Highlights of the Recent Guidance on Insurance Company Acquisitions

(Coauthored by Mark H. Kovey)

Final tax regulations issued in April provide helpful guidance on the acquisition of insurance companies pursuant to an election under section 338 of the Internal Revenue Code and the reinsurance of blocks of insurance when accompanied by the acquisition of other intangible assets, such as a customer list or a distribution network. The new regulations apply to all types of insurance companies, life, property casualty, health, title and so forth, and potentially to all forms of reinsurance (including indemnity, assumption and retrocessions). The following describes many significant issues and discusses the fact that "mere” reinsurance remains subject to the old regulations under Treas. Reg. section 1.817-4(d), which may result in a different answer for federal tax purposes.

After waiting for over 20 years since the enactment of section 338, the regulations finally instruct insurance companies how to treat an election under section 338 as a deemed assumption reinsurance transaction. When the stock of a target insurance company (the target) is purchased, an election under section 338(g) or section 338(h)(10) will result in the transaction treated for federal income tax purposes as if there is no sale of the stock of the target. Instead, the transaction is treated as a taxable sale by the “old” target of all its assets to the “new” target, followed by a deemed liquidation of the old target into its selling shareholder, and the new target is treated as a new taxpayer after the deemed asset sale. The deemed asset sale requires the old target to recognize gain or loss on the deemed transfer of its assets and the new target to receive a new tax basis in those assets (usually at the current fair market value). In addition, the regulations treat the deemed asset sale as a taxable assumption reinsurance transaction between the old target and the new target, which impacts on various tax issues including reserves, tax DAC under section 848 and other aspects of determining underwriting income. Some of the issues are covered by temporary regulations (also released as pro- posed regulations) so taxpayer comments can be received before final adoption of the rules. However, the final and temporary regulations are effective now.