis.
12. All rules and regulations heretofore issued pursuant to the law herein cited are hereby rescinded.
Attention is invited to 8 23(f) of the attached draft, which is a verbatim copy of g 305(i) of the Uniform Act. The IBA suggests that the one-year period of effectiveness of registrations in this section be eliminated, and a clause substituted to provide that registrations shall be effective indefinitely, unless revoked or withdrawn. Such a provision would make it clear that brokers and dealers may safely make a market in any such registered securities at any time after they have been registered. Although we thoroughly agree with the wisdom of this clarification, we think that the IBA proposal would also have the undesirable side-effect of sanctioning all secondary distributions whenever made and irrespective of whether there is a current registration statement then in effect. From the standpoint of the public interest, there may be very little difference between a primary distribution by or for the account of the issuer itself and a secondary distribution by or for the account of substantial security holders. Isolated, nonissuer sales by security holders are, of course, exempt under 826(b) (1) [8402(b) (1) of the Uniform draft) but we think that secondary distributions not qualifying for this or some other exemption, should be made only pursuant to a current registration statement. See the notes to $ 26(b)(3), infra., p. 45. 8 24. Denial, Suspension, and Revocation of Registration.
With the one exception listed below, this is a verbatim copy of $ 306 of the Uniform Act. It establishes guides and standards controlling the discretion of the Commissioner in matters relating to the registration of securities.
We have recommended deletion of g 306 (a) (2) (F) of the Uniform Act giving the Commissioner power to deny the registration if he finds that the offering involves unreasonably high underwriting commissions or options to underwriters. These matters should be fully disclosed in the prospectus or offering circular, but we see no worthwhile public purpose to be served by empowering the local Securities Commissioner to decide whether underwriters' compensation is or is not too high. This provision was deleted from the Virginia version of the Uniform Act, and we strongly recommend its deletion in Maryland. § 25. Definitions.
This is a verbatim copy of g 401 of the Uniform Act, except (1) the definition of “Commissioner" in § 25 (c) was drafted by this Committee, the subject being left to local option in § 401 (a) of the Uniform Act; and (2) the definition of “security” in § 25 (1) excludes variable annuities for the reasons stated in the Notes to § 26 (a) (5). § 26. Exemptions.
This section is an exact copy of $ 402 of the Uniform Act with the following modifications:
(1) 8 402(a) (5) of the Uniform Act exempts securities issued by insurance companies licensed to do business in the state but leaves it to local option whether the exemption shall extend to variable annuities. The Notes of the National Conference on Uniform State Laws suggest that if the particular state believes that variable annuities are "sufficiently regulated by the insurance authorities," then they should be removed from the definition of "security" in 25 (1) and from the exemptions in 26(a)(5). Since the Attorney General of Maryland has ruled that variable annuities are within the jurisdiction of the insurance commissioner (See Opinion of November 2, 1960), and in the belief that dual regulation is both unnecessary and undesirable, this Committee recommends that variable annuities be left within the control of the insurance commissioner and not brought within the scope of the Blue Sky Law.
It should be noted that if variable annuities were included in the definition of “security" in g 25(1), it would be a relatively simple matter to qualify them