Assumption reinsurance would not restart life insurance tax tests

Plain-English summary

Members of a corporate group owned private-placement variable life insurance policies on selected employees to finance employee benefit liabilities. After an event involving the insurer, the policyholder proposed assumption reinsurance that would substitute a licensed reinsurer while leaving the policies' benefits, premiums, rates, and guaranteed charges unchanged. The IRS ruled that changing only the insurer would not be a material change or an exchange of the policies. The transaction therefore would not change the original issue or entry dates for the employer-owned life insurance, interest-deduction, life-insurance qualification, or modified-endowment-contract rules. The ruling relied on the taxpayer's representations that no other policy terms would change and that the original policies had not already been materially altered.

Ruling snapshot

• Question: Would assumption reinsurance that substitutes a new insurer materially change or reissue the existing life insurance policies?
• Outcome: approved (the policies retained their original issue and entry dates)
• Key authorities: IRC §§ 101(j), 264(f), 7702, and 7702A

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202018003 [Third Party Communication:
Release Date: 5/1/2020 Date of Communication: Month DD, YYYY]
Index Number: 101.00-00, 264.00-00,
7702.00-00, 7702A.00-00 Person To Contact:
---------------------, ID No. -----------------
----------------- Telephone Number:
------------------------- --------------------
------------------ Refer Reply To:
-------------------------------------------------- CC:FIP:B04
------------------------------- PLR-118066-19
Date:
January 31, 2020

Taxpayer = -----------------------------------------
Insurer 1 = --------------------------------------------
Insurer 2 = ----------------------------------------------------------
Date 1 = ----------------------------
Date 2 = ------------------

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

   This letter is in response to the request by the authorized representative of

Taxpayer for a ruling that for purposes of sections 101(j), 264(f), 7702, and 7702A of the
Internal Revenue Code (the “Code”), a reinsurance transaction will not constitute a
material change of certain life insurance contracts and will not affect the date the
contracts were issued or entered into.

                                                 FACTS

    Taxpayer is the common parent of a consolidated group of corporations and files

its tax return on a calendar year basis. Taxpayer is a publicly traded holding company
engaged in financial services through its subsidiaries. On Date 1, certain members of
Taxpayer’s consolidated group (in aggregate, “Policyholder”) entered into letter
agreements with Insurer 1 for the issuance of life insurance contracts (each, a “Policy”,
and together, the “Policies”). The Policies were private placement variable life
insurance contracts that insured the lives of selected employees of Policyholder in order
to finance certain employee benefit liabilities.
PLR-118066-19 2

   The Policies qualify as life insurance contracts under section 7702. At the time

each Policy was issued (1) the individual insured was a director, highly compensated
employee, or highly compensated individual of Policyholder within the meaning of
section 101(j)(2)(A)(ii) and (2) the individual insured was an officer, director, or
employee of Policyholder within the meaning of section 264(f)(4)(A). Before each Policy
was issued, the notice and consent requirements of section 101(j)(4) were met.

    The Policies provide that upon the occurrence of one of several enumerated

events, generally involving an unfavorable or potentially unfavorable development with
respect to the condition of the insurer (a “Reinsurance Event”), and at the request of
Policyholder and subject to any regulatory requirements, the insurer will use its best
efforts to enter into an assumption reinsurance agreement (a “Reinsurance
Transaction”) with an assuming reinsurer designated by Policyholder (a “Reinsurer”) to
reinsure the Policies. Any Reinsurer will be licensed to conduct an insurance business
in the state or territory in which it is located and in the states and territories in which the
Policies were issued.

   On Date 2, Insurer 1 was sold and renamed Insurer 2.

   A Reinsurance Event occurred, and Policyholder has requested Insurer 2 to use

its best efforts to enter into a Reinsurance Transaction. The consummation of the
Reinsurance Transaction, however, is contingent on the receipt of the requested ruling.

   Taxpayer has represented that:

1. Prior to a Reinsurance Transaction, none of the Policies will have been altered or
   changed in a manner that would cause them to be treated as newly issued or
   exchanged for federal income tax purposes.

2. Other than substituting a new insurer, the Policies will not be modified or
   restructured as a result of a Reinsurance Transaction. The terms and obligations
   under the Policies will remain unchanged, including the amount and pattern of death
   benefits, the premium pattern, the interest rate or rates, and the mortality and
   expense charges guaranteed under the Policies.

3. After a Reinsurance Transaction, Policyholder will have no further recourse against
   the original insurer except for retained liabilities described in the Policies.

                              REQUESTED RULING
   

   For purposes of sections 101(j), 264(f), 7702, and 7702A, the reinsurance of the
   Policies as described above will not constitute a material change of the Policies and will
   not affect the date each Policy was issued or entered into.
   PLR-118066-19 3

                             LAW AND ANALYSIS
   

Law

   Section 101(a) generally provides that “[e]xcept as otherwise provided in . . .

[section 101(j)], gross income does not include amounts received . . . under a life
insurance contract, if such amounts are paid by reason of the death of the insured.”

   Section 101(j)(1) provides that, in the case of an employer-owned life insurance

contract, the amount excluded from gross income of an applicable policyholder under
section 101(a)(1) shall not exceed an amount equal to the sum of the premiums and
other amounts paid by the policyholder for the contract. Under section 101(j)(3)(A), an
employer-owned life insurance contract is generally a life insurance contract that (i) is
owned by a person engaged in a trade or business and under which that person is a
beneficiary under the contract and (ii) covers the life of an insured who is an employee
on the date the contract is issued. As described in section 101(j)(3)(B), an applicable
policyholder is generally a person who owns an employer-owned life insurance contract.

