8 January 2004 Internal T.I. 2003-0035797 - REINSURANCE RESERVES

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

Should a reinsurer calculate its policy reserves using the pre-1996 or the post-1995 rules where pre-1996 life insurance policies are the subject of the reinsurance contract?

Position: Generally, the post-1995 rules should be used.

Reasons:

Based on the Agency's position that a reinsurance agreement is a "life insurance policy" and a "life insurance policy in Canada" where the underlying policies are "life insurance policies in Canada" and further to discussions with the Department of Finance, we have reconsidered our position as stated in E1999-001593 and we are now of the view that generally a reinsurer which has reinsured pre-1996 life insurance policies after 1995 should apply the post-1996 rules in computing its policy reserves in respect of those policies.

								January 8, 2004

	TORONTO EAST TSO					HEADQUARTERS
									Financial Institutions Section
	Attention:  Soon Yee						J. Leigh
		     Insurance Industry Specialist			(613) 952-1505

2003-003579

Reinsurance Reserves

This is in reply to your memorandum of August 27, 2003 concerning the issue of whether a reinsurer which has reinsured pre-1996 life insurance policies should compute its policy reserves using the pre-1996 or post-1995 rules.

By way of general comment in Rulings document E1999-0015937, we expressed the view that since the insurer of the pre-1996 life insurance policies calculates its reserves using the pre-1996 rules, the reinsurer of the risks under those policies should use the same rules. We also indicated that before we would consider the potential application of the post-1995 rules to reinsured pre-1996 life insurance policies in a particular fact situation, we would need to reconsider whether a reinsurance agreement is a "life insurance policy" and a "life insurance policy in Canada" as defined in subsection 138(12) of the Income Tax Act (the "Act").

You advise that a taxpayer currently under audit disagrees with our view as expressed in that document. As we understand it, the taxpayer is the reinsurer under a reinsurance agreement ("Agreement") with a life insurer with a commencement date of December 31, 1999. The Agreement is a single premium yearly renewable term, indemnity reinsurance agreement reinsuring 100% of the excess of the life insurer's risk over its retention on the reinsured business. Pursuant to the terms of the Agreement, the taxpayer will be liable only to the life insurer and the policyholders do not have a legal contract with the taxpayer. Only the life insurer will be liable to the holders of the underlying policies. The Agreement covers a block of universal life insurance policies in force as of December 31, 1999, each of which was issued or effected on the lives of persons resident in Canada prior to 1996. The taxpayer's position is that the Agreement is a "life insurance policy" and a "life insurance policy in Canada" and that it would be appropriate for the taxpayer to use the post-1995 rules to calculate its reserves. In this regard, you have asked us to review the taxpayer's submission and provide any comments that we may have on the matter.

As previously stated, it is not clear that a reinsurance agreement would in fact be a "life insurance policy" or a "life insurance policy in Canada" under the Act. While it is reasonable to conclude that a reinsurance contract is an insurance policy, it is less clear whether the reinsurance contract is a life insurance policy. Under an indemnity reinsurance contract, the reinsurer is not insuring the lives that are the subject of the policies issued by the ceding company but rather is providing insurance to the ceding company with respect to the risks that it has assumed. It seems to us that the subject matter of any reinsurance contract can only be determined after a review of the terms of the particular contract. However, as a practical matter, generally the Agency has to date accepted the position that a reinsurance agreement would be considered a "life insurance policy" and a "life insurance policy in Canada" where the underlying policies are "life insurance policies in Canada". At this point, we are prepared to maintain this position. Therefore, consistent with this position, we would consider a reinsurance contract issued after 1995 to be a "post-1995 life insurance policy" as defined in subsection 1408(1) of the Income Tax Regulations ("the Regulations") where the underlying policies are "life insurance policies in Canada" for the purposes of subparagraph 138(3)(a)(i) of the Act and section 1404 of the Regulations.

The difficulty, in our view, is that generally the reserve provisions were not drafted with reinsurers in mind and therefore reinsurance contracts do not readily fit within these provisions. For instance, a reinsurance contract may not provide for cash surrender values but rather it is the underlying policies that are the subject of reinsurance that provide for these. Our understanding of industry practice is that generally the reinsurer relies on the ceding company to provide certain information relating to the underlying policies such as gender, age, smoker/non-smoker, etc. and then uses its own assumptions with respect to interest rates, mortality, lapse rates, etc. applicable at the time the reinsurance contract was issued to calculate its policy reserves.

To ascertain the policy intent in a situation such as this, we consulted informally with officials from the Department of Finance who concurred that having the post-1995 rules apply to a reinsurance contract issued after 1995 would not appear to be an inappropriate result, notwithstanding that pre-1996 life insurance policies are the subject of the reinsurance contract.

Given that there are no specific rules in the Act dealing with reserve calculations for reinsurers and in light of our discussions with the Department of Finance, we are now of the view that, in general, a reinsurer, which has entered into a reinsurance contract after 1995 to reinsure on an indemnity basis the risks to the ceding company under pre-1996 life insurance policies, can use the post-1996 rules to compute its policy reserves in respect of those pre-1996 life insurance policies.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

We hope that our comments will be of assistance.

F. Lee Workman
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings Directorate