Foreign reinsurer may use regulated statement reserves

Plain-English summary

A domestic parent asked whether its controlled foreign reinsurance subsidiary could use reserves reported under its home-country insurance rules to measure income under IRC § 954(i). The subsidiary and its branches reinsured life, annuity, and accident and health risks and were regulated by their home-country insurance authorities. The IRS concluded that the gross premium valuation method used for the foreign statement underwriting and loss reserves was a reasonable way to measure income. It approved use of those reserves for life and annuity contracts and for noncancellable and guaranteed renewable accident and health contracts, subject to the stated facts, business circumstances, and foreign reserving rules remaining materially unchanged.

Ruling snapshot

• Question: Were the foreign statement underwriting and loss reserves an appropriate measure of income under IRC § 954(i)(4)(B)(ii)?
• Outcome: Approved
• Key authorities: IRC §§ 816, 951, 953, 954, 957, and 989

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201503009 Third Party Communication: None
Release Date: 1/16/2015 Date of Communication: Not Applicable
Index Number: 954.02-00, 953.00-00
Person To Contact:
------------------------------------------------- ----------------------------, ID No. --------------
----------------------------------- -----------------
----------------------------- Telephone Number:
--------------------------------------------- ----------------------
--------------------------------- Refer Reply To:
CC:INTL:B05
PLR-121796-14
Date:
September 30, 2014

A = -------------------
CFC = ---------------------------------------------------------------
Country A = ----------
Parent = -------------------------------------------------
X = --------
Agency = --------------------------------------
Country B = ----------
Country C = -------------
Country D = ------
Country E = ---------
Country F = ------------------
Country G = ----------
Country H = ------------------------------------------------------------------------
Month Y = -------------------

Dear ----------------------:

   In a letter dated A, you requested rulings allowing CFC to use certain foreign

statement insurance reserves in computing its taxable income on grounds that these
insurance reserves are an appropriate means of measuring income within the meaning
of section 954(i)(4)(B)(ii). Specifically, you requested permission to use: (1) the
underwriting reserves and loss reserves for life and annuity contracts reported by CFC
on its Country A Annual Return and (2) the underwriting reserves and loss reserves for
noncancellable and guaranteed renewable accident and health contracts reported by
CFC on its Country A Annual Return.
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   The rulings given in this letter are based on facts and representations submitted

by Parent and CFC and accompanied by a statement executed under penalty of perjury
by an appropriate party. This office has not verified any of the materials submitted in
support of the request for rulings. Verification of the information, representations, and
other data may be required as part of the audit process.

                                      Facts

   Parent is a publicly-traded domestic corporation that is engaged, through its

subsidiaries, in various lines of business, which primarily include domestic and
international reinsurance of life and annuity contracts. Parent conducts certain foreign
operations through a Country A subsidiary, CFC. Parent owns X% of CFC. CFC was
formed under the laws of Country A and is engaged in the business of reinsuring life
insurance contracts, annuity contracts, and accident and health contracts through
Country A and several branch operations located in Country B, Country C, Country D,
Country E, Country F, Country G, and Country H. CFC is a controlled foreign
corporation as defined in section 957.

   Country A regulates any insurance business conducted in Country A through its

insurance laws and regulations. A government body, the Agency, is responsible for
enforcing insurance laws and regulations in Country A. An insurance company must
obtain a license from the Agency to conduct an insurance business in Country A.

   CFC is licensed by the Agency to reinsure persons other than related persons in

Country A. CFC also reinsures risks through its various branches. CFC and its
branches do not carry on any business other than the reinsurance of life insurance
contracts, annuities, accident and health insurance contracts, and other similar and
ancillary activities. CFC and its branches derive more than 50 percent of its aggregate
net written premiums from the reinsurance of contracts (1) covering the applicable home
country risks of the branches and (2) with respect to which no policyholder, insured,
annuitant, or beneficiary is a related person as defined in section 954(d)(3). CFC does
not carry on non-life insurance businesses except for certain activities which are
incidental to the life insurance business or which are otherwise immaterial to its
insurance business. Parent has represented that CFC would be subject to tax under
Subchapter L if it were a domestic corporation.

