Tax LLM Students Comment on Proposed Reinsurance Regs

Enclosed please find the Comment prepared by students from the New York Law School LL.M. in Taxation Program, addressing the proposed regulations concerning the application and impacts of Section 1297(b)(2)(B) of the Internal Revenue Code on reinsurance companies.

Specifically, the Comment addresses the reinsurance industry's motivation for developing alternative reinsurance solutions, investments strategies and methods.

Please note that the views that we express today are our own and not those of New York Law School.

We wish to present the Comment at the public hearing addressing the following topics:

This clarification will lead to a more efficient and consistent application of Section 1297. However, the proposed language modifies the term "active conduct" in Treas. Reg. § 1.367(a)-2T(b)(3), by excluding "officers and employees of related entities," which disproportionately affects reinsurance companies and increases their costs. Therefore, we request that the IRS and Treasury consider the burden that the proposed modified definition of "active conduct" imposes on the insurance sector and consumers. The proposed regulations also request comments regarding appropriate methods to determine the portion of assets held by foreign insurance companies to meet their obligations. We recommend a "facts and circumstances" test to make this determination. To the extent that such a "facts and circumstances" test overburdens taxpayer and IRS resources, we recommend a broad safe-harbor that allows foreign insurance companies to continue to operate in an economically efficient manner.

Passive Foreign Investment Company Rules

Congress introduced the Passive Foreign Investment Company ("PFIC") "anti-deferral"1 rules to the Internal Revenue Code in 1986. These rules require U.S. shareholders to report undistributed PFIC earnings. The PFIC provisions target U.S. investments in foreign companies that will otherwise receive indefinite deferral.²

Generally, a foreign corporation is a PFIC if either: (1) 75 percent or more of its gross income for the taxable year is passive; or (2) more than 50 percent of its assets produce passive income.³ Typical insurance companies, with large investment portfolios, may have more than 50 percent of their assets producing "passive income." Therefore, Congress enacted an exception for insurance companies, which derive their income from the active conduct of an insurance business.⁴

In 1986 Congress also adopted Treas. Reg. § 1.367(a)-2T, which provides for an exception to the rules of Section 367, if taxpayers meet an "active trade or business" standard.⁵ The regulations allow taxpayers to contribute assets to foreign corporations without triggering Section 367 treatment, if such contributions occur in the context of a legitimate business transaction.⁶ § 1.367(a)-2T(b)(3) embraced the rationale of the Subpart F rules, by requiring a "trade or business" to meet the "active conduct" standard under "[S]ection 954(c)(2)(A) and the related regulations.⁷

Subpart F: Manufacturing Exception

Congress had previously enacted Subpart F rules in 1962 to prevent indefinite deferral of income through the use of foreign entities.⁸ Under Section 951(a)(1)(A)(i), a U.S. shareholder of a Controlled Foreign Corporation ("CFC")⁹ must include in its annual gross income its pro rata share of the CFC's Subpart F income. Subpart F income includes foreign base company sales income ("FBCSI"), which is income earned by the CFC from buying or selling personal property from, to, or on behalf of, related persons. The Senate Report to the Revenue Act of 1962 stated that the FBCSI rules were enacted to prevent a U.S. manufacturer, or its foreign subsidiary, from separating its previous manufacturing activities from its sales activities, primarily to reduce taxation on the sales income.¹⁰

Concurrently, Congress enacted a "manufacturing exception" to allow a CFC to exclude FBCSI from Subpart F, if the CFC derived that income from manufacturing goods in the same country where it sold such goods.¹¹ The "manufacturing exception" excludes from FBCSI income that a CFC derives in connection with the sale of goods "manufactured, produced or constructed" by the CFC.¹²

Case Law

To qualify as an insurance company, a taxpayer "must use its capital and efforts primarily in earning income from the issuance of contracts of insurance."¹³ To determine whether a company qualifies as an insurance company, all relevant facts must be considered, including but not limited to, the size of the company, activities of its staff, whether the company engages in other trade or businesses and source(s) of its income.¹⁴

Neither the Code nor regulations define the terms "insurance" or "insurance contracts."¹⁵ Rather the definition of "insurance" for federal income purposes originates in Helvering v. LeGierse, where the Supreme Court stated that "[h]istorically and commonly insurance involves risk-shifting and risk distributing."¹⁶ Insurance is a contract "whereby for adequate consideration, one party agrees to indemnify another against loss arising from certain specified contingencies or peril."¹⁷ In other words, insurance transfers the risk of economic loss.¹⁸ Insurance prevents the insureds from the effects of a loss.¹⁹

Administrative Guidance: PFIC and CFC Rules

In addition to the statutory and judicial precedents, the IRS and Treasury have also provided guidance on the application of the PFIC and CFC rules. Two years after the enactment of PFIC rules, the IRS and Treasury issued Notice 88-22, which stated that cash and cash equivalents are virtually always considered to be passive income.²⁰ This Notice caused problems for foreign venture capital enterprises, which held assets or cash for the active business purpose of investing.²¹ For similar reasons, the Notice also affected companies that recently raised funds in initial public offerings.²²

