SECTION 4. AFSI ADJUSTMENTS

FOR COVERED REINSURANCE AGREEMENTS

.01 Purpose . The Treasury Department and the IRS anticipate that the forthcom­

ing proposed regulations will be consis­ tent with the guidance provided in this section 4. The Treasury Department and the IRS are providing this interim guid­ ance to assist taxpayers in determining AFSI with respect to Covered Reinsur­ ance Agreements prior to the issuance of the forthcoming proposed regulations.

.02 Covered Reinsurance Agreements . (1) Generally . For a Covered Insur­ ance Company that is a party to a Covered Reinsurance Agreement, the following changes accounted for separately in the AFS with respect to each such agreement are excluded from AFSI:

(a) For the ceding company holding the Withheld Assets, changes in Net Income as a result of changes in the amount of the Withheld Assets Payable to the reinsurer that correspond to the unrealized gains and losses in the Withheld Assets to the extent such unrealized gains and losses are not included in AFSI.

(b) For the reinsurer, changes in Net In­ come as a result of changes in the amount of the Withheld Assets Receivable from the ceding company that correspond to the unrealized gains and losses in the With­ held Assets; provided, however, that such exclusion will be reduced to the extent the reinsurer’s Withheld Assets Receivable is offset and the changes in its Net Income are reduced as a result of accounting for a retrocession of the reinsured risk.

(2) Fair value election . The exclusion provided in section 4.02(1) of this notice will not apply to the extent that: (a) the Covered Insurance Company elects to account for one or more items relevant to the Covered Reinsurance Agreement (off­ setting item) at fair value on its AFS and (b) the election results in changes in the fair value of the Withheld Assets Payable (for the ceding company) or the Withheld Assets Receivable (for the reinsuring company) and changes in the fair value of the offsetting item both being accounted for either through Net Income or through OCI on the AFS of the Covered Insurance Company.

(3) Example . The following example illustrates the rules set forth in section 4.02(1) of this notice. (a) Example – Funds Withheld Reinsurance --(i) Facts . Each of A and B is a life insurance company subject to tax under subchapter L of the Code and has a taxable and accounting year that is based on the calendar year. Each of A and B uses U.S. GAAP

March 6, 2023 526 Bulletin No. 2023–10

tracts other than those described in sec­ tions 2.02(1), 2.02(2)(a), and 2.02(2)(b) of this notice?

(b) Can the result of the rule in section 3.02(1) of this notice be achieved in a more easily administered manner?

(c) In what situations and for what rea­ sons would assets be transferred between a Covered Investment Pool and a Covered Insurance Company’s general account? Should there be additional adjustments beyond those described in this notice with respect to such assets?

(2) AFSI adjustments for covered rein- surance agreements (section 4 of the no- tice) .

(a) Does the notice accurately describe the financial accounting for funds with­ held reinsurance and modified coinsur­ ance agreements? Does the rule described in section 4.02(1) of this notice adequately address the issue?

(b) Should the definition of Covered Reinsurance Agreement in section 2.05(5) of this notice be revised or expanded?

(c) Would it be useful to more specif­ ically describe the fair value elections available under U.S. GAAP and IFRS? If so, how should the elections be de­ scribed?

(d) Does the rule in section 4.02(2) of this notice appropriately adjust the rule in section 4.02(1) of this notice when fair value elections are made?

(e) Should the rule in section 4.02(1) of this notice reference the “embedded derivative”? If so, how should such rule reference the embedded derivative, and how should “embedded derivative” be defined?

(3) Respecting “fresh start” for deter- mining AFSI (section 5 of the notice) .

(a) Are there other formerly tax-ex­ empt entities the repeal of whose subtitle A exemption was associated with special statutory “fresh start” basis rules similar to those applicable to any Fresh Start En­ tity?

(b) Should a rule similar to that in sec­ tion 5.02 of this notice apply to any other entities?

.02 Procedures for Submitting Com- ments .

(1) Deadline . Written comments should be submitted by April 3, 2023. Consid­ eration will be given, however, to any written comment submitted after April 3,

for purposes of preparing its AFS. On January 1 of Year 1, A, the ceding company, enters into a funds withheld reinsurance agreement with B, the rein­ surer. B does not retrocede any risk covered by the funds withheld reinsurance agreement. Pursuant to the terms of the agreement, from a legal title and financial accounting perspective, A retains the as­ sets supporting the reinsured contracts (the With­ held Assets). A has a liability to B with respect to the Withheld Assets (the Withheld Assets Payable). A reflects all the unrealized gains and losses in the Withheld Assets in OCI on its AFS, and A accounts for the corresponding changes in the Withheld Assets Payable as part of its Net Income. B records an as­ set that corresponds to A’s Withheld Assets Payable (the Withheld Assets Receivable), and B accounts for changes in the Withheld Assets Receivable as part of its Net Income.

At the end of Year 1, no Withheld Assets have been sold, and the fair market value of the Withheld Assets has increased by $10x. On A’s AFS, it in­ cludes the $10x unrealized gain in OCI and records the effect of the $10x increase in its Withheld Assets Payable in its Net Income. B records the effect of a corresponding $10x increase in its Withheld Assets Receivable in its Net Income.

(ii) Analysis . Each of A and B is a Covered Insur­ ance Company as defined in section 2.05(1) of this notice. The funds withheld reinsurance contract is a Covered Reinsurance Agreement as defined in sec­ tion 2.05(5) of this notice. The $10x of unrealized gain in the Withheld Assets is included in OCI on A’s AFS. Pursuant to section 4.02(1)(a) of this notice, to the extent the $10x of unrealized gain is not included in A’s AFSI, the amount included in A’s Net Income as a result of the $10x increase in A’s Withheld As­ sets Payable is excluded from A’s AFSI.

The amount included in B’s Net Income as a result of the $10x increase in B’s Withheld Assets Receivable corresponds to the unrealized gain in the Withheld Assets. Pursuant to section 4.02(1)(b) of this notice, this $10x increase is excluded from B’s AFSI.