Proposed Regs for Captives Too Expansive, Mortgage Insurer Says

April 22, 2022

RE: Letter on Proposed Treasury Regulations Issued January 24, 2022 Under IRC Section 953(c)(2) [IRS REG-118250-20]

Dear Sir or Madam:

Essent Group Ltd. ("Essent Group," "EGL," or the "Company") appreciates the opportunity to comment on the Proposed Regulations (REG-118250-20) published in the Federal Register (the "Proposed Regulations") on January 25, 2022, with respect to the related party insurance income ("RPII") rules in section 953(c)(2).¹

I. REQUEST FOR MODIFICATION

The Proposed Regulations provide guidance on various issues regarding passive foreign investment companies ("PFICs"), controlled foreign corporations ("CFCs"), and would substantially modify the RPII rules of section 953(c)(2). Our comments are focused on the proposed modifications to the RPII rules. For the reasons described below, we believe the proposed definition of "related insured" would substantially expand the RPII rules in a way that is contrary to the terms of Section 953(c) and the purposes of the RPII rules. Furthermore, we contend that the outcome of the "related insured" proposal is neither fair nor equitable treatment for individual shareholders in a public company, and does not achieve a particular public-policy outcome or address a perceived abuse. As such, we respectfully request that Prop. Reg. §1.953-3(b)(1)(ii)(D) be withdrawn in its entirety. If, however the provision is not withdrawn, then we request that the exception for publicly-traded companies that has been proposed be expanded to include the directly and indirectly owned subsidiaries of such publicly-traded companies.

II. RPII EXPANDED TO INCLUDE INCOME ATTRIBUTABLE TO RELATED INSUREDS

The legislative history² of the RPII rules makes it clear that the purpose of the rules is to subject RPII of captive insurance companies to U.S. tax where the RPII U.S. shareholders³ or persons related to them are insured by the captive insurer, but the general CFC rules don't apply by reason of the disbursed ownership. A person related to a RPII U.S. shareholder is determined for this purpose by applying the related person test in section 954(d)(3) to each such shareholder separately⁴.

The proposed regulations create a new class of RPII that is not provided for in Section 953(c) and was not intended by Congress. Specifically, the definition of "related insureds" in Prop. Reg. §1.953-3(b)(1)(ii)(D) includes a person (other than a publicly traded corporation or publicly traded partnership) that is more than 50% owned by RPII U.S. shareholders of the foreign corporation. Insurance or reinsurance of a related insured by a RPII CFC⁵ would give rise to RPII. Under the proposed regulations, if a foreign reinsurance company that is a RPII CFC reinsures a U.S. or foreign insurance company, and both the insured company and reinsurance company are held by a foreign holding company which has more than 50% direct or indirect RPII U.S. shareholders, then the affiliated reinsurance transaction would give rise to RPII. The proposed rule therefore defines a related insured by aggregating all RPII U.S. shareholders contrary to section 953(c)(2), which requires the relationship to be tested with respect to each such shareholder.

Affiliated reinsurance transactions are commercial transactions that are routinely undertaken by insurance companies to manage capital and risk within the group. There is no indication in the legislative history of the RPII rules that Congress intended such transactions, which are distinguishable from captive insurance arrangements as the ultimate insured is unrelated to the RPII U.S. shareholder, to give rise to RPII for foreign-parented groups (See Appendix A). The proposed rule, which is drafted as an anti-abuse rule, thus seems to presume that such affiliated reinsurance transactions are per se abusive, even though the ultimate risks are those of persons unrelated to the RPII U.S. shareholders. Under the proposed regulations, unrelated RPII U.S. shareholders with no controlling interest in companies on an individual basis could have RPII from affiliated reinsurance transactions between such companies. The case is even stronger for publicly traded companies. Such affiliated reinsurance arrangements should not be viewed as giving rise to RPII. We believe that the proposed rule greatly expands the definition of a related person and goes beyond Congressional intent. Accordingly, we request that Prop. Reg. §1.953-3(b)(1)(ii)(D) be withdrawn.

The proposed rule provides an exception for publicly traded companies and partnerships. However, insurance multinationals, which operate through insurance and reinsurance companies are generally held by a holding company that is not an insurance company. It is the holding company that is typically publicly traded. Although no explanation is provided for the publicly traded exception, we presume that the underlying premise of the exception is that shareholders of publicly-traded companies having no control over the management or insurance/reinsurance transactions entered into by the publicly traded company should not be subject to RPII by reason of such ownership and such transactions. The same principle should be equally applicable to subsidiaries of the publicly traded companies that they control. Furthermore, aggregating RPII U.S. shareholders to determine if they are "related" under the proposed rule is not an administratively feasible practice for either the RPII U.S. shareholder or for a publicly traded company to perform on its ownership base.

Therefore, we recommend that, if you determine that Prop. Reg. §1.953-3(b)(1)(ii)(D) should not be withdrawn, that the exception for publicly traded corporations and partnerships should be extended to controlled subsidiaries of such entities.

We thank you for the opportunity to provide comments.

Sincerely,

Lawrence E. McAlee
Senior Vice President and CFO

Joseph E. Wenger
Vice President — Tax

Essent Group Ltd.

Copies to:
Angela Walitt, Attorney Advisor, Department of the Treasury
Josephine Firehock, Attorney Advisor, Internal Revenue Service