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Proration and The Separate Account Dividends Received Deduction

Tax Technical Session

May 14, 2010

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Discussion TopicsI. Key Concepts Of Life Co. General Account Proration

II. SA DRD ProrationI. Characteristics that distinguish SA from GA

II. The Calculation

III. Historical Background

IV. Different Interpretations of the rules

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Underwriting

Income Investment

Income Total Premium 50,000 50,000 Muni interest 15,000 15,000 EOY life reserves (500,000) (500,000) BOY life reserves 485,000 485,000 Underwriting expenses (14,000) (14,000)

GFO 36,000 - 36,000 Book Tax Adjustment (15,000) (15,000) Taxable Income 36,000 (15,000) 21,000

Without Proration

I. Key Concepts of Life Co Proration• The IRC §812 Proration rules for life insurers disallows the exclusion of tax preferenced income (TEI, DRD) to the extent the income is credited to life reserves

• The purpose is to prevent life insurers from funding the growth of tax deductible life reserves with income excluded from LICTI

• General Account Proration – Example

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I. Key Concepts of Life Co. Proration

• General Account Proration – Example

Gross Investment Income 15,000 90%

812(c)(1) Net Investment Income 13,500

Less: Policy Interest (15,000) 812(b) Company share of NII -

/NII 13,500

812(a)(1) Company's share 0%

100%Less: Company Share 0%

812(a)(2) Policyholders' share 100%

General Account Proration

UnderwritingIncome

InvestmentIncome Total

Premium 50,000 50,000 Muni interest 15,000 15,000 EOY life reserves (500,000) (500,000) BOY life reserves 485,000 485,000 Underwriting expenses (14,000) (14,000)

GFO 36,000 - 36,000 Proration - P/H Share (100%) 15,000 15,000 Book Tax Adjustment (15,000) (15,000) Taxable Income 36,000 - 36,000

With Proration

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SA Reserves vs.

General Account Reserves

• General Account Reserves Reflect Substantial Mortality Risk

• Separate Account Reserve are comprised primarily of variable policyholder cash accumulations

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Separate Account Proration/DRD

• Life insurance companies with variable product separate accounts are allowed to claim a dividends received deduction on qualified separate account dividend income

• Industry has claimed substantial tax benefits from the SA DRD.

• The benefit grew dramatically during the 1990’s when the variable annuity business experienced explosive growth

• Tax Risk – SA DRD is a contentious area, particularly over the last 10 years

• IRC §812 and Treas. Reg. §1.801-2(e) set forth the rules for determining separate account proration

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SA DRD Historical Background

• SA DRD was part of the 1959 Act• 1984 Act added IRC §812, changed part of the computation

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Separate Account Proration Formula• 1959 Regulations:

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Separate Account Proration Formula• The 1984 Act:

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Interpretations and Risks

I. Different Interpretations, Different RisksI. Level at which the proration calculation is performed

I. Add graphic showing account level, fund level, sub account level

II. Determination of net investment incomeI. IRC §812 defines as 90%; assumes investment expenses are

10%.

II. Exclude STCG

III. Computation of “Amount Retained”I. Include- M&E Charge, VA expense charge, Cost of insurance

II. Reduction for investment expenses

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Benefits of Restructuring

•Addresses a customer service issue – perceived inconsistent sales tax treatment for deposit document (CMBS Product) and lending document products (CMIS Product)

•Aligns the Deposit Document business with the Lending Document business within the CMIA legal entity

•Creates resource efficiencies - Elimination of entity reduces required financial reporting and tax compliance resources needs

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Tax Treatment

• CMIC’s contribution of CMBS stock to CMIA qualifies for non-recognition treatment under IRC §351

• Merger of CMBS into CMIA qualifies qualifies as a tax-free subsidiary-parent merger under IRC §368(a)(1)(A)____

• CMIA assumes carryover basis

• CMBS tax attributes carryover to CMIA in accordance with IRC §381(c)(__)

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Tax Risk Assessment

• Merger – Potential Continuity of business enterprise requirement (“COBE”) risk, which is viewed as a marginal risk, is addressed by structuring as a S-P merger.

• ___ (case) provides authority for recasting a failed S-P merger as a tax-free IRC §332 subsidiary liquidation

• Strong position for tax-free treatment in primary and secondary position.

• In the unlikely event the first and second position were successfully challenged and the transaction was deemed taxable upon exam, gain would be deferred under the provisions of Treas Reg §1.1502-13.

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The Transaction – Share Contribution Followed by Subsidiary-Parent Merger

1. Currently, CMIC owns 100% of CMBS and CMIA.

On 5/30, CMIC contributes . CMBS stock to CMIA

2. Immediately following the contribution, CMBS is merged into CMIA

3. Final Structure

CMBS Stock

CUNA Mutual Insurance

Corp

(CMIC)

CUNA Mutual Business

Services, Inc.

(CMBS)

CUNA Mutual Insurance

Agency, Inc.

(CMIA)

Merge CMBS into

CMIA

CUNA Mutual Insurance

Corp

(CMIC)

CUNA Mutual Business

Services, Inc.

(CMBS)

CUNA Mutual Insurance

Agency, Inc.

(CMIA)

CUNA Mutual Insurance

Corp

(CMIC)

CUNA Mutual Insurance

Agency, Inc.

(CMIA)

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Financial Statement Treatment

• Contribution -

• Merger -