Notice 2003-34 stated that the IRS would apply to PFIC rules where it determines that a foreign corporation is not an insurance company for federal taxation purposes. In this context, the Notice discussed foreign corporations that invest in hedge funds. However, the Notice acknowledged that the insurance business necessitates "substantial investment activities."²³

Administrative Guidance: Manufacturing Exception

Recently, several Private Letter Rulings ("PLRs") clarified the application of the "manufacturing exception."²⁴ In PLR 201340010, a CFC qualified under the "manufacturing exception" when the CFC owned the materials and product at various intervals of a transformation process, while its supply chains were operated by third parties.²⁵ PLR 201325005 addressed the application of the "manufacturing exception" to a branch of a foreign partnership. The branch qualified for the exception, since (via its employees) its subsidiary contributed "to the manufacture, production or construction of products."²⁶

The current proposed modified definition of "active conduct," under § 1.367(a)-2T(b)(3) prevents reinsurance companies from achieving economic efficiency by properly managing their businesses with available resources. In addition, the new definition will dictate to reinsurance companies "where" and "how" to invest, which defeats the legislative purpose and history of Section 1297(b)(2)(B). Moreover, the proposed regulations do not fully consider the industry's motivation for developing alternative management and investment strategies and methods. To that end, the regulations must accommodate the legitimate business practices of the reinsurance sector.

I. There are independent non-tax business reasons to operate an offshore reinsurance business, share management of that business and invest the business' capital via alternative investment vehicles such as hedge funds.

Section 1297(b)(2)(B) enabled the insurance industry to hold active capital offshore without misclassifying it as passive under PFIC rules. Not only did the new exception allow insurance companies to lower their operational costs, but it also allowed reinsurance companies to reduce risk and lower premiums for its insureds.

The proposed regulations impose a modified definition of "active conduct" to exclude insurance employees and officers who perform services for a foreign corporation."²⁷ Thus, any activities of insurance managers and other professional service providers performed during the day-to-day operations of a reinsurance business will be treated as passive. The day-to-day operations of reinsurance companies require a bespoke analysis of understanding risk characteristics of specific assets and investment portfolios. Such activities, among others, are performed by "officers and employees" of reinsurance companies. The exclusion of "officers and employees" will inappropriately cause many foreign insurance subsidiaries to be treated as PFICs.²⁸

The modified definition of "active conduct" test of § 1.367(a)-2T(b)(3) narrowly confines the definition of "who" is an officer or employee of the business for purposes of "substantial managerial and operational activities" to officers and employees of the company, and "the officers and employees of related entities who are made available to and supervise on a day-to-day basis by, and whose salaries are paid by (or reimbursed to the lending related entity by), the transferee foreign corporation."²⁹ This narrow definition prevents reinsurance companies from sharing the management of certain assets to other companies to efficiently run their businesses and beneficially reduce their risks. Moreover, the modified definition prevents reinsurance "officers and employees" from participating in daily business operations, such as monitoring, analyzing and managing the risk of complex asset portfolios.³⁰

Reinsurance Operations and Risk Management

The proposed regulations fail to account for the important mechanism by which reinsurance companies manage risk and deploy executives to run their global operations. The reinsurance business is different than the insurance business, since it serves a different specialized purpose, and manages a different portfolio of risk that potentially impacts the reinsurance company's financials to a much greater degree and in a less consistent manner. In fact, the reinsurance industry minimizes the risk of insurance companies, allows insurance companies to maintain sufficient capital to cover future claims, stabilizes earnings of the insurance companies and increases the amount of policies and business they can write.³¹ Without shared management across domestic and offshore subsidiaries, the reinsurance business has a greater risk of disruption and failure.

The decision making process regarding capital reserves and international operations must rely on the global expertise of an insurance business' multinational executives and effective corporate governance.³² An insurance company cannot efficiently employ officers and staff to manage only single lines of business, since the entire business is interrelated. Moreover, since reinsurance companies raise capital through various investment vehicles, reinsurance companies may encounter certain investment practices riskier than others. Executives must have freedom to act and manage across business lines in order to balance the overall portfolio of both insurance and reinsurance risk and capital reserves, while complying with existing corporate governance requirements.³³ This reality also results from the requirement to have internal controls and risk-mitigating strategies among reinsurance companies.³⁴ In fact, insurance regulators consider executive compensation one of the most significant risks when it comes to governance of the corporation.³⁵ Most significantly, reinsurance companies may need experts across various lines of businesses, due to the rapid emergence of alternative reinsurance markets that require frequent risk monitoring due to relatively low risk guidelines.³⁶

When a homeowner takes out flood or fire insurance policy, he or she is simply transferring his or her risk to the insurance company. The insurance company takes on that risk in exchange for a premium payment from the insured. The insurance company engages in such transactions because it is better situated to bear the risk of loss than the homeowner is, because of its experience with other policyholders. Moreover, the insurance company can pool risk and spread that potential burden of a payout over a "diversified portfolio of policies."³⁷ The distribution of risk allows the insurer to reduce premiums for policyholders.³⁸ In fact, "by assuming numerous relatively small, independent risks that occur randomly over time, the insurer smooths out its receipts of premiums."³⁹

