Foreign life insurer may use home-country reserves to measure income

Plain-English summary

A domestic parent and its controlled foreign life insurer asked to use specified home-country statement reserves to measure insurance income under IRC § 954(i)(4)(B)(ii). The foreign insurer was licensed and regulated in its home country, primarily insured unrelated home-country risks, and would have been taxed under Subchapter L if it were domestic. Its net-level-premium method and related reserves for life, annuity, noncancellable accident and health, and guaranteed renewable contracts reasonably measured income. Its separate-account reserves also followed principles similar to IRC § 817 because assets were marked to market and reserve amounts were adjusted for the corresponding gains or losses. The IRS approved all three requested reserve categories, subject to revocation if material facts, business circumstances, applicable law, or foreign reserving rules changed.

Ruling snapshot

• Question: Could the controlled foreign insurer use specified home-country statement reserves to measure qualified insurance income?
• Outcome: Approved for the life and annuity, accident and health, and separate-account reserve categories described
• Key authorities: IRC §§ 953, 954(i), 816, and 817

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201504008 Third Party Communication: None
Release Date: 1/23/2015 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-123952-14
Date:
September 30, 2014

A = ------------------
CFC = ------------------------------------------------------------
Country A = -------
US Sub = ----------------------------------------------
Corp A = --------------------------------------------
X = --------
Corp B = -------------------------------------------------
Y = --------
Partnership A = ---------------------------------------------------
Z% = ----------
Agency = --------------------------------------------------
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, loss reserves, policyholders’ dividend reserves, and premiums
paid in advance reserves for life and annuity contracts reported by CFC on its Country A
Annual Report; (2) the underwriting reserves, loss reserves, and premiums paid in
advance reserves for noncancellable and guaranteed renewable accident and health
contracts reported by CFC on its Country A Annual Report; and (3) the underwriting
reserves and loss reserves and associated asset basis attributable to CFC’s separate
accounts, as reported on its Country A Annual Report.

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

PLR-123952-14 -2-

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 life insurance, accident
and health insurance, credit insurance, annuities, and endowment and retirement and
savings products. Parent owns all the stock of US Sub. US Sub owns all the shares of
Corp A. Corp A owns X% of Corp B. Corp B owns Y% of the interests in Partnership A,
a U.S. partnership. Partnership A owns Z% of CFC. CFC was formed under the laws
of Country A and is engaged in the life insurance business in Country A. Parent
represents that 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 agency, 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 sell life insurance and annuity contracts to
residents of Country A and is subject to regulation by the Agency as a life insurance
company. CFC is not engaged in any insurance business outside of Country A. CFC
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 section 954(d)(3). CFC is prohibited by
Country A from carrying on non-life insurance businesses other than certain activities
which are incidental to the life insurance business. Parent has represented that CFC
would be subject to tax under Subchapter L if it were a domestic corporation.

As part of its insurance business, CFC issues health and personal accident
insurance contracts that are noncancellable or guaranteed renewable, cancellable, or
are riders to a life insurance contract. CFC also issues separate account-type variable
life insurance and annuity contracts which are separately identified and maintained and
supported by separately identifiable pools of assets. The assets in such pools are
marked to market for local regulatory reporting purposes, and the associated reserves
follow movements in the value of assets, with limited exceptions. For Country A tax and
insurance regulatory purposes, CFC is required to make asset basis and reserve-
related adjustments to its separate accounts. Additionally, CFC issues life annuities
and individual life and savings product policies in Country A.

As required by Country A’s insurance laws and regulations, CFC files an Annual
Report and financial statements with the Agency. The Annual Report of CFC is audited

PLR-123952-14 -3-

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 Report are subject to
inspection by the Agency at any time. The Annual Report of CFC is made available to
the public. CFC’s Annual Report 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.

To comply with Country A’s insurance laws and regulations, CFC must establish
and maintain certain reserves for obligations to holders of their life insurance and
annuity contracts and must set forth the amount of such reserves on the Annual Report.
These reserves are (1) underwriting reserves (including reserves for separate account
contracts); (2) loss reserves; (3) policyholders’ dividend reserves; and (4) premium paid
in advance reserves that CFC maintains in Country A 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 obligations
arising in the future from the life insurance and annuity contracts issued by CFC in
Country A. Underwriting reserves are comprised of insurance premium interpolated
terminal reserves, unearned premium reserves, and risk reserves. The sum of
insurance premium reserves and unearned premium reserves (referred to as the
“standard valuation reserve”) for life insurance and annuity contracts may not be less
than the amount calculated in accordance with the designations of the Agency
concerning the reserve method, interest rate, mortality rate and other coefficients.

The Agency requires life insurance and annuity reserves, other than reserves for
separate account type contracts, to be determined as follows: (1) the prescribed reserve
method for life insurance is the Net Level Premium method (“NLP”); (2) a prescribed
mortality table must be used; and (3) a prescribed standard interest rate assumption is
used.

