4.42.2  Life Insurance Companies

4.42.2.1  (05-29-2002)
Overview

  1. This chapter discusses the examination of life insurance companies.

  2. A life insurance company is an insurance company engaged in the business of issuing life insurance and annuity contracts either separately, or combined with noncancellable health and accident insurance. Further, its life insurance reserves plus earned premiums and unpaid losses on noncancellable life, health, or accident policies not included in life insurance reserves, must comprise more than 50 percent of its total reserves.

  3. In examining a life insurance company return, you should remember the following basic facts:

    1. Life insurance companies must file returns using Form 1120–L and compute taxable income on the accrual basis of accounting (1984 Act).

    2. For taxable years beginning after 1980 a life insurance company and a nonlife company can file a consolidated return only if they have been affiliated for the preceding five years. There are other limitations to the filing of consolidated returns as indicated in the Internal Revenue Code (IRC) and the Regulations under IRC section 1502.

    3. Page 1 of Form 1120–L shows the computation of Life Insurance Company Taxable Income.

4.42.2.2  (05-29-2002)
Guidelines Before Contacting the Taxpayer

  1. Due to the complexity of applicable tax statutes and the involved statements, exhibits, and schedules associated with the Form 1120–L, your preliminary analysis will be important. Most of the basic instructions for pre-contact analysis can be applied to these cases.

  2. It is most important in the auditing of insurance company returns that the prior agent’s reports and workpapers, if available, be thoroughly reviewed, since much of the groundwork for the current audit will be contained therein and will reflect certain adjustments applicable to the current return.

4.42.2.3  (05-29-2002)
Annual Statement and the Insurance Company Income Tax Return Form 1120–L

  1. Unlike examinations of manufacturing and commercial type corporations, some of the verification and reconciliation of income and expense items of insurance companies can be made before actual contact with the taxpayer. This is because most insurance companies are regulated by State insurance commissions and usually are required to file annual detailed financial statements with these regulatory bodies. These financial statements are subsequently verified and audited in considerable detail by examiners of the states in which they do business. The "Annual Statement," or "Convention Form," as it is sometimes called, is a standard form adopted by the National Association of Insurance Commissioners (NAIC) and can be used by the agent in much the same way as the general ledger and subsidiary books of account in other industries. See text 2.6 below 3.1, of this handbook.

  2. The extent of reconciliation that can be accomplished before contacting the taxpayer depends in large part on the detail submitted with the tax return. If sufficient detail is not present, the reconciliations must be made after taxpayer contact, at which time additional information will be secured.

  3. It should be noted that the debits and credits of the accounts appearing in the Annual Statement are prescribed by the NAIC. However, such prescribed entries are not acceptable for Federal income tax purposes if they are contrary to the IRC requirements or the Treasury Regulations thereunder.

  4. If a company had any international transactions the Annual Statement amounts are in mixed dollars, i.e., United States and foreign currencies. All foreign currency amounts must be converted to the United States dollars for tax purposes. This adjustment might affect taxable income.

  5. When a life insurance company income tax return (Form 1120L) is assigned to you, there should be associated with it a copy of the Annual Statement. If this statement is not attached, there will usually be some comment made on the return to the effect that the Annual Statement can be obtained upon request.

  6. Due to the differences between the requirements of the NAIC and the IRC, it is suggested that you first become familiar with the format and contents of the Annual Statement.

4.42.2.3.1  (05-29-2002)
Summary of Annual Statement

  1. For years prior to 1984, the following is a general summary of the contents of the Annual Statement:

    1. Balance Sheet—pages 2 and 3.

    2. Summary of Operations (Profit and Loss Statement)—page 4.

    3. Analysis of Operations by Line of Business (Gain and Loss Exhibit)—page 5.

    4. Analysis of Increase in Reserves During the Year—page 6.

    5. Pages 7 through 16 contain various exhibits supporting items in the Balance Sheet and Summary of Operations.

    6. Page 17 contains the General Interrogatories which should be analyzed before contacting the taxpayer. The remaining pages contain various schedules which detail the items appearing in the Balance Sheet, Summary of Operations, and the supporting exhibits.

  2. For the years 1985 through 1991 the Annual Statement had a similar format except that the Cash Flow was changed with respect to the page number references and exhibits. The following is a general summary of the contents of the Annual Statement for 1992:

    1. Balance Sheet—pages 2 and 3.

    2. Summary of Operations (Profit and Loss Statement)—page 4.

    3. Cash Flow—page 5.

    4. Analysis of Operations Lines of Business (Gain and Loss Exhibit)—page 6.

    5. Analysis of Increase in Reserve and Deposit Funds during the Year—page 7.

    6. Pages 8 through 25 contain various exhibits supporting items in the balance Sheet and the Summary of Operations. It should be noted that in 1992, unlike 1991 and prior years, Exhibit 2 and 3 are combined into Exhibit 2 alone. There is no Exhibit 3.

    7. Pages 26 through 28 contain the General Interrogatories and the Notes to Financial Statements. Both the General Interrogatories and the Notes to Financial Statements should be analyzed before contacting the taxpayer.

    8. The remaining pages contain various schedules which detail items appearing in the Balance Sheet, Summary of Operations, and the supporting exhibits.

