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Firm Highlights Insurance Business Models Affected by PFIC Rules

JUN. 7, 2018

Firm Highlights Insurance Business Models Affected by PFIC Rules

DATED JUN. 7, 2018
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June 7, 2018

Douglas L. Poms
International Tax Counsel, Office of Tax Policy
U.S. Department of Treasury
1500 Pennsylvania Avenue, N.W.
Washington D.C. 20220

Edith Brashares
Dir. International and Business Taxation
Office of Tax Analysis
Office of Tax Policy
U.S. Department of the Treasury
Main Treasury, Room 4221
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Dave Brazell
Financial Economist
Office of Tax Analysis
Office of Tax Policy
U.S. Department of the Treasury
Main Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Re: Passive Foreign Investment Company Rules — Definition of Qualifying Insurance Corporation

Dear Mr. Poms, Ms. Brashares, Mr. Brazell:

Once again thank you for your interest and desire in ensuring the timely and appropriate implementation of the recent modifications to the insurance company exception to passive foreign investment company (“PFIC”) status. As we have previously noted, receiving guidance from Treasury as soon as possible and before the end of 2018 on the application of the exception is extremely important. As you are aware, without further guidance, a non-U.S. insurance1 company may not be able to determine if it is characterized as a PFIC for 2018, and the U.S. shareholders of such company will be the ones subject to the U.S. tax consequences of any such characterization.2 Those consequences may not only impact the ultimate tax liabilities of shareholders, but may subject them to estimated tax, and other penalties.

When we met previously, you mentioned that it would be helpful for us to provide information on particular insurance business models that may be adversely impacted by the new qualifying insurance corporation (“QIC”) test, unless timely guidance is provided.

Without guidance, there are insurance companies that write certain lines of business, which generate significant losses, but do not generally create end of year loss reserves on the company's books,3 that lack clarity to determine whether they will be characterized as QICs and non-PFICs for 2018. In addition, some of these lines of business have historically been written as multi-year contracts that include an upfront premium payment, which may exacerbate the ability of companies writing these lines to meet the QIC test, because unearned premium is not included as an insurance liability for purposes of the test.

There are a number of risk classes that have this reserve profile, for example, term life insurance, property coverage, residual value insurance, financial guaranty, title insurance, and extended warranties for vehicles or consumer products. In addition, each of residual value insurance, financial guaranty, title insurance, and extended warranties for vehicles or consumer products or home warranty have historically been written on a multi-year basis that include an upfront premium payment. QIC status is based on an insurance company's results of operations for a taxable year as reflected in that company's financial statements for the year. For a company writing these risk classes, typically only if a loss event occurs late in the year, may the company have some loss reserves at year end. The bulk of such a company's losses will have been paid during the year and be reflected on the company's financial statements as paid losses. In addition, companies that historically have written multi-year contracts hold assets to pay losses that will arise in future years.

Insurance companies writing coverage for risks such as these, where few or no loss reserves are held until an event occurs and are typically only held for a short time until the losses are paid, and/or that historically have written multi-year contracts, require guidance in determining whether they qualify as QICs. For these companies, guidance on the following topics, among others, would be helpful: (i) clarifying that the scope of “Applicable Insurance Liabilities” includes all losses,4 whether paid during the year or based on the timing of the loss during the year being characterized as loss reserves as of year-end;5 (ii) providing relief for specified risk classes historically written on a multi-year basis by either (a) creating a discount factor to be applied to value their assets for purposes of calculating the 25%, and (if applicable) 10% ratio, or (b) disregarding assets being held to pay losses arising in future years for which a company is already contractually obligated to pay (absent cancelation of the policy by the underlying insured) based on the same percentage as the company's historic (e.g., seven year) year loss ratio; and (iii) providing guidance on the meaning of “Applicable Financial Statement.” In addition, for certain companies writing risks in the above described risk classes that are either rated themselves, or on whose quality an underlying insurer's rating is partially dependent, guidance on the scope of the alternate facts and circumstances test will also be needed.

For example, with respect to “Applicable Financial Statements,” clarity with respect to (i) the meaning of the requirement that there be no GAAP statement or IFRS statement,6 and (ii) whether U.S. federal tax principles will be applied to amounts of loss shown on financial statements (other than the question of whether a transaction is characterized as insurance for federal tax purposes)? With respect to “Applicable Insurance Liabilities,” it would be helpful to have clarity with respect to the limitation on the amount of a company's liabilities to those required by applicable law or regulation,7 or as determined by the Secretary.

We would appreciate the opportunity to have a follow up meeting or call with you to discuss the above in more detail.

Very truly yours,

Saren Goldner

P. Bruce Wright

Eversheds Sutherland LLP
New York, NY

FOOTNOTES

1For purposes of this letter, unless the context requires otherwise, an insurance company includes a company that writes reinsurance.

2In addition, if a company is characterized as a PFIC, the once a PFIC, always a PFIC rule will apply to its U.S. shareholders.

3In this regard, we have previously provided you with information about catastrophe writers.

4Under section 832 of the Internal Revenue Code of 1986, as amended, a U.S. property casualty insurance company calculates its gross income in part by including its “underwriting income” computed based on its “annual statement” filed with its insurance regulator (i.e., its financial statement). For this purpose, underwriting income is calculated by including “premiums earned, “losses incurred,” and “expenses incurred.” “Losses incurred” includes losses paid during the year as well as reserves for losses to be paid in future years.

5For certain risk classes with high severity losses, such as catastrophe risk, it may be appropriate to provide for an averaging of losses over a multi-year period, e.g., eight years.

6It is possible that such statements could be component parts of regulatory filings but not be prepared on a standalone basis and thus should not be bifurcated from the regulatorily required statement, or that regulators could have a standard requirement but allow flexibility and choices based on company preferences and/or other factors.

7This amount may depend on the regulatory reporting methodology adopted by a company and such company may have more than one available methodology. What happens if the methodology chosen and approved by the regulator results in a higher amount of loss than would be reported using another methodology? Must a company assess the choices and always adopt the methodology with the lowest losses.

END FOOTNOTES

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