Like the homeowner who seeks to protect his or her house from a variety of hazards, insurance companies seek to transfer their risk to reinsurance companies. Reinsurance contracts, also known as treaties, protect insurance companies from their own loss exposure. Consider for example, how reinsurance treaties reimburse insurance companies for losses stemming from a catastrophic event. The insurance company purchases a catastrophe treaty covering itself from January 1, 2011 to December 31, 2012. Further, assume that under the catastrophe treaty the reinsurance company will reimburse the next $25 million in losses after the insurance company has paid $10 million in claims. On October 29, 2012 Hurricane Sandy strikes and the losses of the insurance company exceed $10 million, totaling $20 million. To avoid inability to cover insured claims, the insurer will file its claim against reinsurance to recover the amount above $10 million. Thus for the reinsurance company to cover the $10 million claim, it has to have enough capital to carry the insurance company loss and manage its risk.

Reinsurance companies may also buy protection, known as retrocession, to minimize their own risk.⁴⁰ Reinsurance providers purchase retrocessions and sell these policies to other insurance businesses in order to assist in the diversification of insurance portfolios. Diversification across markets helps to minimize the risk of loss when such insurance companies are not equipped to do so themselves during the mega-catastrophic events.⁴¹ In this fashion, the reinsurance company must make vertical and hub-and-spoke management decisions to operate their multinational subsidiaries and maintain enough capital to reimburse insurance companies, which subsequently will reimburse their policyholders.⁴²

The U.S. insurance industry depends on reinsurance companies, since they allow greater insurance availability and affordability to U.S. families and businesses.⁴³ Since the U.S. is the largest consumer of the insurance market in the world, and the insurance business plays a substantial component in the U.S. economy, the insurance sector relies heavily on the domestic and foreign reinsurers.⁴⁴ In fact, the global reinsurance sector capital at year-end 2013 stood at $540 billion, and increased by 7 percent ($35 billion) from 2012.⁴⁵

The reinsurance industry also plays a vital role in property catastrophe insurance and therefore, the global diversification of risks and efficient allocation of capital is necessary. In fact, without global reinsurance capacity the claims burden has fallen on domestic reinsurers and subsidiaries, ultimately affecting U.S. primary insurers and policyholders.⁴⁶ To that end, global reinsurance capitalization has reduced reinsurance premiums significantly.⁴⁷ In 2014, it was reported that property catastrophe reinsurance renewal premiums fell by 11 percent, while the overall premium reduction was 15 percent.⁴⁸ Further, in the U.S. rates dropped 17 percent by midyear of 2014.⁴⁹ Finally, rates fell another 11 percent on January 1, 2015.⁵⁰ These impacts resulted in part from the influx of alternative capital,⁵¹ particularly in property catastrophe insurance.⁵²

The Source and Benefit of Alternative Capital

The benefit of utilizing alternative capital is twofold. First, it allows reinsurance companies allocate their risk with certainty and efficiency. Second, profits and losses from catastrophic events are not correlated with profits and losses in the financial markets.⁵³ One may even say that it is unlikely a hurricane will strike at the same time as a decline in financial markets. Thus, holding uncorrelated assets reduces the risk and diversifies portfolios.

Alternative investment enables reinsurance companies to modulate, diversify portfolios across various markets, reduce insurance premiums and augment existing traditional property catastrophe reinsurance capital.⁵⁴ Moreover, alternative capital enlarges the market capacity for covering extreme losses, when traditional capital is becoming scarcer because of Basel III and Solvency II regulations.⁵⁵ Since 2011, alternative capital has grown more than four times faster than traditional capital.⁵⁶ Finally, alternative investment opportunities reduce the probability that an extreme catastrophic disaster or event that may put the insurance company in default and damage policyholders who insured themselves against these events.⁵⁷

The mere fact that reinsurance companies utilize alternative capital to operate their businesses should not give rise to the imposition of the PFIC rules. In fact, the proposed regulations go against the legislative purpose of Section 1297(b)(2)(B), which is to prevent the PFIC rules from treating reinsurance companies and their subsidiaries as passive entities. If the reinsurance industry is constrained, its costs will increase, leading to an increase in premiums charged to insurance companies, which ultimately result in an increase in consumer premiums. The insurance industry requires greater flexibility in the definition of "active conduct" to allow it to operate in accordance with economic forces rather than be forced to operate in a counter-productive way to accommodate rigid taxation rules. Therefore, the new proposed definition of "active conduct" will only prevent the reinsurance company sector from achieving economic efficiency via management of its staff and business.

The efficient use of resources and creating sourcing of capital should not change the character of a reinsurance business, just as a manufacturing exception still allows a business to maintain its character as a manufacturer under Section 954(d)(1)(A). Similar to the manufacturing industry, the reinsurance business locates its business and manages its capital offshore due to the economic history of the industry.

