§ “…pattern evidence demonstrating that the arrangements did not take into account each participant’s risk profile could be used to show that the arrangements were not insurance. For example, if the documents demonstrated that the arrangement entered into by the other taxpayers was not tailored to those taxpayers’ individual situation and risk because the other taxpayers’ insurance documents were identical to B-1’s and C-1’s documents, this pattern evidence would demonstrate the arrangement was not “insurance”…”
Helvering v LeGriese, 312 U.S. 531 (1941) – The United States Supreme Court defines insurance as involving two components: risk shifting and risk distribution.
Revenue Ruling 77-316 (1977) – The IRS adopts the “economic family doctrine”, standing for the proposition that there is not adequate risk distribution when a parent pays insurance premiums to its subsidiary, since they are both part of the same economic family.
Humana, Inc. v. Commissioner, 881 F.2d 247 (1989) – Sixth Circuit Court of Appeals rejects the use of the “economic family doctrine” when determining whether adequate risk distribution is achieved where a parent pays premiums to a subsidiary insurer.
Harper Group and Includable Subsidiaries v. Commissioner, 96. T.C. 45 (1992) – Tax Court refuses to accept the IRS’s notion that no risk distribution exists where a parent pays premiums to a subsidiary to insure its risk in conducting business. The Court finds that there is adequate risk distribution because 30% of the subsidiary’s premiums are paid by unrelated businesses.
Revenue Ruling 2001-31 (2001) – The IRS acquiesces to the Court’s interpretation of risk distribution and abandons the economic family doctrine. However, the IRS proffers a facts and circumstances approach for future cases, and states it will continue to scrutinize such parent-subsidiary insurance relationships to determine risk distribution. The IRS looks to the following non-exhaustive list:
-Adequacy of corporate and insurance formalities;
-Performance of the subsidiary as an insurance company; and
-Ability of subsidiary to pay insurance claims.
Revenue Ruling 2002-75 (2002) – The IRS states that it will begin to issue private letter rulings regarding whether valid bona fide insurance arrangements exist between related parties.
Revenue Ruling 2002-89 (2002) – The IRS issues the first of three safe harbors aimed at determining whether adequate risk distribution has been achieved by a parent-subsidiary insurance relationship, stating that a subsidiary insurer who receives 50% of unrelated non-parent premiums has achieved adequate risk distribution, and that premiums paid by the parent are thus deductible.
Revenue Ruling 2002-90 (2002 – The IRS issues the second safe harbor ruling, stating that premiums paid by 12 subsidiaries owned by the same parent (the insurer) are deductible, as adequate risk distribution is achieved. The IRS concluded this since each subsidiary paying premiums accounted for no more than 15% of premiums paid and the payor subsidiaries conducted themselves as unrelated parties. In addition, the IRS, citing Revenue Ruling 2001-31, reinforced a number of factors affecting this determination, including the importance of adequate capital of the insuring subsidiary, ability of the insurer to pay claims and the regulation of subsidiary insurance company in the jurisdiction where it conducts its insurance business.
Revenue Ruling 2002-91 (2002) – The IRS issues the third safe harbor. The Ruling states that a group captive arrangement, which included less than 31 unrelated insured companies with each insured accounting for less than 15% of total risk insured, had achieved adequate risk distribution.
Revenue Ruling 2005-40 (2005) – The IRS states that risk distribution is not met if the insurer only insures one entity. The Ruling states further that subsidiaries which are disregarded entities owned by the same parent do not qualify as separate unrelated entities as described in Revenue Ruling 2002-90.
PLR 200907006 (2009) –IRS ruling supporting the legitimacy of a captive insurance company as true insurance where there is adequate risk distribution.
PLR 200950016 and 200950017 (2009) – The IRS states that an insurer is a bona fide insurance company; adequate risk distribution exists where insurer employs the use of a reinsurance pool to insure unrelated risk.
PLR 201030014 (2010)- IRS ruling that adequate risk distribution is met where insured operating business and captive enter into a quota share reinsurance agreement with other unrelated participants.
PLR 201126036 (2011)- This PLR creates a distinction from the Harper Group case, which ruled that 30% of unrelated risk is adequate to achieve proper risk distribution, which reinforces the IRS’s more rigid position which requires 50% of unrelated risk for proper risk distribution.
PLR201219011 (2012)- The IRS once again relies on the safe harbor rulings and confirms that participation in a reinsurance agreement by a captive insurance company is sufficient to achieve adequate risk distribution. It is noted in the ruling that reinsurance is seen by the IRS as similar to direct insurance for many purposes.
Salty Brine v. USA, Salty Brine 1, LTD, ET AL v. United States of America, 5:10CV00108 (TX U.S. Dist. Ct., North) (2012) – The District Court for the Northern District of Texas decided that the contemplated transaction did not amount to insurance because it was effectuated for pure tax avoidance purposes and to fund life insurance policies. The Court found that there were no elements of true insurance as no insurance company was established where the burden of risk was shifted. Further, none of the risk involved was distributed sufficiently to bear the burden of potential claims. The case is easily distinguishable on its facts and further shows the need for a captive insurance company to be created and run like a true insurance company (for a more detailed analysis, click the case name above).
Rent A Center – January 14, 2014
Securitas Holdings, Inc. v. C.I.R., T.C.M. (RIA) 2014-225 (T.C. 2014) – The Tax Court refuses to accept the IRS’ notion that no risk distribution exists where most of the premiums paid to a reinsurance company are attributable to related companies. The Court finds that there is adequate risk distribution because the reinsurance company was exposed to a large pool of statistically independent risk exposures resulting from the large number of employees, offices, vehicles, and services provided by the operating subsidiaries.