   Section 101(j)(2) provides exceptions to the general rule of section 101(j)(1) in

the case of certain employer-owned life insurance contracts with respect to which the
notice and consent requirements of section 101(j)(4) are satisfied. Such exceptions are
available if the insured was, with respect to an applicable policyholder, (i) an employee
at any time during the 12-month period before the insured’s death or (ii) a director, a
highly compensated employee, or high compensated individual at the time the contract
was issued.

  Section 264(f)(1) provides that no deduction is allowed for that portion of the

taxpayer’s interest expense that is allocable to unborrowed policy cash values.

   Section 264(f)(2) describes the portion of the taxpayer’s interest expense that is

allocable to “unborrowed policy cash values,” which is described in section 264(f)(3).

    Section 264(f)(4) proves an exception to the pro rata interest expense

disallowance rule of section 264(f)(1) for certain policies and contracts. Under section
264(f)(4)(A), section 264(f)(1) does not apply to any policy or contract owned by an
entity engaged in a trade or business if the policy or contract covers only one individual
and if that individual is (at the time first covered by the policy or contract) (i) a 20-
percent owner of the entity or (ii) an individual (not described in (i)) who is an officer,
director, or employee of the trade or business.

   Section 7702 provides a statutory definition that a life insurance contract must

meet to be treated as a life insurance contract for federal income tax purposes. More
specifically, a contract must be a life insurance contract under applicable law and must
PLR-118066-19 4

also meet either of two alternative tests: (i) the cash value accumulation test of section
7702(b) or (ii) the guideline premium and cash value corridor test of sections 7702(c)
and (d), respectively. Also, under sections 7702(f)(7)(B) through (E), certain changes in
benefits during the first 15 years beginning on the issue date of a life insurance contract
may trigger cash distributions that receive less favorable tax treatment than distributions
after that period.

   Section 7702(c)(3)(B) sets limits on the amount of mortality and expense charges

that may be taken into account in determining whether an insurance contract satisfies
the definition of a life insurance contract under either the cash value accumulation test
or the guideline premium test of section 7702.

   Section 7702A provides that a contract meeting the requirements of section 7702

is a modified endowment contract for purposes of section 72 if the contract either (i) is
entered into on or after June 21, 1988, and fails to meet the 7-pay test of section
7702A(b) or (ii) is received in exchange for a contract described in (i).

   Section 7702A(b) states that a contract fails to meet the 7-pay test if the

accumulated amount paid under the contract at any time during the first 7 contract
years exceeds the sum of the net level premiums that would have been paid on or
before such time if the contract provided for paid-up future benefits after the payment of
7 level annual premiums. Section 7702A(c)(1) provides that the determination under
section 7702A(b) of the 7 level annual premiums shall be made at the time the contract
is issued.

   Section 7702A(c)(3)(A) provides that if there is a material change in the benefits

under (or other terms of) a contract, such contract is treated as a new contract entered
into on the day on which such material change takes effect and appropriate adjustments
must be made in determining whether the contract meets the 7-pay test to take into
account the cash surrender value of the contract.

   Section 7702A(c)(3)(B) states that for purposes of section 7702A(c)(3)(A), a

material change includes any increase in the death benefit under the contract or any
increase in, or addition of, a qualified additional benefit under the contract, but that a
material change does not include any increase that is attributable to the payment of
premiums necessary to fund the lowest level of the death benefit and qualified
additional benefits payable in the first 7 contract years (determined after taking into
account death benefit increases described in subparagraph (A) or (B) of section
7702(e)(2)) or to crediting of interest or other earnings (including policyholder dividends)
in respect of such premiums.

Analysis

  A material change to a life insurance contract will cause the contract to be

considered exchanged for a new life insurance contract, and the new life insurance
PLR-118066-19 5

contract will be considered newly issued or newly entered into. Such a new life
insurance contract will be re-tested to determine whether it meets the tests and criteria
described above.

   In a Reinsurance Transaction, the Reinsurer will assume all obligations under the

Policies, with the exception of a certain limited category of retained liabilities described
in the Policies. The terms and obligations of the Policies will remain unchanged,
including the amount and pattern of death benefits, the premium pattern, the interest
rate or rates, and the mortality and expense charges guaranteed. The Policies that
Policyholder will own after a Reinsurance Transaction will be the same Policies that
Policyholder originally purchased except for the change in insurer.

                                     RULING

    A Reinsurance Transaction will not constitute a material change or an exchange

of the Policies for purposes of sections 101(j), 264(f), 7702, and 7702A and will not
affect the date the Policies were issued or entered into.

                                    CAVEATS

    The ruling contained in this letter is based upon information and representations

Taxpayer submitted, accompanied by penalty of perjury statements executed by
appropriate parties. This office has not verified any of the material submitted in support
of the ruling request, and it is subject to verification on examination.

   Except as provided above, no opinion is expressed or implied concerning the

federal income tax consequences of any other aspect of this or other transactions or
item of income of Taxpayer. This ruling letter is directed only to the taxpayer who
requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited
as precedent.

  A copy of this letter should be attached to the federal income tax return of the

taxpayers involved for the taxable year in which the transaction covered by this ruling is
consummated.
PLR-118066-19 6

   Pursuant to a power of attorney on file in this office, a copy of this ruling is being

furnished to your authorized representatives.

                                    Sincerely,


                                    Dan Phillips
                                    Senior Counsel, Branch 4
                                    Associate Chief Counsel
                                    (Financial Institutions and Products)