    Each branch of CFC is a separate and clearly identified unit of the reinsurance

business of CFC and maintains separate books and records. Each branch is authorized
or licensed by the applicable insurance regulatory body for its home country to sell
reinsurance to persons other than related persons as defined in section 954(d)(3).
Each branch’s financial position is overseen by the Agency.
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    The branches and the Country A home office of CFC reinsure contracts that are

regulated as life insurance and annuity contracts by the Agency. The branches and the
home office also reinsure health and personal accident insurance contracts that are
noncancellable or guaranteed renewable, cancellable, or are riders to a life insurance
contract. CFC holds reserves with respect to such noncancellable health and personal
accident insurance contracts which CFC treats as life insurance reserves. CFC does
not receive premiums from any insurance contract in connection with the life or health of
a resident of the United States or from a related party as defined under section
953(e)(2)(B)(ii). Each branch (with the exception of the Country C branch) derived more
than 30% of its net written premiums from contracts that cover home country risks with
respect to which no policyholder, insured, annuitant, or beneficiary is a related person
within the meaning of section 953(d)(3). Each branch and the Country A home office
conducts, with respect to contracts which cover risks other than applicable home
country risks (as defined in section 953(e)(2)(B)(ii), substantially all the activities
necessary for the generation of income with respect to each branch’s reinsurance
business, including client relationship management, negotiating terms of reinsurance
contracts with clients, providing underwriting and claims management services,
including technological solutions, actuarial assistance and e-underwriting tools, actuarial
pricing for risk assessment, account administration, providing product development and
advice on financial needs, including funding and financial products, and providing
related services to clients.

    As required by Country A’s insurance laws and regulations for insurers engaged

in the reinsurance business, CFC files an annual return and financial statements
(“Annual Return”) with the Agency. The Annual Return of CFC is audited by an outside
accounting auditor in addition to the company’s auditor. The accounting records of CFC
that form the basis for preparing the Annual Return are subject to inspection by the
Agency at any time. The Annual Return of CFC is made available to the public. CFC's
Annual Return is used for financial purposes in addition to regulatory purposes, such as
for credit rating purposes. Month Y is the official year-end for life insurance companies
operating in Country A.

   CFC has appointed a qualified actuary to be involved in matters prescribed by

the Agency as actuarial matters, including the method of calculating reserves. The
actuary must submit a written opinion to the Agency indicating whether the reserves
relating to the insurance contracts prescribed by the Agency are established and
maintained according to actuarial soundness. CFC is also subject to solvency
requirements which require a risk-based level of regulatory capital targeting an optimal
capital level over and above the prudent reserve estimate.
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PLR-121796-14

   To comply with Country A’s insurance laws and regulations for reinsurance

companies, CFC must establish and maintain certain reserves. These reserves are (1)
underwriting reserves (including reserves for variable contracts) and (2) loss reserves
that the branches maintain on their books for life insurance and annuity contracts. The
rules for calculating these reserves are prescribed by insurance laws, regulations and
other Agency guidance and are summarized below.

   Underwriting reserves must be held to secure the performance of future

obligations arising in the future from insurance contracts. The underwriting reserves
consist of the present value of future benefits plus future expenses, minus the present
value of future gross contract premiums, under current interest, mortality, morbidity, and
lapse assumptions, with provision for moderate adverse deviation. This method is
commonly referred to as the Gross Premium Valuation Method (“GPV”). The default
basis for reporting financial information to the Agency is Country A generally accepted
accounting principles, which do not prescribe a particular insurance reserve
methodology. Parent represents that the GPV method is commonly used in Country A.

   The branches may also hold loss reserves for outstanding claims (including

claims that may have been incurred but not reported) from life insurance and annuity
contracts reinsured by CFC. CFC calculates loss reserves using a combination of
known reported claims plus estimates based on each branch’s individual loss
experience and general local country industry experience.

