Application of Section 338 to Insurance Companies, 3868-3874 [E8-729]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 73, Number 15 (Wednesday, January 23, 2008)]
[Rules and Regulations]
[Pages 3868-3874]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-729]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9377]
RIN 1545-BF02


Application of Section 338 to Insurance Companies

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations under section 197 of 
the Internal Revenue Code (Code) that apply to a section 197 intangible 
resulting from an assumption reinsurance transaction, and under section 
338 that apply to reserve increases after a deemed asset sale. The 
final regulations also provide guidance with respect to existing 
section 846(e) elections to use historical loss payment patterns. The 
final regulations apply to insurance companies.

DATES: Effective Date: These regulations are effective on January 23, 
2008.
    Applicability Date: For date of applicability of these regulations, 
see Sec.  1.197-2(g)(5)(ii)(E), Sec.  1.338-11(d)(7) and Sec.  1.846-
4(b).

FOR FURTHER INFORMATION CONTACT: William T. Sullivan (202) 622-7052 or 
Donald J. Drees, Jr. (202) 622-3970 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collection of information in these final regulations has been 
reviewed and approved by the Office of Management and Budget in 
accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) 
under control number 1545-1990.
    The collection of information in these final regulations is in 
Sec.  1.338-11(e)(2). This information is required by the IRS to allow 
an insurance company to choose to cease using its historical loss 
payment pattern, and instead use industry-wide factors, to discount 
unpaid losses.
    An agency may not conduct or sponsor, and the person is not 
required

[[Page 3869]]

to respond to a collection of information unless the collection of 
information displays a valid control number.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax information are confidential, as required by 26 U.S.C. 6103.

Background and Explanation of Provisions

    On March 8, 2002, the IRS and the Treasury Department published a 
notice of proposed rulemaking REG-118861-00 in the Federal Register (67 
FR 10640) (2002-1 Cumulative Bulletin (CB) 651) (the 2002 proposed 
regulations) that set forth rules applying to taxable acquisitions and 
dispositions of insurance businesses, including those that are deemed 
to occur when an election under section 338 of the Code is made. (See 
Sec.  601.601(d)(2)(ii)(b)). The CB is made available by the 
Superintendent of Documents, U.S. Government Printing Office, 
Washington, DC 20402. Written comments were received in response to the 
2002 proposed regulations, and a public hearing was held. After 
consideration of all the comments, the IRS and the Treasury Department 
published final regulations in the Federal Register on April 10, 2006, 
(TD 9257) (71 FR 17990), as corrected in the Federal Register (TD 9257) 
(71 FR 26826) to remove an error that might have proven to be 
misleading.
    TD 9257 also contains temporary regulations under sections 197, 
338, and 846, which serve as the basis for a cross-reference notice of 
proposed rulemaking published in the Federal Register (REG-146384-05) 
(71 FR 18053) with respect to issues that were the subject of comments 
on the 2002 proposed regulations. Specifically, Sec.  1.197-
2T(g)(5)(ii) provides guidance with regard to the interplay between 
section 197(f)(5) (concerning the treatment of certain reinsurance 
transactions) and section 848 (requiring the capitalization of certain 
policy acquisition expenses); Sec.  1.338-11T(d) addresses reserve 
increases after a deemed asset sale that results from a section 338 
election; and Sec.  1.338-11T(e) provides guidance on the effect of a 
section 338 election on an insurance company's election under section 
846(e) to use its historical loss payment pattern to discount certain 
unpaid losses.
    Although the 2002 proposed regulations generated a number of 
comments which are discussed in detail in the preamble to TD 9257, no 
new comments were received with respect to the temporary regulations 
that served as a cross-reference notice of proposed rulemaking in 2006. 
Accordingly, this Treasury decision adopts the proposed regulations 
without substantive change and removes the corresponding temporary 
regulations. This Treasury decision also revises cross-references where 
appropriate to reflect the removal of temporary regulations and their 
replacement with final regulations and corrects two obvious errors, one 
a mathematical error in the last sentence of Sec.  1.381(c)(22)-
1(b)(7)(v), Example 3, the other an error in the captioning of Sec.  
1.338(i)-1(c)(2)(ii)(B).

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It is hereby 
certified that the collection of information requirement in these 
regulations will not have a significant economic impact on a 
substantial number of small entities. This certification is based on 
the fact that these regulations do not have a substantial economic 
impact because they merely provide guidance about the operation of the 
tax law in the context of acquisitions of insurance companies and 
businesses. Moreover, they are expected to apply predominantly to 
transactions involving larger businesses. In addition, the collection 
of information requirement merely requires a taxpayer to prepare a 
written representation that contains minimal information relating to 
the making of an election. Therefore, a Regulatory Flexibility Analysis 
under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not 
required. Under section 7805(f) of the Code, the notice of proposed 
rulemaking preceding this regulation was submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Drafting Information

    The principal author of the final regulations is William T. 
Sullivan, Office of Chief Counsel (Financial Institutions and 
Products). However, other personnel from the IRS and the Treasury 
Department participated in the development of these regulations.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the entries for Sec. Sec.  1.197-2T, 1.338-1T, and 1.338-11T to read, 
in part, as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 1.197-0 is amended by:
0
1. Revising the introductory text and the entries for Sec.  1.197-
2(g)(5)(ii).
0
2. Removing the entries for Sec.  1.197-2T.
    The revisions read as follows:


Sec.  1.197-0  Table of contents.