CFC also holds: (1) loss reserves for outstanding claims (including incurred but
not reported claims) under life insurance and annuity contracts issued by CFC, which
CFC calculates using the company’s individual loss experience, in accordance with
rules and regulations prescribed by the Agency; (2) policyholders’ dividend reserves,
which comprise policyholders’ dividend reserves and policyholders’ profit dividend
reserves. Policyholders’ dividend reserves are reserves for dividends that have been
declared and that have been credited, or will be credited at the next policy anniversary
date, to policyholders, and that have not been withdrawn by policyholders.
Policyholders’ profit dividend reserves are reserves with respect to certain dividends
that are not yet reflected in the policyholders’ dividend reserves; and (3) premiums paid
in advance reserves which include any premium that has been paid but whose due date
falls in the following year.

PLR-123952-14 -4-

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 has knowledge and experience concerning actuarial matters.

Parent represents that: (1) CFC is not engaged in any insurance business
outside of Country A and does not carry on non-life insurance business; (2) any
difference in the methods under Country A law used to calculate the reserves related to
an insurance policy issued by CFC as compared to the methods used to calculate such
reserves for the same insurance policy under subchapter L (if CFC were a US
insurance company) 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 CFC’s underwriting reserves, loss reserves, policyholders’ dividend reserves,
and premiums paid in advance reserves is 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
     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;

PLR-123952-14 -5-

(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 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).

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—

PLR-123952-14 -6-

(1) its life insurance reserves . . ., plus

(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.

Section 954(i)(3) generally provides that income credited under a separate
account-type contract is allocable only to such contract.

Section 817(a) provides that, with respect to any variable contract, reserves are
adjusted

(1) by subtracting therefrom an amount equal to the sum of the amounts
added from time to time (for the taxable year) to the reserves separately
accounted for . . . by reason of appreciation in value of assets (whether or
not the assets have been disposed of), and

(2) by adding thereto an amount equal to the sum of the amounts
subtracted from time to time (for the taxable year) from such reserves by
reason of depreciation in value of assets (whether or not the assets have
been disposed of).

Under section 817(b) the basis of each asset in a segregated asset account is
increased or decreased by the amount of appreciation or depreciation, respectively, to
the extent the reserves or other items referred to in section 817(a) are adjusted.

For purposes of Part I of Subchapter L, a life insurance company that issues
variable contracts “shall separately account for the various income, exclusion,

PLR-123952-14 -7-

deduction, asset, reserve, and other liability items properly attributed to such variable
contracts.” Section 817(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:

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)).

PLR-123952-14 -8-

Analysis

CFC is subject to regulation as a life insurance company 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)). 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.

CFC issues life insurance and annuity contracts in connection with the lives and
health of residents of Country A, a country other than the U.S. CFC derives more than
30% of its net written premiums from contracts that cover Country A risks with respect
to which no policyholder, insured, annuitant, or beneficiary is a related person within the
meaning of section 954(d)(3). Such contracts are, therefore, exempt contracts within
the meaning of section 953(e)(2). CFC uses the NLP method to determine its life
insurance 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, loss reserves,
and premiums paid in advance reserves on these policies using a methodology similar
to that used to compute life insurance reserves. Therefore, the foreign statement
underwriting reserves, loss reserves, and premiums paid in advance reserves for
noncancellable and guaranteed renewable accident and health contracts are also an
appropriate means of measuring income within the meaning of section 954(i)(4)(B)(ii).

CFC issued separate account type contracts as part of its life insurance
business. For Country A insurance regulatory purposes, CFC is required to mark-to-
market its portfolio investment assets held pursuant to its separate account-type
contracts, to adjust the basis of its marked portfolio investment assets to fair market
value, and to adjust its underwriting reserves and loss reserves to offset any gain/loss
attributable to the marked assets. Because these foreign statement insurance reserves
are maintained under principles similar to section 817, these reserves are also an
appropriate means of measuring insurance income within the meaning of section
954(i)(4)(B)(ii).

Rulings

PLR-123952-14 9

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

1. The foreign statement underwriting reserves, loss reserves, policyholders’
   dividend reserves, and premiums paid in advance reserves maintained by CFC with
   respect to its exempt life insurance or 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, loss reserves, and premiums
   paid in advance reserves maintained by CFC for its exempt noncancellable and
   guaranteed renewable accident and health contracts are an appropriate means of
   measuring income within the meaning of section 954(i)(4)(B)(ii).

3. The foreign statement insurance reserves maintained by CFC with respect
   to its exempt separate account contracts are an appropriate means of measuring
   income under 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
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.

PLR-123952-14 10

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)

Sincerely,

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

cc: