Notice 2016-32: Diversification requirements for insurance companies under section 817(h)

Diversification requirements for insurance companies

The IRS today released an advance version of Notice 2016-32 that provides guidance to taxpayers regarding the diversification requirements under section 817(h) for a segregated asset account that invests in a government money market fund (MMF).

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Read Notice 2016-32 [PDF 78 KB]


The IRS notice provides an alternative diversification criterion so that a segregated asset account that invests in a government MMF can meet the diversification requirement. Therefore, the IRS and Treasury Department have determined that variable contracts should be able to offer government MMFs as an investment option and Reg. section 1.817-5 is intended to be amended to reflect this.

Notice 2016-32

Notice 2016-32 provides the following:  

  • Generally, the policyholder of a variable contract may select among various investment strategies each of which results in investment in different groups of assets. Each of these groups may be a segregated asset account within the meaning of Reg. section 1.817-5(e) and each segregated asset account must be adequately diversified within the meaning of section 817(h).
  • An MMF is a type of investment company registered under the Investment Company Act of 1940 (1940 Act) and regulated as an MMF under Rule 2a–7 under the 1940 Act (17 CFR 270.2a–7).  
  • Rule 2a–7 defines a government MMF as an MMF “…that invests 99.5 percent or more of its total assets in cash, government securities, and/or repurchase agreements that are collateralized fully [by cash items or government securities].” 
  • Pending the promulgation and effective date of future administrative or regulatory guidance, taxpayers may rely on the alternative diversification requirement under Reg. section 1.817-5 for a segregated asset account that invests in a government MMF if: (1) no policyholder has investor control; and (2) either—(a) the account either is itself a government MMF under Rule 2a-7(a)(14), or (b) the account invests all of its assets in an “investment company, partnership, or trust” as defined in Reg. section 1.817-5(f)(1) that satisfied the criteria of Reg. section 1.817-5(f)(2) and qualifies as a government MMF under Rule 2a-7(a)(14).

KPMG observation

In July 2014, the Securities and Exchange Commission (SEC) adopted new rules, effective on October 14, 2016, under which the only money market funds that will use a stable net asset value and will not be subject to fees and gates will be government money market funds. With today’s notice, the IRS and Treasury have adopted a practical interpretation of the section 817(h) diversification requirement that allows life insurance companies to issue variable policies with the option to invest in stable net asset value money market funds with no fees or gates.  

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