    This section lists the headings that appear in Sec.  1.197-2.

Sec.  1.197-2 Amortization of goodwill and certain other 
intangibles.
* * * * *
    (g) * * *
    (5) * * *
    (ii) Determination of adjusted basis of amortizable section 197 
intangible resulting from an assumption reinsurance transaction.
    (A) In general.
    (B) Amount paid or incurred by acquirer (reinsurer) under the 
assumption reinsurance transaction.
    (C) Amount required to be capitalized under section 848 in 
connection with the transaction.
    (1) In general.
    (2) Required capitalization amount.
    (3) General deductions allocable to the assumption reinsurance 
transaction.
    (4) Treatment of a capitalization shortfall allocable to the 
reinsurance agreement.
    (i) In general.
    (ii) Treatment of additional capitalized amounts as the result 
of an election under Sec.  1.848-2(g)(8).
    (5) Cross references and special rules.
    (D) Examples
    (E) Effective/applicability date.


0
Par. 3. Section 1.197-2(g)(5)(ii) is revised to read as follows:


Sec.  1.197-2  Amortization of goodwill and certain other intangibles.

* * * * *
    (g) * * *
    (5) * * *
    (ii) Determination of adjusted basis of amortizable section 197 
intangible resulting from an assumption reinsurance transaction--(A) In 
general. Section 197(f)(5) determines the basis of an amortizable 
section 197 intangible for insurance or annuity contracts

[[Page 3870]]

acquired in an assumption reinsurance transaction. The basis of such 
intangible is the excess, if any, of--
    (1) The amount paid or incurred by the acquirer (reinsurer) under 
the assumption reinsurance transaction; over
    (2) The amount, if any, required to be capitalized under section 
848 in connection with such transaction.
    (B) Amount paid or incurred by acquirer (reinsurer) under the 
assumption reinsurance transaction. The amount paid or incurred by the 
acquirer (reinsurer) under the assumption reinsurance transaction is--
    (1) In a deemed asset sale resulting from an election under section 
338, the amount of the adjusted grossed-up basis (AGUB) allocable 
thereto (see Sec. Sec.  1.338-6 and 1.338-11(b)(2));
    (2) In an applicable asset acquisition within the meaning of 
section 1060, the amount of the consideration allocable thereto (see 
Sec. Sec.  1.338-6, 1.338-11(b)(2), and 1.1060-1(c)(5)); and
    (3) In any other transaction, the excess of the increase in the 
reinsurer's tax reserves resulting from the transaction (computed in 
accordance with sections 807, 832(b)(4)(B), and 846) over the value of 
the net assets received from the ceding company in the transaction.
    (C) Amount required to be capitalized under section 848 in 
connection with the transaction--(1) In general. The amount required to 
be capitalized under section 848 for specified insurance contracts (as 
defined in section 848(e)) acquired in an assumption reinsurance 
transaction is the lesser of--
    (i) The reinsurer's required capitalization amount for the 
assumption reinsurance transaction; or
    (ii) The reinsurer's general deductions (as defined in section 
848(c)(2)) allocable to the transaction.
    (2) Required capitalization amount. The reinsurer determines the 
required capitalization amount for an assumption reinsurance 
transaction by multiplying the net positive or net negative 
consideration for the transaction by the applicable percentage set 
forth in section 848(c)(1) for the category of specified insurance 
contracts acquired in the transaction. See Sec.  1.848-2(g)(5). If more 
than one category of specified insurance contracts is acquired in an 
assumption reinsurance transaction, the required capitalization amount 
for each category is determined as if the transfer of the contracts in 
that category were made under a separate assumption reinsurance 
transaction. See Sec.  1.848-2(f)(7).
    (3) General deductions allocable to the assumption reinsurance 
transaction. The reinsurer determines the general deductions allocable 
to the assumption reinsurance transaction in accordance with the 
procedure set forth in Sec.  1.848-2(g)(6). Accordingly, the reinsurer 
must allocate its general deductions to the amount required under 
section 848(c)(1) on specified insurance contracts that the reinsurer 
has issued directly before determining the general deductions allocable 
to the assumption reinsurance transaction. For purposes of allocating 
its general deductions under Sec.  1.848-2(g)(6), the reinsurer 
includes premiums received on the acquired specified insurance 
contracts after the assumption reinsurance transaction in determining 
the amount required under section 848(c)(1) on specified insurance 
contracts that the reinsurer has issued directly. If the reinsurer has 
entered into multiple reinsurance agreements during the taxable year, 
the reinsurer determines the general deductions allocable to each 
reinsurance agreement (including the assumption reinsurance 
transaction) by allocating the general deductions allocable to 
reinsurance agreements under Sec.  1.848-2(g)(6) to each reinsurance 
agreement with a positive required capitalization amount.
    (4) Treatment of a capitalization shortfall allocable to the 
reinsurance agreement--(i) In general. The reinsurer determines any 
capitalization shortfall allocable to the assumption reinsurance 
transaction in the manner provided in Sec. Sec.  1.848-2(g)(4) and 
1.848-2(g)(7). If the reinsurer has a capitalization shortfall 
allocable to the assumption reinsurance transaction, the ceding company 
must reduce the net negative consideration (as determined under Sec.  
1.848-2(f)(2)) for the transaction by the amount described in Sec.  
1.848-2(g)(3) unless the parties make the election provided in Sec.  
1.848-2(g)(8) to determine the amounts capitalized under section 848 in 
connection with the transaction without regard to the general 
deductions limitation of section 848(c)(2).
    (ii) Treatment of additional capitalized amounts as the result of 
an election under Sec.  1.848-2(g)(8). The additional amounts 
capitalized by the reinsurer as the result of the election under Sec.  
1.848-2(g)(8) reduce the adjusted basis of any amortizable section 197 
intangible with respect to specified insurance contracts acquired in 
the assumption reinsurance transaction. If the additional capitalized 
amounts exceed the adjusted basis of the amortizable section 197 
intangible, the reinsurer must reduce its deductions under section 805 
or section 832 by the amount of such excess. The additional capitalized 
amounts are treated as specified policy acquisition expenses 
attributable to the premiums and other consideration on the assumption 
reinsurance transaction and are deducted ratably over a 120-month 
period as provided under section 848(a)(2).
    (5) Cross references and special rules. In general, for rules 
applicable to the determination of specified policy acquisition 
expenses, net premiums, and net consideration, see section 848(c) and 
(d), and Sec.  1.848-2(a) and (f). However, the following special rules 
apply for purposes of this paragraph (g)(5)(ii)(C)--
    (i) The amount required to be capitalized under section 848 in 
connection with the assumption reinsurance transaction cannot be less 
than zero;
    (ii) For purposes of determining the company's general deductions 
under section 848(c)(2) for the taxable year of the assumption 
reinsurance transaction, the reinsurer takes into account a tentative 
amortization deduction under section 197(a) as if the entire amount 
paid or incurred by the reinsurer for the specified insurance contracts 
were allocated to an amortizable section 197 intangible with respect to 
insurance contracts acquired in an assumption reinsurance transaction; 
and
    (iii) Any reduction of specified policy acquisition expenses 
pursuant to an election under Sec.  1.848-2(i)(4) (relating to an 
assumption reinsurance transaction with an insolvent insurance company) 
is disregarded.
    (D) Examples. The following examples illustrate the principles of 
this paragraph (g)(5)(ii):

