Foreign insurance reserves may measure qualifying insurance income

Plain-English summary

A controlled foreign corporation wrote life insurance, annuity, and noncancellable or guaranteed-renewable accident and health contracts in its home country. Its regulator required audited underwriting and loss reserves calculated under a gross-premium-valuation approach using prescribed actuarial assumptions. The corporation qualified as a home-country-regulated insurance company, and the covered policies were exempt contracts issued to unrelated non-U.S. persons. The IRS found that the foreign reserve methods appropriately measured income under section 954(i)(4)(B)(ii). It allowed the corporation to use those foreign-statement reserves when determining foreign personal holding company income for both the life contracts and the covered accident and health contracts.

Ruling snapshot

• Question: Could the controlled foreign insurer use its home-country underwriting and loss reserves to measure qualified insurance income?
• Outcome: approved for the described life and noncancellable or guaranteed-renewable accident and health contracts
• Key authorities: IRC §§ 816, 953(e), 954(i), 957; Treas. Reg. §§ 1.801-3 and 1.446-1(c)(1)(ii)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201718020                                              Third Party Communication: None
Release Date: 5/5/2017                                         Date of Communication: Not Applicable
Index Number: 954.02-00
                                                               Person To Contact:
-----------------------------------------------                ----------------------------, ID No. --------------
------------------------------------------------------------   -----------------
--------------------                                           Telephone Number:
-----------------------                                        ----------------------
----------------------------------                             Refer Reply To:
                                                               CC:INTL:B05
                                                               PLR-126741-16
                                                               Date:
                                                               February 09, 2017


Legend

A=-----------------------
CFC=-----------
Country A=-----------------------
Parent=-----------------------------------------------
US Sub=-------------------------------------------
Corp A= ---------
Corp B=----------------------------------------------
Regulator=------------------------------------------------
Day X=-------------------
Insurance Regulations=-------------------------------------------------------------
Rule I=----------------
Rule II=---------------
Date A= ---------------------------
Date B=----------------------

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

      In a letter dated A, you requested a ruling allowing CFC to use certain foreign
statement insurance reserves in computing foreign personal holding company income
under section 954 on the 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
insurance contracts reported by CFC on its Country A annual report; and (2) the
underwriting reserves and loss reserves attributable to its noncancellable and
guaranteed renewable accident and health (“A&H”) contracts reported by CFC on its
Country A annual report.

      The rulings contained in this letter are based upon information and
representations submitted by Parent and accompanied by a penalty of perjury
PLR-126741-16                                2

statement executed by an appropriate party. While this office has not verified any of the
material submitted in support of the request for rulings, it is subject to verification on
examination.

       Parent is a publicly-traded domestic corporation that is engaged, through its
subsidiaries and affiliates, in various lines of business, which include property and
casualty insurance, life insurance, retirement products, mortgage insurance and
financial services. Parent owns all the stock of US Sub. US Sub owns all of the stock
of Corp A. Corp A owns all of the stock of Corp B. Corp B owns all of the stock of
CFC. Parent represents that CFC is a controlled foreign corporation as defined in
section 957.

       CFC is engaged principally in the underwriting of life insurance contracts and
accident and health contracts in Country A. Country A regulates any insurance
business conducted in Country A through its insurance laws and regulations. Regulator
is responsible for enforcing insurance laws and regulations in Country A. An insurance
company must obtain a license from Regulator to conduct an insurance business in
Country A.

         CFC is licensed by Regulator to sell life insurance and annuity contracts to
persons in Country A and is subject to regulation by Regulator as a life insurer. CFC
does not carry on business other than life insurance and certain activities that are
incidental to the life insurance business. CFC derives more than 50 percent of its
aggregate net written premiums from the issuance of life insurance contracts covering
applicable home country risks. No policyholder, insured, or beneficiary to a life
insurance or annuity contract that CFC issues is a related person as defined in section
954(d)(3). Parent has represented that CFC would be subject to tax under Subchapter
L if it were a domestic corporation.

       CFC issues health and personal accident insurance contracts that are
noncancellable or guaranteed renewable, cancellable, or riders to a life insurance
contract. CFC holds reserves with respect to such noncancellable health and personal
accident insurance contracts which it treats as life insurance reserves. Generally, 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 required by Country A's insurance laws and regulations, CFC files an annual
report and financial statements with Regulator. The annual report is audited by external
accounting auditors. The accounting records of CFC that form the basis for preparing
the annual report are subject to inspection by Regulator at any time. The annual report
is made available to the public. In additional to its use for regulatory purposes, the
annual report is used for financial purposes, such as Country A credit rating, by lenders,
and the public. Day X is the official year-end for CFC.
PLR-126741-16                                 3

