Assumption reinsurance did not materially change an employer-owned life insurance policy

Plain-English summary

A policyholder held a group flexible-premium variable life insurance policy covering directors and highly compensated employees or individuals. The issuing insurer proposed to transfer the policy to a related reinsurer through assumption reinsurance as part of a corporate restructuring. The reinsurer would replace the issuer, but the policy's death benefits, premiums, interest rates, charges, and other contractual obligations would remain unchanged. The IRS ruled that the transfer would not materially change the policy or alter its original issue or entry date for sections 101(j), 264(f), and 7702. This preserved the policy's existing tax treatment under those provisions based on the represented facts.

Ruling snapshot

• Question: Would transferring the policy to a new insurer through assumption reinsurance materially change it or reset its issue date for sections 101(j), 264(f), and 7702?
• Outcome: approved
• Key authorities: IRC §§ 101(j), 264(f), 7702; Treas. Reg. § 1.809-5(a)(7)(ii); Colonial American Life Insurance Co. v. Commissioner, 491 U.S. 244 (1989)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201736019                                              Third Party Communication: None
Release Date: 9/8/2017                                         Date of Communication: Not Applicable
Index Number: 101.00-00, 264.04-00,
              7702.00-00                                       Person To Contact:
                                                               ----------------------, ID No. ------------------
--------------------                                           Telephone Number:
------------------------------------------------------------   ----------------------
--------------                                                 Refer Reply To:
------------------------                                       CC:FIP:B04
------------------------------------                           PLR-139002-16
                                                               Date:
                                                               June 15, 2017




Policyholder           = -----------------------------------------------------------------------------------------
                         -------------
State                  = ---------------------
Issuer                 = ----------------------------------------------
Reinsurer              = ---------------------------------------------------
Parent                 = -----------------
Date                   = ---------------------------



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

        This letter is in response to the submission by the authorized representative of
Policyholder requesting a ruling that a transfer of a group flexible premium variable life
insurance policy (“Policy”) from Issuer to Reinsurer pursuant to a reinsurance contract
will not cause Policy to be materially changed and will not affect the date the Policy was
issued or entered into for purposes of sections 101(j), 264(f), and 7702 of the Internal
Revenue Code.

                                                     FACTS

        Policyholder is a life insurance company incorporated in State and licensed to
issue life insurance and annuity contracts in all states, the District of Columbia, and
Puerto Rico. Policyholder is the common parent of a life-nonlife consolidated group.
Policyholder files its life-nonlife consolidated return on a calendar year basis using an
accrual method of accounting.

       Issuer and Reinsurer are subsidiaries of Parent. On Date, Issuer issued Policy to
Policyholder. The term “Policy” refers to the group policy and to each coverage of an
PLR-139002-16                                2

insured thereunder. At the time Policy was first issued, each insured was a director,
highly compensated employee, or highly compensated individual of Policyholder within
the meaning of section 101(j)(2)(A)(ii), and each individual covered was an officer,
director, or employee of Policyholder within the meaning of section 264(f)(4)(A). Before
Policy was issued, the notice and consent requirements of section 101(j)(4) were
satisfied. The coverage of each insured under Policy (1) qualifies as a life insurance
contract under section 7702 by meeting the requirements of the cash value
accumulation test of section 7702(a)(1), and (2) is a modified endowment contract
within the meaning of section 7702A.

       Issuer proposes to enter into an assumption reinsurance contract (“Reinsurance
Contract”) with Reinsurer to cede its interest in Policy. Under Reinsurance Contract,
Reinsurer will deal directly with Policyholder concerning Policy, receive all premiums
under Policy, assume all liabilities under Policy, and assume all administrative functions
necessary for Policy. The terms and obligations under the reinsured Policy, including
the amount and pattern of death benefits, the premium pattern, the interest rate or rates,
and mortality and expense charges guaranteed under Policy, will be exactly the same
as the terms and obligations under Policy as it existed prior to the proposed reinsurance
transaction, with the exception that Reinsurer will replace Issuer as the insurer. After
Reinsurance Contract is entered into, Policyholder will have no further recourse to or
relationship with Issuer concerning Policy. Policyholder represents that, prior to
entering into Reinsurance Contract, Policy will not have been changed in a manner that
would cause it to be treated as newly issued or entered into for federal income tax
purposes. Policyholder will not receive a new policy form in connection with the
proposed assumption reinsurance transaction because the terms of Policy, and
Policyholder's rights thereunder, will not be changed.

        Upon receiving the required state approvals of the proposed assumption
reinsurance transaction, Reinsurer will provide Policyholder with an assumption
certificate evidencing the transaction. Although Policyholder did not initiate the
proposed assumption reinsurance transaction, it will provide its consent to the
transaction upon a favorable private letter ruling on this matter and upon receiving the
required state approvals.