    Example 1. (i) Facts. On January 15, 2006, P acquires all of the 
stock of T, an insurance company, in a qualified stock purchase and 
makes a section 338 election for T. T issues individual life 
insurance contracts which are specified insurance contracts as 
defined in section 848(e)(1). P and new T are calendar year 
taxpayers. Under Sec. Sec.  1.338-6 and 1.338-11(b)(2), the amount 
of AGUB allocated to old T's individual life insurance contracts is 
$300,000. On the acquisition date, the tax reserves for old T's 
individual life insurance contracts are $2,000,000. After the 
acquisition date, new T receives $1,000,000 of net premiums with 
respect to new and renewal individual life insurance contracts and 
incurs $100,000 of general deductions under section 848(c)(2) 
through December 31, 2006. New T engages in no other reinsurance 
transactions other than the assumption reinsurance transaction 
treated as occurring by reason of the section 338 election.
    (ii) Analysis. The transfer of insurance contracts and the 
assumption of related liabilities deemed to occur by reason of the 
election under section 338 is treated as an assumption reinsurance 
transaction. New T determines the adjusted basis under section 
197(f)(5) for the life insurance contracts acquired in the 
assumption reinsurance

[[Page 3871]]

transaction as follows. The amount paid or incurred for the 
individual life insurance contracts is $300,000. To determine the 
amount required to be capitalized under section 848 in connection 
with the assumption reinsurance transaction, new T compares the 
required capitalization amount for the assumption reinsurance 
transaction with the general deductions allocable to the 
transaction. The required capitalization amount for the assumption 
reinsurance transaction is $130,900, which is determined by 
multiplying the $1,700,000 net positive consideration for the 
transaction ($2,000,000 reinsurance premium less $300,000 ceding 
commission) by the applicable percentage under section 848(c)(1) for 
the acquired individual life insurance contracts (7.7 percent). To 
determine its general deductions, new T takes into account a 
tentative amortization deduction under section 197(a) as if the 
entire amount paid or incurred for old T's individual life insurance 
contracts ($300,000) were allocable to an amortizable section 197 
intangible with respect to insurance contracts acquired in the 
assumption reinsurance transaction. Accordingly, for the year of the 
assumption reinsurance transaction, new T is treated as having 
general deductions under section 848(c)(2) of $120,000 ($100,000 + 
$300,000/15). Under Sec.  1.848-2(g)(6), these general deductions 
are first allocated to the $77,000 capitalization requirement for 
new T's directly written business ($1,000,000 x .077). Thus, $43,000 
($120,000 - $77,000) of the general deductions are allocable to the 
assumption reinsurance transaction. Because the general deductions 
allocable to the assumption reinsurance transaction ($43,000) are 
less than the required capitalization amount for the transaction 
($130,900), new T has a capitalization shortfall of $87,900 
($130,900 - $43,000) with regard to the transaction. Under Sec.  
1.848-2(g), this capitalization shortfall would cause old T to 
reduce the net negative consideration taken into account with 
respect to the assumption reinsurance transaction by $1,141,558 
($87,900 / .077) unless the parties make the election under Sec.  
1.848-2(g)(8) to capitalize specified policy acquisition expenses in 
connection with the assumption reinsurance transaction without 
regard to the general deductions limitation. If the parties make the 
election, the amount capitalized by new T under section 848 in 
connection with the assumption reinsurance transaction would be 
$130,900. The $130,900 capitalized by new T under section 848 would 
reduce new T's adjusted basis of the amortizable section 197 
intangible with respect to the specified insurance contracts 
acquired in the assumption reinsurance transaction. Accordingly, new 
T would have an adjusted basis under section 197(f)(5) with respect 
to the individual life insurance contracts acquired from old T of 
$169,100 ($300,000 - $130,900). New T's actual amortization 
deduction under section 197(a) with respect to the amortizable 
section 197 intangible for insurance contracts acquired in the 
assumption reinsurance transaction would be $11,273 ($169,100 / 15).