Up until the early 20th century, most of the reinsurance business operated overseas.⁵⁸ In fact, a large portion of the industry emerged in the U.S. because of the world wars in Europe.⁵⁹ Few U.S.-based reinsurance companies were established in the late 20^th century. Rather, Bermuda became an international center of the reinsurance industry.⁶⁰ Moreover, due to extraordinarily large loss events in the U.S. over the last two decades new classes of markets have emerged.⁶¹ These developments have allowed reinsurance companies to redistribute insurance risks worldwide, while increasing capital and decreasing interest rates. Therefore, U.S. investors and shareholders should not be penalized for utilizing alternative capital. The geographical location and business structure result from socio-economic factors in the reinsurance business and its operations. Therefore, the IRS and Treasury should consider adopting the unchanged language of "active conduct" under § 1.367(a)-2T(b)(3), because the inclusion of "officers and employees of related entities" reflects the legislative intent of Section 1297(b)(2)(B) and allows the industry to run its course.

II. The methodology for managing reinsurance assets should be based on a "facts and circumstances" test because tax law should not dictate how the reinsurance sector efficiently manages its assets and business operations.

The proposed regulations acknowledge that risk plays an important component in determining whether the company is engaged in "insurance business." However, the proposed regulations do not recognize that within reinsurance companies there are several sub-categories of businesses that allocate risk and manage assets and capital in different ways. In fact, it is impossible to generalize about the insurance sector as whole, as individual companies have different mixes of assets and liabilities, operate in various environments, and are affected differently by market forces.⁶²

Consider how low interest rates affect life-insurance companies. Unlike non-life insurance contracts (which are rather short-term, extending over one year, and have payouts for short-tailed risks expected to be paid in the short or medium term), life insurance companies have longer-term liabilities and guaranteed interest-rate returns. Since asset choices are generally driven by an asset-liabilities rationale, as a consequence, the structure and investments of non-life insurance companies will be different from life insurance companies. The returns of life insurance companies are affected by their fixed-income portfolios and thus, prolonged interest rates will impact insurers with both, long-term liabilities and shorter-term assets. Consequently, life insurance companies that offer or sell products with high-return guarantees may have difficulty fulfilling their promises.⁶³ On the other hand, non-life insurance companies with short-tailed liabilities may benefit from low interest rates, which in fact reduce credit risk in insurers' investment portfolios.

A reinsurance company that underwrites a life insurer implements hedging strategies based on derivatives allowing that insurance company to lock higher rates and lower the risk accordingly. Hedging of risk through diversification is a foundation upon which the insurance industry operates.⁶⁴ Although hedging may introduce significantly more investment risk, reinsurers must allocate significantly more capital to buffer this risk, offsetting any increases to returns on capital driven by higher investment returns.⁶⁵ In the life-insurance example, the reinsurance liability risk diversifies better with hedge fund assets (due to higher returns on investment), providing enhanced capital efficiency and return on capital. Since risk visibility relates to the stability of the investment portfolio, reinsurance businesses must also assess the value of each item relative to the other items in their portfolio.⁶⁶ One of the methods that reinsurance companies use to determine which policies to underwrite is the beta method.⁶⁷ This method allows reinsurance companies to expand their international market, thus increasing their capital and policy underwriting.⁶⁸

In addition to the concept of hedging, reinsurance companies also consider political risk⁶⁹ to efficiently manage their assets. Political risk allows reinsurance companies to decide in what countries to transact.⁷⁰ The threat of post-investment political changes affects investment opportunities for reinsurance companies, who heavily rely upon foreign source insurance businesses such as Swiss Re and Munich Re to spread risk, otherwise manageable through U.S. sources.⁷¹

The purpose of the reinsurance industry is to spread the risk of loss from smaller to larger insurance companies in an effort to widen the pool of resources available if and when a payout is required, while minimizing the risk to smaller insurance businesses.⁷² Therefore, reinsurance companies should not be constrained, but rather encouraged to maximize their economic returns and increase yields through alternative investment solutions.⁷³ The reinsurance industry must constantly seek the most economically feasible method of reducing and diversifying its risk, while increasing its capital.⁷⁴

To impose an arbitrary percentage or number for determining the extent to which assets are held to meet obligations under insurance and annuity contracts will only prevent operations of reinsurance companies in a free market. In fact, the already complex state-by-state regulations, Basel III and Solvency II regulations leave little opportunities for this industry to increase economic returns, such as alternative capital solutions.⁷⁵ The methodology for determining whether a business is active should be flexible as applied to the reinsurance industry. It is unrealistic to require reinsurance companies to control activities and management of the other insurance companies with which they engage in reinsurance transactions.

Due to the nature of the reinsurance and insurance sectors, we propose that the IRS and Treasury adopt the "facts and circumstances" test in determining the methodology for allocating reinsurance capital. Such a test will clearly reflect the objective criteria for industry. Moreover, the "facts and circumstances" test originates in the § 1.367(a)-2T(b)(3) definition of "active conduct."⁷⁶ Therefore, adopting the "facts and circumstances" test will ensure the appropriate allocation of assets that are held to meet obligations under insurance and annuity contracts among reinsurance and insurance businesses.

III. If a "facts and circumstances " test overburdens taxpayer and IRS resources, a broad safe-harbor that accommodates the reinsurance business may permit economic efficiency.

