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Separate Account Dividends Received Deduction

Tax Technical Session

May 14, 2010

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Discussion Topics

I. The Concept of 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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I. The Concept of Proration

• Prevent a life insurer from funding the growth of tax deductible reserves with tax preferenced income

• General Account Reserves – Example

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SA DRD General Background

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

• Industry has claimed substantial tax benefits from the SA• 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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Historical Background

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

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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 -