    Example 2. (i) Facts. The facts are the same as Example 1, 
except that T only issues accident and health insurance contracts 
that are qualified long-term care contracts under section 7702B. 
Under section 7702B(a)(5), T's qualified long-term care insurance 
contracts are treated as guaranteed renewable accident and health 
insurance contracts, and, therefore, are considered specified 
insurance contracts under section 848(e)(1). Under Sec. Sec.  1.338-
6 and 1.338-11(b)(2), the amount of AGUB allocable to T's qualified 
long-term care insurance contracts is $250,000. The amount of T's 
tax reserves for the qualified long-term care contracts on the 
acquisition date is $7,750,000. Following the acquisition, new T 
receives net premiums of $500,000 with respect to qualified long-
term care contracts and incurs general deductions of $75,000 through 
December 31, 2006.
    (ii) Analysis. The transfer of insurance contracts and the 
assumption of related liabilities deemed to occur by reason of the 
election under section 338 is treated as an assumption reinsurance 
transaction. New T determines the adjusted basis under section 
197(f)(5) for the insurance contracts acquired in the assumption 
reinsurance transaction as follows. The amount paid or incurred for 
the insurance contracts is $250,000. To determine the amount 
required to be capitalized under section 848 in connection with the 
assumption reinsurance transaction, new T compares the required 
capitalization amount for the assumption reinsurance transaction 
with the general deductions allocable to the transaction. The 
required capitalization amount for the assumption reinsurance 
transaction is $577,500, which is determined by multiplying the 
$7,500,000 net positive consideration for the transaction 
($7,750,000 reinsurance premium less $250,000 ceding commission) by 
the applicable percentage under section 848(c)(1) for the acquired 
insurance contracts (7.7 percent). To determine its general 
deductions, new T takes into account a tentative amortization 
deduction under section 197(a) as if the entire amount paid or 
incurred for old T's insurance contracts ($250,000) were allocable 
to an amortizable section 197 intangible with respect to insurance 
contracts acquired in the assumption reinsurance transaction. 
Accordingly, for the year of the assumption reinsurance transaction, 
new T is treated as having general deductions under section 
848(c)(2) of $91,667 ($75,000 + $250,000/15). Under Sec.  1.848-
2(g)(6), these general deductions are first allocated to the $38,500 
capitalization requirement for new T's directly written business 
($500,000 x .077). Thus, $53,167 ($91,667 - $38,500) of general 
deductions are allocable to the assumption reinsurance transaction. 
Because the general deductions allocable to the assumption 
reinsurance transaction ($53,167) are less than the required 
capitalization amount for the transaction ($577,500), new T has a 
capitalization shortfall of $524,333 ($577,500 - $53,167) with 
regard to the transaction. Under Sec.  1.848-2(g), this 
capitalization shortfall would cause old T to reduce the net 
negative consideration taken into account with respect to the 
assumption reinsurance transaction by $6,809,519 ($524,333 / .077) 
unless the parties make the election under Sec.  1.848-2(g)(8) to 
capitalize specified policy acquisition expenses in connection with 
the assumption reinsurance transaction without regard to the general 
deductions limitation. If the parties make the election, the amount 
capitalized by new T under section 848 in connection with the 
assumption reinsurance transaction would increase from $53,167 to 
$577,500. Pursuant to paragraph (g)(5)(ii)(C)(4) of this section, 
the additional $524,333 ($577,500 - $53,167) capitalized by new T 
under section 848 would reduce new T's adjusted basis of the 
amortizable section 197 intangible with respect to the insurance 
contracts acquired in the assumption reinsurance transaction. 
Accordingly, new T's adjusted basis of the section 197 intangible 
with regard to the insurance contracts is reduced from $196,833 
($250,000 - $53,167) to $0. Because the additional $524,333 
capitalized pursuant to the Sec.  1.848-2(g)(8) election exceeds the 
$196,833 adjusted basis of the section 197 intangible before the 
reduction, new T is required to reduce its deductions under section 
805 by the $327,500 ($524,333 - $196,833).

