IRS Issues Comprehensive Guidance on the Application of Sections 338 and 1060 to Insurance Companies

(Co-authored with Mark H. Kovey).

On March 8, 2002, the IRS issued a package of proposed regulations dealing with the myriad of issues relating to the application of sections 338 and 1060 to life and property and casualty insurance companies. The regulations, which were necessary after the IRS published final rules applying a deemed assumption reinsurance approach under section 338, are effective when final regulations are adopted. The proposed regulations’ package includes guidance under section 197 relating to the insurance contract intangible acquired in a section 338 or 1060 transaction as well the interplay of the assumption reinsurance principles with the corporate acquisition provisions. 

Noteworthy in the new package is the addition of rules which specify the amount of assets which are treated as transferred in exchange for the assumption of insurance liabilities when a section 338 election is made. In addition, the proposed rules: (i) attempt to eliminate the possibility that the reinsurer (or the new Target in a section 338 election) will have immediate premium income in excess of its deduction for assumed insurance reserves, i.e., the “negative ceding commission” or “bargain purchase” situation, and (ii) provide guidance on the interplay between sections 848 and 197. These issues were specifically addressed in industry comments. Also addressed by the industry and the proposed regulations is the treatment of increases in acquired insurance reserves after either a section 338 or 1060 acquisition. Finally, in the context of section 338 elections, the proposed regulations provide needed guidance on the election’s effect on the special loss discount amount under section 847, the treatment of old Target’s net negative capitalization and other DAC amounts under section 848, and when old Target’s policyholders surplus account under section 815 is deemed distributed. As indicated below, the approach taken by the IRS is not the approach that was recommended by the insurance industry on some of the issues. The regulations are proposed to be effective to transactions occurring after the adoption of final regulations.