   CFC represents that: (1) Neither CFC nor its branches carry on reinsurance

business other than certain businesses which are incidental to the reinsurance of life
insurance contracts, annuity contracts, and accident and health insurance contracts; (2)
any difference in the methods under Country A law used to calculate the reserves
related to an insurance policy issued by the branches as compared to the methods used
to calculate such reserves for the same insurance policy under subchapter L (if the
branches were U.S. insurance companies) would not cause a material difference in the
measurement of CFC’s income during the life of such policy; and (3) the foreign reserve
method used to calculate the branches’ underwriting reserves and loss reserves, are
not contrary to the rules and principles applicable to the calculation of reserves under
subchapter L, as modified by section 954(i).

                                      Law

   In general, a United States shareholder of a controlled foreign corporation

(“CFC”) must include in gross income its pro rata share of the CFC’s Subpart F income
for each year. Sec. 951(a). Subpart F income includes, among other types of income,
insurance income under section 953 and foreign base company income under section

954. Sec. 952(a)(1) and (2). Section 953(a) defines the term “insurance income” to
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PLR-121796-14

include any income which is attributable to issuing or reinsuring of an insurance or
annuity contract, and which would be taxed under Subchapter L if such income were the
income of a domestic insurance company. Section 953 provides that section 953
insurance income does not include “exempt insurance income” derived by a “qualifying
insurance company.” Section 953(b)(3) provides that reserves for any insurance or
annuity contract shall be determined in the same manner as under section 954(i).

    Section 954(a)(1) defines the term “foreign base company income” to include,

among other types of income, foreign personal holding company income. Section
954(c)(1) sets forth the types of income (e.g., interest and dividends) that are
considered to be foreign personal holding company income. Section 954(i)(1) provides
that for purposes of section 954(c)(1), foreign personal holding company income does
not include “qualified insurance income” of a “qualifying insurance company”.

   In general, section 953(e)(3) defines a “qualifying insurance company” as any

controlled foreign corporation which:

    (A)   is subject to regulation as an insurance company by its home country, and

is licensed, authorized, or regulated by the applicable insurance regulatory body for its
home country to sell insurance or annuity contracts to persons other than related
persons (within the meaning of Code section 954(d)(3)) in such home country;

   (B)    derives more than 50 percent of its aggregate net written premiums from

the issuance by such controlled foreign corporation of contracts covering applicable
home country risks of such corporation and with respect to which no policyholder,
insured, annuitant, or beneficiary is a related person (as defined in Code section
954(d)(3)); and

 (C)    is engaged in the insurance business and would be subject to tax under

Subchapter L if it were a domestic corporation.

  Section 953(e)(4) defines a “qualified insurance company branch” as a qualified

business unit (within the meaning of section 989(a) of a controlled foreign corporation if:

   (A)   the unit is licensed, authorized, or regulated by the applicable insurance

regulatory body for its home country to sell insurance, reinsurance, or annuity contracts
to persons other than related persons in such home country; and

  (B)     such CFC is a qualifying insurance company (as defined in section

953(e)(3)) as if such unit were a qualifying insurance company branch.
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PLR-121796-14

   Section 954(i)(2) defines the term “qualified insurance income” to mean income

of a qualifying insurance company falling into two categories. First, income received
from unrelated persons and derived from investments made by a qualifying insurance
company or qualifying insurance company branch (collectively referred to as a “QIC”)
either of its reserves allocable to exempt contracts or of 80 percent of its unearned
premiums from exempt contracts (as both are determined in accordance with section
954(i)(4)). Sec. 954(i)(2)(A). Second, income received from unrelated persons and
derived from investments made by a QIC of an amount of its assets allocable to exempt
contracts equal to: (1) in the case of property, casualty, or health insurance contracts,
one-third of the premiums earned on those contracts during such year; and (2) in the
case of life insurance or annuity contracts, 10 percent of the reserves described in
section 954(i)(2)(A) for such contracts. Sec. 954(i)(2)(B).

    Exempt contracts are defined under section 953(e)(2) to include insurance or

annuity contracts issued by a qualifying insurance company in connection with the lives
or health of residents of a country other than the U.S. but only if such company derives
more than 30 percent of its net written premiums from otherwise exempt contracts
which cover applicable home country risks and with respect to which no policyholder,
insured, annuitant or beneficiary is a related person within the meaning of section
954(d)(3). A contract issued by a QIC or QIC branch which covers risks other than
applicable home country risks is not treated as an exempt contract unless such
company or branch conducts substantial activity with respect to an insurance business
in its home country and performs in its home country substantially all of the activities
necessary to give rise to the income generated by such contract. Sec. 953(e)(2)(C).