    (E) Effective/applicability date. This section applies to 
acquisitions and dispositions of insurance contracts on or after April 
10, 2006.
* * * * *


Sec.  1.197-2T  [Removed]

0
Par. 4. Section 1.197-2T is removed.


0
Par. 5. Section 1.338-0 is amended by revising the entries for Sec.  
1.338-11(d) and (e) to read as follows:


Sec.  1.338-0  Outline of topics.

* * * * *
Sec.  1.338-11 Effect of section 338 election on insurance company 
targets.
* * * * *
    (d) Reserve increases by new target after the deemed asset sale.
    (1) In general.
    (2) Exceptions.
    (3) Amount of additional premium.
    (i) In general.
    (ii) Increases in unpaid loss reserves.
    (iii) Increases in other reserves.
    (4) Limitation on additional premium.
    (5) Treatment of additional premium under section 848.
    (6) Examples.
    (7) Effective/applicability date.
    (i) In general.
    (ii) Application to pre-effective date increases to reserves.
    (e) Effect of section 338 election on section 846(e) election.
    (1) In general.
    (2) Revocation of existing section 846(e) election.
* * * * *


0
Par. 6. Section 1.338-1 is amended by adding paragraph (b)(2)(vii) to 
read as follows:


Sec.  1.338-1  General principles; status of old target and new target.

* * * * *

[[Page 3872]]

    (b) * * *
    (2) * * *
    (vii) Section 846(e) (relating to an election to use an insurance 
company's historical loss payment pattern).
* * * * *


Sec.  1.338-1T  [Removed]

0
Par. 7. Section 1.338-1T is removed.


0
Par. 8. Section 1.338-11 is amended by revising paragraphs (d) and (e) 
to read as follows:


Sec.  1.338-11  Effect of section 338 election on insurance company 
targets.

* * * * *
    (d) Reserve increases by new target after the deemed asset sale--
(1) In general. If in new target's first taxable year or any subsequent 
year, new target increases its reserves for any acquired contracts, new 
target is treated as receiving an additional premium, which is computed 
under paragraph (d)(3) of this section, in the assumption reinsurance 
transaction described in paragraph (c)(1) of this section. New target 
includes the additional premium in gross income for the taxable year in 
which new target increases its reserves for acquired contracts. New 
target's increase in reserves for the insurance contracts acquired in 
the deemed asset sale is a liability of new target not originally taken 
into account in determining AGUB that is subsequently taken into 
account. Thus, AGUB is increased by the amount of the additional 
premium included in new target's gross income. See Sec. Sec.  1.338-
5(b)(2)(ii) and 1.338-7. Old target has no deduction under this 
paragraph (d) and makes no adjustments under Sec. Sec.  1.338-
4(b)(2)(ii) and 1.338-7.
    (2) Exceptions. New target is not treated as receiving additional 
premium under paragraph (d)(1) of this section if--
    (i) It is under state receivership as of the close of the taxable 
year for which the increase in reserves occurs; or
    (ii) It is required by section 807(f) to spread the reserve 
increase over the 10 succeeding taxable years.
    (3) Amount of additional premium--(i) In general. The additional 
premium taken into account under this paragraph (d) is an amount equal 
to the sum of the positive amounts described in paragraphs (d)(3)(ii) 
and (d)(3)(iii) of this section. However, the additional premium cannot 
exceed the limitation described in paragraph (d)(4) of this section.
    (ii) Increases in unpaid loss reserves. The positive amount with 
respect to unpaid loss reserves is computed using the formula A/B x (C-
[D + E]) where--
    (A) A equals old target's discounted unpaid losses (determined 
under section 846) included in AGUB under paragraph 11(b)(1) of this 
section;
    (B) B equals old target's undiscounted unpaid losses (determined 
under section 846(b)(1)) as of the close of the acquisition date;
    (C) C equals new target's undiscounted unpaid losses (determined 
under section 846(b)(1)) at the end of the taxable year that are 
attributable to losses incurred by old target on or before the 
acquisition date;
    (D) D (which may be a negative number) equals old target's 
undiscounted unpaid losses as of the close of the acquisition date, 
reduced by the cumulative amount of losses, loss adjustment expenses, 
and reinsurance premiums paid by new target through the end of the 
taxable year for losses incurred by old target on or before the 
acquisition date; and
    (E) E equals the amount obtained by dividing the cumulative amount 
of reserve increases taken into account under this paragraph (d) in 
prior taxable years by A/B.
    (iii) Increases in other reserves. The positive amount with respect 
to reserves other than discounted unpaid loss reserves is the net 
increase of those reserves due to changes in estimate, methodology, or 
other assumptions used to compute the reserves (including the adoption 
by new target of a methodology or assumptions different from those used 
by old target).
    (4) Limitation on additional premium. The additional premium taken 
into account by new target under paragraph (d)(1) of this section is 
limited to the excess, if any, of--
    (i) The fair market value of old target's assets acquired by new 
target in the deemed asset sale (other than Class VI and Class VII 
assets); over
    (ii) The AGUB allocated to those assets (including increases in 
AGUB allocated to those assets as the result of reserve increases by 
new target in prior taxable years).
    (5) Treatment of additional premium under section 848. If a portion 
of the positive amounts described in paragraphs (d)(3)(ii) and (iii) of 
this section are attributable to an increase in reserves for specified 
insurance contracts (as defined in section 848(e)), new target takes an 
allocable portion of the additional premium in determining its 
specified policy acquisition expenses under section 848(c) for the 
taxable year of the reserve increase.
    (6) Examples. The following examples illustrate this paragraph (d):