Much like the complexity of the insurance and reinsurance sectors, a company's decisions and processes to merge, divest and/or acquire another business are multi-tiered, complicated and nuanced. To manage the unique aspects of this stage of company activity, the IRS set forth Treas. Reg. 1.263(a)-5 (and much administrative guidance) to help taxpayers determine whether their M&A expenditures were deductible or required capitalization. This authority is essentially a formalized "facts and circumstances" test designed to analyze typical investigative versus facilitative M&A and integration activities. Unfortunately, these detailed regulations and guidance led to a significant diversion of taxpayer and IRS resources in controversy over the character of such expenses.⁷⁷

To deal with this fallout, the IRS first issued an administrative memorandum to help with negotiations.⁷⁸ The memorandum was succeeded by Rev. Proc. 2011-29, which set forth a safe-harbor regarding the percentage of expenses that a taxpayer might deduct in a transaction without the risk of an extensive and expensive audit of such a position. Taxpayers may still deduct expenses beyond that safe-harbor, but they will be subject to the "facts and circumstances" test under the regulations and related precedent.

Perhaps a similar broad safe-harbor could work here (both for "active conduct" by affiliated employees and officers and for capital reserve allocation and management), but we recommend that the IRS engage in substantial dialogue with the reinsurance sector, so that such a test does not constrain the natural operations of the reinsurance business.

Dated: July 22, 2015

² General Explanation of the Tax Reform Act of 1986 released by the Joint Committee on Taxation, JCS-10-87 at p. 1023 (May 4, 1987).

³ I.R.C. § 1297(a)(1); (b)(1) defining "passive income" as "any income which is of a kind which would be foreign personal holding company income as defined in Section 954(c)."

⁴ Technical and Miscellaneous Revenue Act of 1988 (H.R. 4333, 100^th Congress, Public Law 100-647), https://www.congress.gov/bill/100th-congress/house-bill/4333/text?q=%7B%22search%22%3A%5B%22%5C%22p1100-647%5C%22%22%5D%7D; I.R.C. § 1297(a)(2) -- Passive foreign investment company.

⁵ Treas. Reg. § 1.367(a)-2T(b)(3); I.R.C. § 367 generally requires U.S. person to recognize gain on transfers to foreign corporations. Otherwise, under Subchapter C certain transfers to U.S. corporations are non-recognition events.

⁶ T.D. 8087, 51 F.R. 17936 (May 16, 1986).

⁷ 2008-32 I.R.B. 289 (August 8, 2011).

⁸ I.R.C. §§ 951-964.

⁹ I.R.C. § 957(a), defining the term "controlled foreign corporation" "means any foreign corporation if more than 50 percent of (1) the total combined voting power of all classes of stock of such corporation entitled to vote, or (2) the total value of the stock of such corporation is owned . . . or is considered as owned." I.R.C. § 957(b) provides special definition for insurance, defining the term "controlled foreign corporation" to "include not only a foreign corporation as defined by subsection (a) but also one of which more than 25 percent of the total combined voting power of all classes of stock (or more than 25 percent of the total value of stock) is owned . . . or is considered as owned . . . by United States shareholders on any day during the taxable year of such corporation, if the gross amount of premiums or other consideration in respect of the reinsurance or the issuing of insurance or annuity contracts . . . exceeds 75 percent of the gross amount of all premiums or other consideration in respect of all risks."

¹⁰ 24 S. Rep. No. 1881, 87th Cong., 2d Sess. (1962) H.R. 10650 at 84, and also H. Rep. No. 1447, 87th Cong., 2d Sess, (1962) H.R. 10650 at 62 ("The 'foreign base company sales income' referred to here means income from the purchase and sale of property without any appreciable value being added to the product by the selling corporation. This does not, for example, include cases where any significant amount of manufacturing, installation, or construction activity is carried on with respect to the product by the selling corporation. On the other hand, activity such as minor assembling, packaging, repackaging or labeling will not be sufficient to exclude the profits from this definition.").

¹¹ P.L. 87-834, 76 Stat. 960 (1962), 1962-3 C.B. 111; Treas. Reg. § 1.954-3(a)(4).

¹² Treas. Reg. § 1.954-3(a)(4)(i), describes the manufacturing exception as "the definition [of foreign base company sales income] does not apply to income of a controlled foreign corporation from the sale of a product which it manufactures. In a case in which a controlled foreign corporation purchases parts or materials which it then transforms or incorporates into a final product, income from the sale of the final product would not be foreign base company sales income if the corporation substantially transforms the parts or materials, so that, in effect, the final product is not the property purchased. Manufacturing hit and construction activities (and production, processing, or assembling activities which are substantial in nature) would generally involve substantial transformation of purchased parts or materials. . . .The 'foreign base company sales income' referred to here means income from the purchase and sale of property, without any appreciable value being added to the product by the selling corporation. This does not, for example, include cases where any significant amount of previous manufacturing, major assembling, or construction activity is carried on with respect to the product by the selling corporation." S. Rep. No. 87-1881, 1962-3 C.B. 703, 790, 949; H. Rep. No. 87-1447, 1962-3 C.B. 402, 466, 592-593.

¹³See Louisville Title Company v. Lucas, 27 F.2d 413 (W.D.Ky.); Industrial Life Insurance Co. v. United States, 344 F. Supp. 870, 877 (D.S.C. 197), aff'd 481 F.2d 609 (4^th Cir. 1973).

