IRS Provides Guidance on Reasonable Mortality Charges for Life Insurance Contracts Based on 2017 CSO Tables

By Thomas A. Gick, Graham Green, William Walderman
Sutherland Asbill & Brennan LLP

Oct 27, 2016

On October19, the Internal Revenue Service (IRS) issued an advance version of Notice 2016-63, addressing the “reasonable mortality charge” requirement under IRC §§7702 and 7702A for life insurance contracts based on the 2017 Commissioners’ Standard Ordinary (CSO) mortality and morbidity tables. The “reasonable mortality charge” requirement is set forth in IRC §7702(c)(3)(B)(i) and applies under:

The cash value accumulation test of IRC §7702(b),
The guideline premium limitation of IRC §7702(c), and
The 7-pay test of IRC §7702A(b).

In general, state insurance regulatory law allows issuers of life insurance contracts to begin using the 2017 CSO tables for contracts issued on or after January1, 2017, and issuers must use the 2017 CSO tables for contracts issued on or after January1, 2020.

Notice 2016-63 generally requires use of the 2017 CSO tables for IRC §§7702 and 7702A computations for life insurance contracts issued before 2020 with mortality guarantees based on the 2017 CSO tables, and for all life insurance contracts issued after 2019, by providing a “reasonable mortality charge” safe harbor for such contracts. The safe harbor allows IRC §§7702 and 7702A computations to be based on the full amount of mortality charges specified in the 2017 CSO tables (even if the issuer imposes current mortality charges lower than the guarantees), provided that the contract does not guarantee mortality charges lower than those specified by the 2017 CSO tables.

Notice 2016-63 also generally confirms existing safe harbors based on earlier CSO tables under Notice 88-128, 1988-2 C.B. 540 (1958 and 1980 CSO tables) and Notice 2006-95, 2006-2 C.B. 848 (2001 CSO tables).

In addition, Notice 2016-63 specifies the circumstances under which contracts eligible to use prior CSO tables for IRC §§7702 and 7702A computations will be deemed to be new contracts required to use the 2017 CSO tables if modified or changed. In general, these rules are similar to those stated in Notice 2006-95, with an important exception: the reduction or deletion of benefits is not treated as an event resulting in a new contract, even if not necessarily effected pursuant to specific contractual terms, and this exception is retroactively extended to the previous safe harbors.