    Example 1. (i) Facts. On January 1, 2006, P purchases all of the 
stock of T, a non-life insurance company, for $120 and makes a 
section 338 election for T. On the acquisition date, old T has total 
reserve liabilities under state law of $725, consisting of 
undiscounted unpaid losses of $625 and unearned premiums of $100. 
Old T's tax reserves on the acquisition date are $580, which consist 
of discounted unpaid losses (as defined in section 846) of $500 and 
unearned premiums (as computed under section 832(b)(4)(B)) of $80. 
Old T has Class I through Class V assets with a fair market value of 
$800. Old T also has a Class VI asset with a fair market value of 
$75, consisting of the future profit stream of certain insurance 
contracts. During 2006, new T makes loss and loss adjustment expense 
payments of $200 with respect to the unpaid losses incurred by old T 
before the acquisition date. As of December 31, 2006, new T reports 
undiscounted unpaid losses of $475 attributable to losses incurred 
before the acquisition date. The related amount of discounted unpaid 
losses (as defined in section 846) for those losses is $390.
    (ii) Computation and allocation of AGUB. Under Sec.  1.338-5 and 
paragraph (b)(1) of this section, as of the acquisition date, AGUB 
is $700, reflecting the sum of the amount paid for old T's stock 
($120) and the tax reserves assumed by new T in the transaction 
($580). The fair market value of old T's Class I through V assets is 
$800, whereas the AGUB available for such assets under Sec.  1.338-6 
is $700. There is no AGUB available for old T's Class VI assets, 
even though such assets have a fair market value of $75 on the 
acquisition date.
    (iii) Adjustments for increases in reserves for unpaid losses. 
Under paragraph (d) of this section, new T must determine whether 
there are any amounts by which it increased its unpaid loss reserves 
that will be treated as an additional premium and an increase in 
AGUB. New T applies the formula of paragraph (d)(3) of this section, 
where A equals $500, B equals $625, C equals $475, D equals $425 
($625 - $200), and E equals $0. Under this formula, new T is treated 
as having increased its reserves for discounted unpaid losses 
attributable to losses incurred by old T by $40 ($500/$625 x ($475 - 
[$425 + 0]). The limitation under paragraph (d)(5) of this section 
based on the difference between the fair market value of old T's 
Class I through Class V assets and the AGUB allocated to such assets 
is $100. Accordingly, new T includes an additional premium of $40 in 
gross income for 2006, and increases the AGUB allocated to old T's 
Class I through Class V assets to reflect this additional premium.
    Example 2. (i) Facts. Assume the same facts as in Example 1. 
Further assume that during 2007 new T deducts total loss and loss 
expense payments of $375 with respect to losses incurred by old T 
before the acquisition date. On December 31, 2007, new T reports 
undiscounted unpaid losses of $150 with respect to losses incurred 
before the acquisition date. The related amount of discounted unpaid 
losses (as defined in section 846) for those unpaid losses is $125.
    (ii) Analysis. New T must determine whether any amounts by which 
it increased its unpaid losses during 2007 will be treated as an 
additional premium in paragraph (d)(3)

[[Page 3873]]

of this section. New T applies the formula under paragraph (d)(3) of 
this section, where A equals $500, B equals $625, C equals $150, D 
equals $50 ($625 - $575), and E equals $50 ($40 divided by .8). In 
paragraph (d)(3) of this section, new T is treated as increasing its 
reserves for discounted unpaid losses by $40 during 2007 with 
respect to losses incurred by old T ($500/$625 x ($150-[$50 + $50]). 
New T determines the limitation of paragraph (d)(5) of this section 
by comparing the $800 fair market value of the Class I through V 
assets on the acquisition date to the $740 AGUB allocated to such 
assets (which includes the $40 addition to AGUB included during 
2006). Thus, new T recognizes $40 of additional premium as a result 
of the increase in reserves during 2007, and adjusts the AGUB 
allocable to the Class I through V assets acquired from old T to 
reflect such additional premium.