¹⁴Bowers v. Lawyers Mortgage Co., 285 U.S. 182, 188 (1932); Cardinal Life Insurance Co. v. United States, 300 F. Supp. 387, 391-92 (N.D. Tex. 1969); I.R.C. § 831(a), Treas. Reg. § 1.801-3(a)(1); Rev. Rul. 83-172, 1983 C.B. 107.

¹⁵ However, a "life insurance contract" is defined under Section 7702.

¹⁶Helvering v. LeGierse, 312 U.S. 531, 539 (1941).

¹⁷Epmier v. United States, 199 F.2d 508, 509-510 (7^th Cir. 1952).

¹⁸Allied Fidelity Corp. v. Commissioner, 572 F.2d 1190, 1193 (7^th Cir. 1978).

¹⁹Clougherty Packing Co. v. Commissioner, 811 F.2d 1297, 1300 (9^th Cir. 1987).

²⁰ IRS Notice 88-22, 1988.

²¹ Barner, Brian, Julie Olivas, and Camille Shoff, A 21st Century PFIC Regime: Must All Working Capital Be Passive?, The Tax Adviser (May 1, 2014), http://www.aicpa.org/publications/taxadviser/2014/may/pages/clinic-story-06.aspx.

²²Id.

²³ IRS Notice 2003-34, 2003.

²⁴ PLR 201340010, pg. 2.

²⁵Id.

²⁶ Without taking into account any exceptions in Section 954(e).

²⁷ Prop. Tres. Reg. § 1.1297-(4)(b)(1).

²⁸ I.R.C. § 1297(c).

²⁹ Treas. Reg. § 1.367(a)-2T(b)(3).

³⁰ Taoufik Gharib, Hedge fund reinsurers: are the rewards worth the risks?, Bermuda: Re/insurance (Nov. 28, 2014), http://www.bermudaremsurancemagazine.com/article/hedge-fund-reinsurers-are-the-rewards-worth-the-risk.

³¹ Insurance Information Institute, Alternative Capital and Its Impact on Insurance and Reinsurance Markets (Mar. 2015), http://www.iii.org/sites/default/files/docs/pdf/paper_alternativecapital_final.pdf; Insurance Information Institute, Catastrophes and Insurance Issues (Jul. 2015), http://www.iii.org/publications/insurance-handbook/insurance-and-disasters/catastrophes-and-insurance-issues, reporting that in 2014 insurance property losses due to catastrophic events were estimated at least $15.5 billion. The data excludes losses covered by federally administered National Flood Insurance Program.

³² John Quelch and Helen Bloom, Ten Steps to a Global Human Resources Strategy, Strategy and Business (Jan. 1999), http://www.strategy-business.com/article/9967?gko=db7b9; Rodney Lester and Oliver Reichert, Insurance Governance and Risk Management, World Bank, No. 11 (Nov. 2009), http://sitesources.worldbank.org/FINANCIALSECTOR/Resources/primer11_Insurance_governance_Risk_management.pdf

³³Existing U.S. Corporate Governance Requirements, National Association of Insurance Commissioners (2012), http://www.naic.org/documents/committees_ex_isftf_corp_governance_111222_existing_us_corp_gov_reqs.pdf; NAIC Committee Adopts Corporate Governance Models, National Association of Insurance Commissioners (Aug. 18, 2014) at 7 (delineating the Insurance Holding Company Systems Regulatory Act (2012) and providing specific corporate governance requirements for the insurance sector that are inconsistent with the proposed regulatory constraints).

³⁴Id.

³⁵Supra, note 33 at 5.

³⁶ Taoufik Gharib, Hedge fund reinsurers: are the rewards worth the risks?, Bermuda: Re/insurance (Nov. 28, 2014), http://www.bermudareinsurancemagazine.com/article/hedge-fund-reinsurers-are-the-rewards-worth-the-risk.

³⁷ Richard Brealey, Stewart Mayers and Franklin Allen, Principles of Corporate Finance, 662 (11^th Ed. 2013).

³⁸Supra, note 31.

³⁹Clougherty Packing Co., 811 F.2d at 1300; Commissioner v. Treganowan 183, F.2d 288, 291 (2d Cir. 1950); Beech Aircraft Corp. v. United States, 797 F.2d 920 (10^th Cir. 1986).

⁴⁰ International Association of Insurance Supervisors, Reinsurance and Financial Stability (July 19, 2012), reporting that retrocessional premiums (e.g., when reinsurers buy reinsurance protection) amount to $25 billion worldwide in 2012 to protect itself from insured losses. Reinsurers generally keep proportionately more risk "net" as compared to primary insurers.

⁴¹ David J. Cummins, Reinsurance for Natural and Man-Made Catastrophes in the United States: Current State of the Market and Regulatory Reforms, Risk Management and Insurance Review, Vol. 10, No. 2 (Oct. 1, 2007).

⁴²Id.

