Rev. Rul. 68-27

Advice has been requested whether an organization engaged in issuing medical service contracts under the circumstances described below qualifies as an insurance company within the meaning of the Internal Revenue Code of 1954.

An organization issues medical service contracts to various groups and individuals who prepay the contract price at fixed monthly rates. The organization furnishes a medical clinic staffed with salaried physicians, nurses, and technicians to provide a major portion of the medical services contracted for, which includes care for the injured or the sick as well as preventive care. When the clinic is unable to perform the medical services contracted for either because the injury or illness occurs in another geographical area or because a special type of treatment is required that the clinic is unable to provide, or because hospitalization is required, the organization pays the entire cost of such services.

The organization is under the jurisdiction of the insurance commissioner of the state in which it is organized, and is classified under state law as a health care service contractor. Under the law of that state, a health care service contractor is not deemed to be engaging in the insurance business and is not subject to the laws relating to insurance companies. However, the organization is obligated to include within its agreements provisions for reimbursements or indemnity of subscribers paying for services which the contractor is unable to perform. The agreements must be underwritten by an authorized insurance company, or guaranteed by an authorized surety, or guaranteed by a deposit of cash or securities of a designated amount. The financial operations of the organization disclose that a predominant portion of its expenses relates to the service feature and only a minor portion relates to the dollar indemnity feature.

For purposes of part I of subchapter L of the Code, section 1.801-3(a) of the Income Tax Regulations defines an insurance company, in part, as follows:

(1) The term `insurance company' means a company whose primary and predominant business activity during the taxable year is the issuing of insurance or annuity contracts * * *.

The meaning of the term `insurance company' as defined in the regulations cited above is equally applicable to insurance companies other than life. See sections 1.831-1(a) and 1.831-3(a) of the regulations.

In terms of the definition in the regulations, a predominant activity of an organization qualifying as an insurance company must be the issuing of insurance contracts.

An insurance contract must involve the element of shifting or assuming the risk of loss of the insured and must, therefore, be a contract under which the insurer is liable for a loss suffered by its insured. See Jordan, Superintendent of Insurance v. Group Health Association , 107 F.2d 239 (1939), and State ex rel. Fishback, Insurance Commissioner v. Universal Service Agency , 87 Wash. 413, 151 P. 768 (1915). With respect to the preventive phase of the medical service contract issued by the organization there is no hazard or peril insured against. With respect to the sick or disabled phase of the contract, although an element of risk exists, it is predominantly a normal business risk of an organization engaged in furnishing medical services on a fixed-price basis, rather than an insurance risk. As a result of illness or disablement, the contracting organization generally does not incur any expense other than that which it incurs in providing the medical services through a salaried staff of physicians, nurses, and technicians.

Since the essential element of an insurance contract is lacking, the medical service contract issued by the organization is not a contract of insurance. Therefore, the predominant business activity of the organization is not the issuance of insurance contracts.

Accordingly, the organization does not qualify as an insurance company within the meaning of the Code.