    Example 3. (i) Facts. The facts are the same as Example 2, 
except that on January 1, 2008, new T reinsures the outstanding 
liability with respect to losses incurred by old T before the 
acquisition date through a portfolio reinsurance transaction with R, 
another non-life insurance company. R agrees to assume any remaining 
liability relating to losses incurred by old T before the 
acquisition date in exchange for a reinsurance premium of $200. 
Accordingly, as of December 31, 2008, new T reports no undiscounted 
unpaid losses with respect to losses incurred by old T before the 
acquisition date.
    (ii) Analysis. New T must determine whether any amount by which 
it increased its unpaid loss reserves will be treated as an 
additional premium under paragraph (d) of this section. New T 
applies the formula of paragraph (d)(3) of this section, where A 
equals $500, B equals $625, C equals $0, and D equals -$150 ($625 - 
($575 + $200), and E equals $100 ($80 divided by .8). Thus, new T is 
treated as having increased its discounted unpaid losses by $40 in 
2008 with respect to losses incurred by old T before the acquisition 
date ($500/$625 x (0 -[-$150 + $100]). New T includes this positive 
amount in gross income, subject to the limitation of paragraph 
(d)(4) of this section. The limitation of paragraph (d)(4) of this 
section equals $20, which is computed by comparing the $800 fair 
market value of the Class I through V assets acquired from old T 
with the $780 AGUB allocated to such assets (which includes the $40 
addition to AGUB in 2006 and the $40 addition to AGUB in 2007). 
Thus, New T includes $20 in additional premium, and increases the 
AGUB allocated to the Class I through V assets acquired from old T 
by $20. As a result of these adjustments, the limitation under 
paragraph (d)(4) of this section is reduced to zero.

    (7) Effective/applicability date--(i) In general. This section 
applies to increases to reserves made by new target after a deemed 
asset sale occurring on or after April 10, 2006.
    (ii) Application to pre-effective date increases to reserves. If 
either new target makes an election under Sec.  1.338(i)-1(c)(2) or old 
target makes an election under Sec.  1.338(i)-1(c)(3) to apply the 
rules of this section, in whole, to a qualified stock purchase 
occurring before April 10, 2006, then the rules contained in this 
section shall apply in whole to the qualified stock purchase.
    (e) Effect of section 338 election on section 846(e) election--(1) 
In general. New target and old target are treated as the same 
corporation for purposes of an election by old target to use its 
historical loss payment pattern under section 846(e). See Sec.  1.338-
1(b)(2)(vii). Therefore, if old target has a section 846(e) election in 
effect on the acquisition date, new target will continue to use the 
historical loss payment pattern of old target to discount unpaid losses 
incurred in accident years covered by the election, unless new target 
elects to revoke the section 846(e) election. In addition, new target 
may consider old target's historical loss payment pattern when 
determining whether to make the section 846(e) election for a 
determination year that includes or is subsequent to the acquisition 
date.
    (2) Revocation of existing section 846(e) election. New target may 
revoke old target's section 846(e) election to use its historical loss 
payment pattern to discount unpaid losses. If new target elects to 
revoke old target's section 846(e) election, new target will use the 
industry-wide patterns determined by the Secretary to discount unpaid 
losses incurred in accident years beginning on or after the acquisition 
date through the subsequent determination year. New target may revoke 
old target's section 846(e) election by attaching a statement to new 
target's original tax return for its first taxable year.
* * * * *


Sec.  1.338-11T  [Removed]


0
Par. 9. Section 1.338-11T is removed.


0
Par. 10. Section 1.338(i)-1 is amended by:
0
1. Revising the section heading to read as set forth below.
0
2. Redesignating paragraph (c)(2)(ii)(b) as paragraph (c)(2)(ii)(B).
    The revisions read as follows:


Sec.  1.338(i)-1  Effective/applicability date.

* * * * *

0
Par. 11. Section 1.381(c)(22)-1(b)(7)(v) is amended by revising the 
last sentence of Example 3 to read as follows:


Sec.  1.381(c)(22)-1  Successor life insurance company.

* * * * *
    (b) * * *
    (7) * * *
    (v) * * *

     Example 3. * * * In that case, in the taxable year of the 
indemnity reinsurance transaction, S takes into account as ordinary 
income the portion of the old T's accounts ($1) that old T or S has 
not previously taken into account as income.
* * * * *


Sec.  1.846-0  [Amended]


0
Par. 12. Section 1.846-0 is amended by removing the entries for 
Sec. Sec.  1.846-2T and 1.846-4T.
0
Par. 13. Section 1.846-2(d) is revised to read as follows:

Sec.  1.846-2  Election by taxpayer to use its own historical loss 
payment pattern.

* * * * *
    (d) Effect of section 338 election on section 846(e) election. For 
rules regarding qualified stock purchase occurring on or after April 
10, 2006, see Sec. Sec.  1.338-1(b)(2)(vii) and 1.338-11(e).

0
Par. 14. Section 1.846-4 is amended by revising the section heading and 
paragraph (b) to read as follows:


Sec.  1.846-4  Effective/applicability date.