⁴³ Swiss Re, The Essential Guide to Reinsurance, 14-22 (2013), http://media.swissre.com/documents/The_essential_guide_to_reinsurance_updated_2013.pdf, reporting that reinsurers made more than 60% of payments related to the destruction of the World Trade Center in 2001 and hurricanes Katrina, Rita and Wilma in 2005, respectively. Without reinsurance, some domestic direct insurers may have experienced difficulties in meeting claims in the event of major catastrophe. In anticipation of such losses, capital limitations may have forced insurers to restrict the scope of coverage or to write less business. Reinsurance, therefore, helps to make insurance more broadly available and adds credibility to its promise to pay.

⁴⁴ Federal Insurance Office, Annual Report on the Insurance Industry (Jun. 2013), http://www.treasury.gov/initiatives/fio/reports-and-notices/Documents/FIO%20Annual%20Report%202013.pdf, stating that in 2013 insurance premiums in the life and health (L/H) and property and casualty (P/C) insurance sectors totaled more than $1.1 trillion in 2012, or approximately 7 percent of gross domestic product. In the United States, insurers directly employ approximately 2.3 million people, or 1.7 percent of nonfarm payrolls. Separately, more than 2.3 million licensed insurance agents and brokers hold more than 6 million licenses. U.S.-based insurers are also significant participants in the global financial markets. As of yearend 2012, the L/H and P/C sectors reported $7.3 trillion in total assets -- roughly half the size of total assets held by insured depository institutions. Of the $7.3 trillion in total assets, $6.8 trillion were invested assets.

⁴⁵ Federal Insurance Office, Annual Report on the Insurance Industry (Sept. 2014), http://www.treasury.gov/initiatives/fio/reports-and-notices/Documents/2014_Annual_Report.pdf.

⁴⁶ International Association of Insurance Supervisors, Reinsurance and Financial Stability (2011), http://hb.betterregulation.com/external/Insurance%20and%20Financial%20Stability%20November%2011%20Modif.%20Feb%2012.pdf, stating that "the access to global reinsurance and the reinsurance recoveries obtained from global and domestic reinsurance by primary insurers mitigated the financial impact these catastrophes [Piper Alpha and Hurricane Andrew] would have had on U.S. primary insurers and by extension also on U.S. policyholders."

⁴⁷ Guy Carpenter & Co., News Release, January 1, 2014 Renewals Bring Downward Pressure on Pricing (Dec. 30, 2013), http://www.guycarp.com/content/dam/guycarp/en/documents/PressRelease/2013/January%201,%202014%20Renewals%20Bring%20Downward%20Pressure%20on%20Pricing,%20Reports%20Guy%20Carpenter.pdf; Standard & Poor's Rating Service, A Slippery Slope, Pricing Slides as Reinsurance Strive for Competitive Footing (Jul. 14, 2014), https://www.spratings.com/search#Reinsurance?type=All.

⁴⁸ Guy Carpenter & Co., July 1 Renewals Indicate Downward Pressure On Reinsurance Rates Likely to Continue Through 2013 (Jul. 8, 2013), http://www.gccapitalideas.com/2013/07/08/july-1-renewals-indicate-downward-pressure-on-reinsurance-rates-likely-to-continue-through-2013/; Guy Carpenter & Co., January 1, 2014 Renewals Bring Downward Pressure On Pricing (Dec. 29, 2013), http://www.gccapitalideas.com/2013/12/29/january-1-2014-renewals-bring-downward-pressure-on-pricing/.

⁴⁹ Guy Carpenter & Co., Reinsurance Pricing Falls Again at June 1, 2014, As Competition Heightens (Sun. 2, 2014), http://www.gccapitalideas.com/2014/06/02/reinsurance-pricing-falls-again-at-june-1-2014-as-competition-heightens/; Guy Carpenter & Co., July 1 Renewals Reveal Continued Double Digit Price Decreases Across Many Lines and Geographies (Jul. 7, 2014), http://www.gccapitalideas.com/2014/07/07/july-1-renewals-reveal-continued-double-digit-price-decreases-across-many-lines-and-geographies/.

⁵⁰ Guy Carpenter & Co., January 1, 2015 Renewals see Lower Pricing and Broader Coverage for Clients (Jan. 2015), http://www.gccapitalideas.com/2015/01/06/january-1-2015-renewals-see-lower-pricing-and-broader-coverage-for-clients/.

⁵¹ Alternative capital comes from financial markets such as hedge funds, mutual funds, pension funds and sovereign wealth funds. Generally, the inflow of alternative capital into the reinsurance industry comes via collateralized reinsurers, particularly instruments such as catastrophe bonds, industry loss warranties, sidecars and gamut of insurance-linked securities funds and solutions.

⁵² Guy Carpenter & Co., January 1, 2014 Renewals Bring Downward Pressure On Pricing (Dec. 29, 2013), http://www.gccapitalideas.com/2013/12/29/january-1-2014-renewals-bring-downward-pressure-on-pricing/.

⁵³Supra, note 31.

⁵⁴ McKinsey & Company, Could Third-Party Capital Transform The Reinsurance Markets, (Sept. 2013), http://www.mckinsey.com/client_service/financial_services/latest_thinking/insurance, reporting that "the ability to lock in rates with multiyear structures, as catastrophe bonds have durations of two to three years or longer. This helps to prevent significant pricing shifts after a large catastrophic even (such as the 7 percent rate increase after Hurricane Katrina)."