         The assumption reinsurance transaction was represented as being necessary to
accommodate a corporate restructuring. This corporate restructuring is intended to
facilitate business specialization and to result in more stable cash flows. After the
restructuring, Reinsurer will maintain the personnel, expertise, and resources to service
group variable life insurance policies such as Policy.

                                         ISSUE
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       For purposes of sections 101(j), 264(f), and 7702, whether the transfer of Policy
from Issuer to Reinsurer pursuant to the Reinsurance Contract will cause Policy to be
materially changed or will affect the date Policy was issued or entered into.

                                           LAW

       Section 101(a) 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. In general, an employer-owned
life insurance contract is a life insurance contract that is owned by a person engaged in
a trade or business and under which that person is a beneficiary under the contract, and
that covers the life of an insured who is an employee on the date the contract is issued.
Section 101(j)(3)(A). An applicable policyholder is a person who owns an employer-
owned life insurance contract, or a related person as described in section 101(j)(3)(B).

       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. Those exceptions
are based either on (i) the insured's status as an employee at any time during the 12-
month period before the insured's death, or as a director, a highly compensated
employee or highly compensated individual at the time the contract is issued; or (ii) the
extent to which death benefits are paid to (or used to purchase an equity interest in the
applicable policyholder from) a family member, trust, or estate of the insured employee.

      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) states that, for purposes of section 264(f)(1), the portion of the
taxpayer's interest expense that is allocable to unborrowed policy cash values is an
amount that bears the same ratio to that interest expense as the taxpayer's average
unborrowed policy cash values of life insurance policies, and annuity and endowment
contracts, issued after June 8, 1997, bears to the sum of (i) in the case of assets of the
taxpayer that are life insurance policies or annuity or endowment contracts, the average
unborrowed policy cash values of those policies and contracts, and (ii) in the case of
any other assets of the taxpayer, the average adjusted bases (within the meaning of
section 1016) of those assets.

      Section 264(f)(3) defines the term “unborrowed policy cash value” as, with
respect to any life insurance policy or annuity or endowment contract, the excess of
PLR-139002-16                                  4

(A) the cash surrender value of the policy or contract determined without regard to any
surrender charge, over (B) the amount of any loan with respect to the policy or contract.
If the amount described in (A) with respect to any policy or contract does not reasonably
approximate its actual value, the amount taken into account under (A) is the greater of
the amount of the insurance company liability or the insurance company reserve with
respect to the policy or contract (as determined for purposes of the annual statement
approved by the National Association of Insurance Commissioners) or another amount
as determined by the Secretary.

        Section 264(f)(4) provides 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 policy 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
also meet either of two alternative tests: (1) the cash value accumulation test of section
7702(a)(1), or (2) the guideline premium and cash value corridor test of section
7702(a)(2)(A) and (B). 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 which 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 1.809-5(a)(7)(ii) of the Income Tax Regulations defines assumption
reinsurance as “an arrangement whereby another person (the reinsurer) becomes
solely liable to the policyholders on the contracts transferred by the taxpayer. Such
term does not include indemnity reinsurance or reinsurance ceded.”

       Describing assumption reinsurance, the United States Supreme Court stated:

              [T]he reinsurer steps into the shoes of the ceding company
              with respect to the reinsured policy, assuming all its liabilities
              and its responsibility to maintain required reserves against
              potential claims. The assumption reinsurer thereafter
PLR-139002-16                                 5

              receives all premiums directly and becomes directly liable to
              the holders of the policies it has reinsured.

Colonial Am. Life Ins. Co. v. Commissioner, 491 U.S. 244, 247 (1989).

                                        ANALYSIS

       An assumption reinsurance agreement is not initiated by the policyholder and
does not result in a change of the existing contractual obligations of the underlying life
insurance policy. It merely allows the obligation of the original insurer under the existing
policies to be assumed by the reinsurer. All terms of the reinsured underlying policies
remain unchanged, including the amount and pattern of death benefit, the premium
pattern, the rate guaranteed on issuance of the contract, and the mortality and expense
charges. The substitution of the reinsurer for the original insurer is the only modification
to the underlying contracts. The contracts that the policyholders will have after the
assumption reinsurance transaction will be the same contracts the policyholders
purchased originally except for the fact that the original insurer has been replaced. No
formal exchange of contracts occur.

                                      CONCLUSION

       For purposes of sections 101(j), 264(f), and 7702, the transfer of Policy from
Issuer to Reinsurer pursuant to Reinsurance Contract will not constitute a material
change of the Policy and will not affect the date Policy was issued or entered into.

                                        CAVEATS

      The ruling contained in this letter is based upon the information and
representations submitted by Taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of the
materials submitted in support of the ruling request, 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 the Taxpayer. The ruling is directed only to the taxpayer who
requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent.
PLR-139002-16                                  6


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


                                           Sincerely,




                                           Alexis A. MacIvor
                                           Branch Chief, Branch 4
                                           Office of the Associate Chief Counsel
                                           (Financial Institutions & Products)