        CFC has appointed a qualified actuary to be involved in matters designated by
Regulator as actuarial matters, including the application of appropriate method of
reserve calculation and the preparation of the actuarial report. The actuary must have
knowledge and experience concerning actuarial matters, and meet requirements
prescribed by Regulator. The actuary is required to prepare the annual report and
certify to Regulator whether or not the reserves relating to the insurance contracts
prescribed by Regulator are established and maintained in accordance with actuarial
soundness.
        To comply with Country A's insurance laws, CFC must establish and maintain
certain reserves for its obligations to holders of its life insurance contracts and to set
forth the amount of such reserves on the annual report. The reserves at issue in this
ruling request are limited to the underwriting reserves and loss reserves that CFC
maintains on its books for life insurance contracts. Country A insurance and
reinsurance companies are subject to Insurance Regulations that target a minimum
level of capital to ensure that each insurer maintains a capital adequacy level that is
commensurate with its risk profile at all times. The Insurance Regulations generally
require a company to develop a risk-based level of regulatory capital targeting the
optimal capital level over and above the prudent estimate reserve.

       Underwriting reserves are required to secure the performance of future
obligations arising from insurance contracts. Underwriting reserves consist of the
present value of future benefits plus future expenses, minus the present value of future
gross (contract) premiums, all under reasonably current interest, mortality, morbidity,
and lapse assumptions. Under Rule I, the reserves include provision for moderately
adverse deviation. Under Rule II, the reserves are developed on a best estimate basis.
This method is commonly referred to as the Gross Premium Valuation (“GPV”) method.
Generally, the Insurance Regulations call for the use of the GPV method, which is a
methodology used by the insurance industry throughout Europe and Asia. For the fiscal
year ended on Date A, CFC used the GPV method in accordance with Rule I to
compute all of its insurance reserves as reflected in its annual report required to be filed
with Regulator. For fiscal years beginning on and after Date B, CFC intends to use the
GPV method in accordance with Rule II to compute all of its insurance reserves as will
be reflected in its future Country A annual reports filed with Regulator.

       CFC may also hold loss reserves for outstanding claims (including claims that
have been incurred but not reported) from insurance contracts issued by CFC. CFC
calculates the loss reserves using the company’s individual loss experience, in
accordance with the rules and regulations prescribed for these reserves by Regulator.
Under Rule I, the loss reserves include a contingency provision for adverse deviation
above the best estimate; for Rule II, the loss reserves are developed on a best estimate
basis.
PLR-126741-16                                 4

       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 other than certain businesses which are
       incidental to the life insurance contracts and accident and health contracts.

(2) The net written premium income received by CFC for the year ending on Date A is
representative of the net written premium income generally received by CFC.

(3) 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 U.S. insurance company) would not cause a material difference in the measurement
of CFC’s income during the life of such policy.

(4) The foreign reserve method used to calculate CFC’s underwriting and loss reserves
is not contrary to the rules and principles applicable to the calculation of reserves under
Subchapter L, as modified by section 954(i).

(5) Each contract covered by the rulings requested is (i) a life insurance contract, as
defined in section 953(e)(5), determined without regard to sections 72(s), 101(f), 817(h),
and 7702; (ii) regulated as a life insurance contract by Regulator; and (iii) no
policyholder, insured, or beneficiary with respect to the contract is a United States
person.

(6) The noncancellable and guaranteed renewable A&H policies included in the rulings
requested are only “noncancellable life, health, or accident insurance policies” within the
meaning of Treas. Reg. § 1.801-3(c) or “guaranteed renewable life, health, and accident
insurance policies” within the meaning of Treas. Reg. § 1.801-3(d).

(7) The underwriting reserves and loss reserves at issue in the rulings requested do not
include (i) deficiency reserves, (ii) contingency reserves, (iii) equalization reserves, (iv)
excess interest reserves for excess interest credited beyond the end of the taxable year,
or (v) any reserves for accrued liabilities that under the accrual method meet the “all
events test” (as described in Treas. Reg. §1.446-1(c)(1)(ii)).

                                            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. Subpart F income includes, among other types of income, insurance
income under section 953 and foreign base company income under section 954.
PLR-126741-16                                5

       Section 953(a)(1) 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(a)(2) 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 953(e)(1) defines exempt insurance income as income derived by a
qualifying insurance company which is attributable to the issuing (or reinsuring) of an
exempt contract by such company and is treated as earned by such company in its
home country for purposes of such country’s tax laws. 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).

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

       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
PLR-126741-16                                 6

954(i)(4)). 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.

        Section 816(a) defines the term “life insurance company” as an insurance
company that is engaged in the business of issuing life insurance and annuity contracts
(either separately or combined with accident and health insurance), or noncancellable
contracts of health and accident insurance, if (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. For purposes of the preceding sentence,
“insurance company” means any company more than half of the business of which
during the taxable year is the issuing of insurance or annuity contracts or the reinsuring
of risks underwritten by insurance companies.

       Section 816(b)(1) defines the term “life insurance reserve” as amounts (A)
computed or estimated on the basis of recognized mortality or morbidity tables and
assumed rates of interest, and (B) that 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)(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 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.

