Amount of reduction
(3) Amount of reduction. The reduction required by this paragraph (g)(3) equals the amount obtained by dividing (i) The portion of the capitalization shortfall (as defined in paragraph (g)(4) of this section) allocated to the reinsurance agreement under paragraph (g)(7) of this section; by (ii) The applicable percentage set forth in section 848(c)(1) for the category of specified insurance contracts reinsured by the agreement. (4) Capitalization shortfall. A capitalization shortfall equals the excess of (i) The sum of the required capitalization amounts (as defined in paragraph (g)(5) of this section) for all reinsurance agreements (other than reinsurance agreements for which an election has been made under paragraph (h)(3) of this section); over (ii) The general deductions allocated to those reinsurance agreements, as determined under paragraph (g)(6) of this section. (5) Required capitalization amount(i) In general. The required capitalization amount for a reinsurance agreement (other than a reinsurance agreement for which an election has been made under paragraph (h)(3) of this section) equals the amount (either positive or negative) obtained by multiplying (A) The net positive or negative consideration for an agreement not described in paragraph (h)(2) of this section, and the net positive consideration for an agreement described in paragraph (h)(2) of this section, but for which an election under paragraph (h)(3) of this section has not been made; by (B) The applicable percentage set forth in section 848(c)(1) for that category of specified insurance contracts. (ii) Special rule with respect to net negative consideration. Solely for purposes of computing a party's required capitalization amount under this paragraph (g)(5) (A) If either party to the reinsurance agreement is the direct issuer of the reinsured contracts, the party computing its required capitalization amount takes into account the full amount of any net negative consideration without regard to any potential reduction under paragraph (g)(3) of this section; and (B) If neither party to the reinsurance agreement is the direct issuer of the reinsured contracts, any net negative consideration is deemed to equal zero in computing a party's required capitalization amount except to the extent that the party with the net negative consideration establishes that the other party to that reinsurance agreement capitalizes the appropriate amount. (6) General deductions allocable to reinsurance agreements. An insurance company's general deductions allocable to its reinsurance agreements equals the excess, if any, of (i) The company's general deductions (excluding additional amounts treated as general deductions under paragraph (g)(8) of this section); over (ii) The amount determined under section 848(c)(1) on specified insurance contracts that the insurance company has issued directly (determined without regard to any reinsurance agreements). (7) Allocation of capitalization shortfall among reinsurance agreements. The capitalization shortfall is allocated to each reinsurance agreement for which the required capitalization amount (as determined in paragraph (g)(5) of this section) is a positive amount. The portion of the capitalization shortfall allocable to each agreement equals the amount which bears the same ratio to the capitalization shortfall as the required capitalization amount for the reinsurance agreement bears to the sum of the positive required capitalization amounts. (8) Election to determine specified policy acquisition expenses for an agreement without regard to general deductions limitation(i) In general. The reduction specified by paragraph (g)(3) of this section does not apply if the parties to a reinsurance agreement make an election under this paragraph (g)(8). The election requires the party with net positive consideration to capitalize specified policy acquisition expenses with respect to the reinsurance agreement without regard to the general deductions limitation of section 848(c)(1). That party must reduce its deductions under section 805 or section 832(c) by the amount, if any, of the party's capitalization shortfall allocable to the reinsurance agreement. The additional capitalized amounts are treated as specified policy acquisition expenses attributable to premiums and other consideration on the reinsurance agreement, and are deductible in accordance with section 848(a)(2). (ii) Manner of making election. To make an election under paragraph (g)(8) of this section, the ceding company and the reinsurer must include an election statement in the reinsurance agreement, either as part of the original terms of the agreement or by an addendum to the agreement. The parties must each attach a schedule to their federal income tax returns which identifies the reinsurance agreement for which the joint election under this paragraph (g)(8) has been made. The schedule must be attached to each of the parties' federal income tax returns filed for the later of (A) The first taxable year ending after the election becomes effective; or (B) The first taxable year ending on or after December 29, 1992. (iii) Election statement. The election statement in the reinsurance agreement must (A) Provide that the party with net positive consideration for the reinsurance agreement for each taxable year will capitalize specified policy acquisition expenses with respect to the reinsurance agreement without regard to the general deductions limitation of section 848(a)(1); (B) Set forth the agreement of the parties to exchange information pertaining to the amount of net consideration under the reinsurance agreement each year to ensure consistency; (C) Specify the first taxable year for which the election is effective; and (D) Be signed by both parties. (iv) Effect of election. An election under this paragraph (g)(8) is effective for the first taxable year specified in the election statement and for all subsequent taxable years for which the reinsurance agreement remains in effect. The election may not be revoked without the consent of the Commissioner. (9) Example. The principles of this paragraph (g) are illustrated by the following examples.