  3. In 1993 the format of the Annual Statement was again changed. The following is a general summary of the contents of the Annual Statement for 1993:

    1. Balance Sheet—pages 2 and 3.

    2. Summary of Operations (Profit and Loss Statement)—page 4.

    3. Cash Flow—page 5.

    4. Analysis of Operations Lines of Business (Gain and Loss Exhibit)—page 6.

    5. Analysis of Increase in Reserve and Deposit Funds during the Year—page 7.

    6. Pages 8 through 27 contain various exhibits supporting items in the Balance Sheet and the Summary of Operations. It should again be noted that in 1993, unlike 1991 and prior years, Exhibit 2 is a combination of the old Exhibits 2 and 3. Exhibit 3 is now known as Realized Capital Gains and (Losses) on Investments, formerly Exhibit 4. Exhibit 4 in the 1993 Annual Statement is completely new. It shows the Unrealized Capital Gains and (Losses) on Investments.

    7. Pages 28 through 30 contain the General Interrogatories and the Notes to Financial Statements. Both the General Interrogatories and the Notes to Financial Statements should be analyzed before contacting the taxpayer.

    8. The remaining pages contain various schedules which detail items appearing in the Balance Sheet, Summary of Operations, and the supporting exhibits.

4.42.2.4  (05-29-2002)
Contacting the Taxpayer

  1. If the life insurance company to be examined is in the large case category, a pre-examination conference will be held with the tax director (or equivalent corporate officer) and other company officials. The purpose of this meeting is to establish certain examination procedures mutually satisfactory to both the taxpayer and examiners. The case manager and team coordinator will both be present at this conference. Specialist supervisors should also attend when their participation facilitate planning. Items to be discussed at this initial meeting include:

    1. Years to be examined.

    2. Scope of audit, including support district participation.

    3. Service personnel to be involved, including specialists.

    4. Scheduled starting and completion dates.

    5. Communications agreement which includes names of company personnel to be contacted for records and personnel authorized to discuss issues on behalf of the company.

    6. Space and office equipment requirements.

    7. Record retention agreement and use of taxpayer’s computer for running selected audit programs.

    8. Use of document request forms for flow of information.

    9. Books and records to be available at the start of the examination.

    10. Timetable for the principal schedules, exhibits and analyses the taxpayer will furnish.

    11. Other pertinent agreements which may be secured includes replies to numbered requests which will be answered within a prescribed time otherwise the company will give a firm date for the reply; adjustments which will be provided as soon as finalized; on unagreed issues, the company should arrange meetings at which the case manager, team coordinator, tax counsel and other appropriate company representatives can discuss the issues further; and requests for technical advice which should be submitted as early as possible during the audit.

  2. A copy of that portion of the audit plan which covers the above items discussed at the initial conference will be furnished the company. Such copy will be signed by the case manager and the corporate officer in charge.

  3. Where the return to be examined is that of a small company, the initial contact should be made with the corporate officer who signed the return. Usually the agent will be referred to the preparer of the return.

    1. A definite date for beginning the examination should be made at this time. It should be suggested that all records and data to support the items reported on the return be made available.

    2. Agents should follow the guidelines set forth in the Audit Technique Handbook for Internal Revenue Agents.

  4. See the Case Managers Handbook.

4.42.2.5  (05-29-2002)
Books and Records in General

  1. In the smaller life insurance companies, the books and records consist principally of a ledger, cash receipts and disbursement books, and some form of a general journal. Generally, no particular problem should be encountered in becoming familiar with the records maintained.

  2. In the larger life insurance companies, most of the routine bookkeeping is accomplished by mechanical means. For this reason, it is best to work from summary sheets, computer runs, breakdowns of items under audit, and special computer printouts provided through the assistance of the Computer Audit Specialist (CAS). These are readily available upon request by the examiner. Requests, however, must usually be directed to the tax department.

  3. Depending upon the policy of the company, you may or may not have direct access to department heads who have control over books and records pertaining to their respective departments. Where direct access is not authorized, the necessary arrangements should be made through the tax department officer.

  4. As soon as practicable, arrangements should be made with the CAS for programming the retrieval of selected data from the company’s machine sensible records. The scope of the computer assisted audit will be determined by the case manager.

4.42.2.6  (05-29-2002)
Principal Books and Records

  1. In addition to the Annual Statements, the following books and records should be requested during the course of the audit and checked in considerable detail. If a large case is involved, these should be incorporated in the Large Case Audit Plan:

    1. Corporate Minute Books.

    2. Copy of last audit report by State Insurance Examiners.

    3. Securities and Exchange Commission Form 10K.

    4. General Ledger and General Journal.

    5. Trial Balances.

    6. Chart of Accounts.

    7. Workpapers reconciling general books to Annual Statement.

    8. Workpapers containing reconciliation of income and expenses shown on the return with amounts shown on the Annual Statement.

    9. Workpapers reconciling asset valuations from Annual Statement to return.

    10. Workpapers reconciling life and pension plan reserves from Exhibit 8 of Annual Statement to return.

    11. Reserve Valuation Summaries identifying the individual components of each reserve, i.e., unmatured settlement options, guaranteed insurability, substandard reserves, unearned premium reserves, etc.

    12. Records, including printouts, detailing the breakdown of expenses in Exhibits 5 and 6 of the Annual Statement. These records should indicate the allocation and composition of each line in the exhibits. In addition, if available, a separate analysis by cost centers should be secured.

    13. Subsidiary records supporting the depreciation deduction.

    14. Pertinent records necessary to verify premium income, other underwriting income, interest paid, underwriting expenses and dividends paid.

    15. Pertinent data processing records.

  2. The agent should not ask for all of the records at one time, particularly where a large insurance company is the subject of examination, inasmuch as the records are voluminous and their audit is time-consuming. Instead, they should be requested on an as needed basis. For this purpose Form 4564 (Information Document Request) should be used.


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