   Section 954(i)(4)(B)(i) generally provides that in the case of life insurance and

annuity contracts, a QIC’s reserves allocable to exempt contracts are equal to the
greater of (1) the net surrender value of the contract or (2) the reserve determined
under section 954(i)(5). Section 954(i)(4)(B)(ii), however, provides:

   The amount of the reserves under Code section 954(i)(4)(B)(i) shall be the
   foreign statement reserve for the contract (less any catastrophe,
   deficiency, equalization, or similar reserves), if, pursuant to a ruling
   request submitted by the taxpayer or as provided in published guidance,
   the Secretary determines that the factors taken into account in
   determining the foreign statement reserve provide an appropriate means
   of measuring income.

Code section 954(i)(4)(B)(ii) was enacted by section 614 of the Job Creation and
Worker Assistance Act of 2002. The staff of the Joint Committee on Taxation explains
this provision as follows:
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   The provision does, however, permit a taxpayer in certain
   circumstances, subject to approval by the IRS through the ruling
   process or in published guidance, to establish that the reserve for
   such contracts is the amount taken into account in determining the
   foreign statement reserve for the contract (reduced by catastrophe,
   equalization, or deficiency reserve or any similar reserve). IRS
   approval is to be based on whether the method, the interest rate,
   the mortality and morbidity assumptions, and any other factors
   taken into account in determining foreign statement reserves (taken
   together or separately) provide an appropriate means of measuring
   income for Federal income tax purposes. In seeking a ruling, the
   taxpayer is required to provide the IRS with necessary and
   appropriate information as to the method, interest rate, mortality
   and morbidity assumptions and other assumptions under the
   foreign reserve rules so that a comparison can be made to the
   reserve amount determined by applying the tax reserve method
   that would apply if the qualifying insurance company were subject
   to tax under Subchapter L of the Code (with the modifications
   provided under present law for purposes of these exceptions). The
   IRS also may issue published guidance indicating its approval.

Staff of the Joint Comm. On Taxation, Technical Explanation of the Job Creation and
Worker Assistance Act of 2002 (JCX-12-02 (March 6, 2002)).

     Sections 953 and 954 do not define the terms “life insurance or annuity contract”

or “property, casualty, or health contract.” Section 953(e)(5) generally provides that, for
purposes of sections 953 and 954, the determination of whether a contract issued by a
CFC is a life insurance or annuity contract shall be made without regard to section 7702
if: (1) such contract is regulated as a life insurance or annuity contract by the
corporation’s home country, and (2) no policyholder, insured, annuitant, or beneficiary
with respect to the contract is a United States person.

   Section 816(a) of the Internal Revenue Code (the “Code”) defines “life insurance

company” as “an insurance company which is engaged in the business of issuing life
insurance and annuity contracts . . . or noncancellable contracts of health and accident
insurance, if—

   (1) its life insurance reserves . . ., plus
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  (2) unearned premiums, and unpaid losses (whether or not ascertained), on
      noncancellable life, accident, or health policies not included in life insurance
      reserves,

  comprise more than 50 percent of its total reserves . . . .”

  Section 816(b)(1) defines the term “life insurance reserves” for purposes of Part I

of Subchapter L of the Code as amounts:

  (A) which are computed on the basis of recognized mortality or morbidity
      tables and assumed rates of interest, and

  (B) which are set aside to mature or liquidate, either by payment or
      reinsurance, future unaccrued claims arising from life insurance,
      annuity, and noncancellable accident and health insurance contracts
      (including life insurance or annuity contracts combined with
      noncancellable accident and health insurance) involving, at the time
      with respect to which the reserve is computed, life, accident, or health
      contingencies.