⁵⁵ Phillipe Trainar, Alternative Capital in (Re)insurance, The Geneva Association (Jul. 2014), https://www.genevaassociation.org/media/887425/ga2014-ie70-trainar.pdf; Basel Committee on Banking Supervision, Basel III: A Global Regulatory Framework for more Resilient Banks and Banking Systems (Dec. 2010); Federal Register, Vol. 78, No. 198, Friday, Oct. 11, 2013, p. 62018; Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II), http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32009L0138&from=EN.

⁵⁶Supra, note 31, reflecting 2014 growth through September 30^th, using Aon Benfield Analytics source; see aslo Aon Benfield, Reinsurance Market Update (Apr. 1, 2014), http://thoughtleadership.aonbenfield.com/Documents/20140401_analytics_reinsurance_market_outlook_apapr2014.pdf, reporting that "during 2013 alternative capital continued to grow, totaling USD 50 billion or just over 9 percent of the total capital available for reinsurance at the end of the year. The influx of new funds from capital markets investors remains the main driver of growth in the alternative sector."

⁵⁷Supra, note 37, at 633.

⁵⁸ David M. Holland, A Brief History of Reinsurance, Reinsurance News, Issue 65 (Feb. 2009).

⁵⁹Id.

⁶⁰ Insurance Act 1978, Consolidated Laws of Bermuda, http://www.bma.bm/legislation/Insurance/Insurance%20Act%201978.pdf.

⁶¹ These events include: Hurricane Andrew in 1992, September 11, 2001, Hurricanes Katrina, Rita and Wilma in 2005 and recent Superstorm Sandy in 2012.

⁶² Pablo Antolin, Sebastian Schich and Juan Yermo, The Economic Impact of Protracted Low Interest Rates on Pension Funds and Insurance Companies, OECD Journal: Financial Market Trends, Vol. 1, Issue 1 (2011).

⁶³Id.

⁶⁴Supra, note 41. Hedging of risk through diversification is a transfer of risk to reinsurance businesses who manage that risk through asset management.

⁶⁵Supra, note 20 and 36.

⁶⁶ Richard Brealey, Stewart Mayers and Franklin Allen, Principles of Corporate Finance, Chapter 27: Managing International Risk, 708 (11^th Ed. 2013).

⁶⁷Id.

⁶⁸Supra, note 66, at 709 citing R. M. Stulz, The Cost of Capital in Internationally Integrated Markets: The Case of Nestle, European Financial Management 1, no. 1, 11-22 (1995); R. S. Harris, F. C. Marston, D. R. Mishra, and T. J. O'Brien, Ex Ante Cost of Capital Estimates of S&P 500 Firms: The Choice Between Global and Domestic CAPM, Financial Management, 51-66 (2003); and Standard & Poor's, Domestic v. Global CAPM, Global Cost of Capital Report, (4th Quarter 2003), reporting that "[t]he world is getting smaller and "flatter," however, and investors everywhere are increasing their holdings of foreign securities. Pension funds and other institutional investors have diversified internationally . . . [i]f investors throughout the world held the world portfolio, then costs of capital would converge. The cost of capital would still depend on the risk of the investment, but not on the domicile of the investing company."

⁶⁹Supra, note 66, at 698-712.

⁷⁰Supra, note 66, at 710.

⁷¹Supra, note 41.

⁷² Beilis, C, R. Lyon, S. Klugman, and J. Shepherd, Understanding Actuarial Management: The Actuarial Control Cycle (2d Ed., Sydney: The Institute of Actuaries of Australia, 2010), defining reinsurance and retrocession as "insurance that is purchased by an insurer from a reinsurer to transfer risk. Retrocession refers to the purchase of insurance by reinsurers from other reinsurance companies to transfer risk."

⁷³ Patrick Jenkins, Low rate weigh on insurers even as it feeds their merger mania, Inside Business, Financial Times (Jul. 6, 2015), http://www.ft.com/intl/cms/s/0/0a5457cc-23c8-11e5-9c4e-a775d2b173ca.html#axzz3fzXSnHVE.

⁷⁴Supra, note 41, at 179-220 proposing that "[t]he market for reinsurance is truly a global market. Only by diversifying losses across the world, is it possible for the insurance industry to provide coverage and pay losses in areas such as Florida and California, which have high exposure to catastrophic risk and large concentrations of property values. The United States is by far the leading market in terms of both the demand for reinsurance and the amount of loss payments funded by reinsurers. [T]hus, U.S. insurance markets are heavily dependent upon both domestic and foreign reinsurers."

⁷⁵Supra, note 55.

⁷⁶ Treas. Reg. § 1.367(a)-2T(b)(3).

⁷⁷See e.g., TAM 201002036. Prior to the introduction of the regulations, the character of these expenditures was also subject to extensive controversy. See e.g., National Starch & Chemical Corp. v. Comr., 93 T.C. 67 (1989), aff'd, 918 F.2d 426 (3d Cir. 1990), aff'd sub nom. INDOPCO, Inc. v. Comr., 503 U.S. 79 (1992).

⁷⁸ Kathy Petronchak, Examination of Transaction Costs in the Acquisition of Businesses (2002/2003).