Section 954(i)(4)(B)(ii) was originally enacted by section 614 of the Job Creation and
Worker Assistance Act of 2002. Under the Protecting Americans from Tax Hikes
(PATH) Act of 2015 (P.L. 114-113, 12/18/2015), section 954(i) was permanently
extended and made effective for taxable years of foreign corporations beginning after
PLR-126741-16                               7

December 31, 2014, and for taxable years of U.S. shareholders with or within which
such taxable years of such foreign corporations end. In its Technical Explanation to the
PATH Act, the staff of the Joint Committee on Taxation explains section 954(i)(4)(B)(ii)
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.

Joint Comm. on Taxation, Technical Explanation of the Revenue Provisions of the
Protecting Americans from Tax Hikes Act of 2015, House Amendment #2 to the Senate
Amendment to H.R. 2029 (Rules Committee Print 114-40) (JCX-144-15 (December 17,
2015)).

                                       Analysis

        CFC is subject to regulation as an insurer of life insurance, annuities, and
noncancellable and guaranteed renewable A&H insurance contracts in Country A. CFC
is licensed and regulated by Regulator, which is the insurance regulatory body for
Country A, to issue life insurance and annuity contracts to persons other than related
persons within the meaning of section 954(d)(3)) in Country A. Parent has also
represented that CFC is engaged in the life insurance business in Country A and would
be subject to tax under Subchapter L if it were a domestic corporation. Parent has
represented that CFC derives more than 50 percent of its aggregate net written
premiums from the issuance by CFC of life insurance contracts to persons other than
related persons (as defined in section 954(d)(3)). Accordingly, CFC is a QIC under
section 953(e)(3).

        CFC issues life insurance contracts in connection with the lives and health of
residents of Country A, a country other than the United States. CFC derives more than
30 percent 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). Life insurance contracts issued by CFC are
therefore exempt contracts within the meaning of section 953(e)(2).

      CFC must establish, maintain, and calculate its underwriting reserves and loss
reserves in accordance with the insurance laws and regulations prescribed by
Regulator. Regulator generally requires a life insurance company to determine the
PLR-126741-16                               8

amount of its underwriting reserves and loss reserves based on guidance provided by
Regulator. CFC must set forth its underwriting reserves and loss reserves on the
Country A annual report, which must be filed annually with Regulator. These reserves
are the measure of the legal obligations to policyholders on the financial statement used
for regulatory purposes by life insurance companies doing business in Country A
(whether U.S.-owned, locally owned, or owned by companies headquartered in other
foreign countries). Regulator requires CFC to hold its underwriting reserves and loss
reserves for the fulfillment of claims owed to policyholders and beneficiaries. The
reserves are not catastrophe, deficiency, equalization, or similar reserves. Under the
rules prescribed by Regulator for determining reserves required to be calculated for
purposes of the Country A annual report, the method, interest rate, the mortality and
morbidity assumptions and other factors taken into account provide an appropriate
means of measuring income within the meaning of section 954(i)(4)(B)(ii).

         CFC issues noncancellable and guaranteed renewable A&H 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 on these policies using a methodology similar to that used to compute life
insurance reserves. The treatment of noncancellable and guaranteed renewable A&H
contracts as life insurance contracts, the reserves for which are computed as life
insurance reserves, is consistent with the treatment of such reserves for standard
actuarial, local regulatory, local tax, and U.S. GAAP purposes. Under the rules
prescribed by Regulator for determining reserves required to be calculated for purposes
of the Country A annual report, the method, interest rate, the mortality and morbidity
assumptions and other factors taken into account provide an appropriate means of
measuring income within the meaning of section 954(i)(4)(B)(ii).

                                         Ruling

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

(1) Under the facts set forth above, the foreign statement underwriting reserves and loss
reserves maintained by CFC with respect to its exempt life insurance contracts are an
appropriate means of measuring income within the meaning of section 954(i)(4)(B)(ii)
and may be used in determining the foreign personal holding company income of CFC
under section 954(i).

(2) Under the facts set forth above, the foreign statement underwriting reserves and loss
reserves maintained by CFC for its 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) and may be used in determining the foreign personal holding
company income of CFC under section 954(i).
PLR-126741-16                                  9

                                          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 the current reserving method of CFC.


                                  Procedural Statements

      This ruling is directed only to 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.

         In accordance with the power of attorney on file with this office, a copy of this
letter is being sent to your authorized representatives.

       A copy of this letter must be attached to any income tax return to which it is
relevant. Alternatively, taxpayers filing their returns electronically may satisfy this
requirement by attaching a statement to their return that provides the date and control
number of the letter ruling.


                                        Sincerely,



                                        Steven D. Jensen
                                        Senior Counsel, Branch 5
                                        Office of Associate Chief Counsel
                                        (International)