                                    Analysis

    CFC is subject to regulation as a reinsurer of life insurance, annuities, and

noncancellable accident and health contracts by Country A. CFC is licensed,
authorized, and regulated by the Agency, which is the insurance regulatory body for
Country A, to sell life insurance and annuity contracts to persons other than related
persons (within the meaning of Code section 954(d)(3)) in Country A. CFC has
represented that it derives more than 50 percent of its aggregate net written premiums
from its issuance of life insurance and annuity contracts covering risks in connection
with the lives or health of residents of Country A and with respect to which no
policyholder, insured, annuitant, or beneficiary is a related person (as defined in Code
section 954(d)(3)). Each of the branches is a qualified business unit (within the
meaning of section 989(a) of CFC. Each branch is authorized or licensed by the
applicable insurance regulatory body for its home country to sell reinsurance to persons
other than related persons (within the meaning of section 954(d)(3) in such home
country. Premiums received by the branches are treated as earned in its home country
for the purpose of each home country’s tax laws. Finally, CFC is engaged in the life
insurance business and would be subject to tax under Subchapter L if it was a domestic
corporation. Accordingly, CFC is a QIC and the branches are qualifying insurance
company branches.
PLR-121796-14 9

   The branches primarily reinsure life insurance and annuity contracts in

connection with the lives and health of residents of their countries and do not reinsure
risks on the lives or health of residents of the United States. With the exception of the
Country C branch, each branch derives more than 30% of its net written premiums from
contracts that cover home country risks with respect to which no policyholder, insured,
annuitant, or beneficiary is a related person within the meaning of section 954(d)(3).
Each branch performs in its home country substantial insurance business activity, and
with respect to contracts which cover risks other than applicable home country risks (as
defined in section 953(e)(2)(B)(ii), substantially all the activities necessary to give rise to
the income generated by such contract. Therefore, life insurance and annuity contracts
issued by CFC, with the exception of contracts issued by the Country C branch and the
Country A home office, are exempt contracts within the meaning of section 953(e)(2).

   CFC uses the GPV method to determine its underwriting and loss reserves.

Because this method is a reasonable method for computing reserves, the foreign
statement reserves are an appropriate means of measuring income within the meaning
of section 954(i)(4)(B)(ii).

    CFC issues noncancellable and guaranteed renewable contracts and riders to

life insurance contracts as part of its life insurance business. For Country A tax and
insurance regulatory purposes, CFC computes the underwriting reserves and loss
reserves using a methodology similar to that used to compute life insurance reserves.
Therefore, the foreign statement underwriting reserves and loss reserves are also an
appropriate means of measuring income within the meaning of section 954(i)(4)(B)(ii).

                                       Rulings

   Based on the information submitted and the representations made, we rule as

follows:

   1.     The foreign statement underwriting reserves and loss reserves, which are

required by the Agency to be maintained for the reinsurance of life insurance and
annuity contracts, are an appropriate means of measuring income within the meaning of
section 954(i)(4)(B)(ii) .

  2.    The foreign statement underwriting reserves and loss reserves for

noncancellable and guaranteed renewable accident and health contracts reinsured by
CFC, as required to be reported on the Country A annual return, are an appropriate
means of measuring income within the meaning of section 954(i)(4)(B)(ii).

                                       Caveats

    We express no opinion on any provisions of the Code or regulations not

specifically covered by the above ruling. This ruling will be subject to revocation if any
of the following circumstances occurs: (1) a change in the material facts on which this
PLR-121796-14 10

ruling was based; (2) a material change in the business circumstances of CFC which
would impact its reserving method; or (3) a change in the applicable law or foreign rules
relating to CFC’s current reserving method.

                             Procedural Statements

   This ruling is directed only to Parent and CFC. Section 6110(k)(3) provides that

it may not be used or cited as precedent.

   Except as expressly provided herein, no opinion is expressed or implied

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter.

    Parent should attach a copy of this ruling letter to its Federal income tax return

for the taxable years to which this letter applies. In accordance with the power of
attorney on file in this office, a copy of this letter is being sent to your authorized
representatives.

                                   Sincerely,

                                   Steven Musher
                                   Associate Chief Counsel
                                   (International)

   By:




                                   Steven D. Jensen
                                   Senior Counsel, Branch 5
                                   (International)