* * * * *
    (b) Section 338 election. Section 1.846-2(d) applies to section 
846(e) elections made with regard to a qualified stock purchase made on 
or after April 10, 2006.


0
Par. 15. For each entry in the ``Section'' column remove the phrase in 
the ``Remove'' column and add the phrase in the ``Add'' column in its 
place.

------------------------------------------------------------------------
            Section                   Remove                Add
------------------------------------------------------------------------
Sec.   1.338(i)-1(c)(2)(i)....  Sec.  Sec.         Sec.   1.338-11
                                 1.338-11 and
                                 1.338-11T(d).
Sec.   1.338(i)-1(c)(2)(i)....  1.197-2T(g)(5)(ii
                                 ),
Sec.   1.338(i)-1(c)(2)(ii)...  Sec.  Sec.         Sec.   1.338-11
                                 1.338-11 and
                                 1.338-11T(d).
Sec.   1.338(i)-1(c)(2)(ii)...  1.197-2T(g)(5)(ii
                                 ),
Sec.   1.338(i)-1(c)(2)(ii)(B)  Sec.  Sec.         Sec.   1.338-11
 (First sentence).               1.338-11 and
                                 1.338-11T(d).
Sec.   1.338(i)-1(c)(2)(ii)(B)  1.197-2T(g)(5)(ii
 (First sentence).               ),

[[Page 3874]]

 
Sec.   1.338(i)-1(c)(2)(ii)(B)  Sec.  Sec.         Sec.   1.338-11
 (Second sentence).              1.338-11 and
                                 1.338-11T(d).
Sec.   1.338(i)-1(c)(2)(ii)(B)  1.197-2T(g)(5)(ii
 (Second sentence).              ),
Sec.   1.338(i)-1(c)(3)(i)....  Sec.  Sec.         Sec.   1.338-11
                                 1.338-11 and
                                 1.338-11T(d).
Sec.   1.338(i)-1(c)(3)(i)....  1.197-2T(g)(5)(ii
                                 ),
Sec.   1.338(i)-1(c)(3)(ii)...  Sec.  Sec.         Sec.   1.338-11
                                 1.338-11
                                 and1.338-11T(d).
Sec.   1.338(i)-1(c)(3)(ii)...  1.197-2T(g)(5)(ii
                                 ),
Sec.   1.338(i)-1(c)(3)(ii)(B)  Sec.  Sec.         Sec.   1.338-11
 (First sentence).               1.338-11 and
                                 1.338-11T(d).
Sec.   1.338(i)-1(c)(3)(ii)(B)  1.197-2T(g)(5)(ii
 (First sentence).               ),
Sec.   1.338(i)-1(c)(3)(ii)(B)  Sec.  Sec.         Sec.   1.338-11
 (Second sentence).              1.338-11 and
                                 1.338-11T(d).
Sec.   1.338(i)-1(c)(3)(ii)(B)  1.197-2T(g)(5)(ii
 (Second sentence).              ),
Sec.   1.1060-1(a)(2)(i)......  Sec.  Sec.         Sec.   1.338-11
                                 1.338-11 and
                                 1.338-11T(d).
Sec.   1.1060-1(a)(2)(i)......  1.197-2T(g)(5)(ii
                                 ),
Sec.   1.1060-1(a)(2)(ii).....  Sec.  Sec.         Sec.   1.338-11
                                 1.338-11 and
                                 1.338-11T(d).
Sec.   1.1060-1(a)(2)(ii).....  1.197-2T(g)(5)(ii
                                 ),
Sec.   1.1060-1(a)(2)(ii)(B)..  Sec.  Sec.         Sec.   1.338-11
                                 1.338-11 and
                                 1.338-11T(d).
Sec.   1.1060-1(a)(2)(ii)(B)..  1.197-2T(g)(5)(ii
                                 ),
Sec.   1.1060-1(a)(2)(iii)....  Sec.  Sec.         Sec.   1.338-11(d)
                                 1.338-11T(d) and
                                 1.338-11T(d).
Sec.   1.1060-1(a)(2)(iii)....  1.197-2T(g)(5)(ii
                                 ),
Sec.   1.1060-1(a)(2)(iii)(B).  Sec.  Sec.         Sec.   1.338-11
                                 1.338-11 and
                                 1.338-11T(d).
Sec.   1.1060-1(a)(2)(iii)(B).  1.197-2T(g)(5)(ii
                                 ),
------------------------------------------------------------------------

PART 602--OMB CONTROL NUMBERS UNDER PAPERWORK REDUCTION ACT

0
Par. 16. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


0
Par. 17. In Sec.  602.101, paragraph (b) is amended by removing the 
entry for Sec.  1.338-11T from the table and adding an entry to the 
table in numerical order to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
 CFR part or section where identified and
                described                     Current OMB  control No.
------------------------------------------------------------------------
 
                                * * * * *
1.338-11.................................  1545-1990
 
                                * * * * *
------------------------------------------------------------------------


Linda Stiff,
Deputy Commissioner for Services and Enforcement.
    Approved: January 9, 2008.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
 [FR Doc. E8-729 Filed 1-22-08; 8:45 am]
BILLING CODE 4830-01-P