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Proposed Captive Insurance Settlement Was Reasonable


FSA 1993-1034

DATED
DOCUMENT ATTRIBUTES
  • Institutional Authors
    Internal Revenue Service
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    business expense deduction, captive insurance companies
  • Industry Groups
    Insurance
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 1999-2475 (4 original pages)
  • Tax Analysts Electronic Citation
    1999 TNT 95-22
Citations: FSA 1993-1034

 

INTERNAL REVENUE SERVICE

 

MEMORANDUM

 

CC:* * *

 

DOM:FS:* * *

 

 

date: * * *

 

 

Regional Counsel * * * CC:* * *

 

to: Attn:* * *

 

 

from: Assistant Chief Counsel (Field Service) CC:DOM:FS

 

 

subject: * * *

 

 

[1] This is in response to your request for our views on the settlement offer you intend to make to the taxpayer in the case identified above.

 

ISSUE

 

 

[2] Whether, on the facts of this case, a settlement pursuant to which the taxpayer concedes the "captive insurance" adjustments in the first year and the Service concedes the "captive insurance" adjustments in the second year is an appropriate disposition of the case.

 

FACTS

 

 

[3] * * * is a * * * corporation engaged in the telephone communications services business. It is the sole shareholder of * * * a * * * corporation incorporated * * * Coverage for workers' compensation, automobile, and general liability insurance was purchased for * * * and its operating subsidiaries from * * * a third party domestic insurance company, and * * * reinsured this coverage with * * * also participated in an underwriting pool comprised of risks of unrelated parties.

[4] The relative amount of * * * third party business is in dispute. The Service contends that unrelated business comprises only * * *% of the captive's total business in * * * and only * * * of the captive's total business in * * * Petitioner maintains that the unrelated business was * * * of * * * total business and * * *% of * * * total business. The Service's figures are derived from the amounts reported as unrelated premium income on * * * financial statements for each year in issue. Petitioner bases its figures on an accounting method it characterizes as an "underwriting method" of accounting.

[5] According to the petitioner's interrogatory answer, under the "underwriting method" of accounting, the taxpayer keeps the underwriting year open until it obtains all of the premium information from the reinsured companies. "This process will normally take many years. Therefore, . . . the underwriting year remains open and premiums are adjusted as information is obtained as to the ultimate amount of the premiums to be received by the reinsurance company for a particular underwriting year."

[6] Based in part on the fact the government bears the burden of proof on this issue in the instant case and in part on the recent affirmance of our losses in Ocean Drilling & Exploration Co. v. United States, No. 92-5127 (Fed. Cir. March 9, 1993), aff'g 24 Cl. Ct. 214 (1991); Sears. Roebuck and Co. v. Commissioner, 972 F.2d 858 (7th Cir. 1992) aff'g in part and rev'g in part 96 T.C. 45, modified, 96 T.C. 671 (1991); The Harper Group v. Commissioner, 979 F.2d 1341 (9th Cir. 1992), aff'g 96 T.C. 45 (1991); and AMERCO v. Commissioner, 979 F.2d 162, aff'g 96 T.C. 18 (1991), in which the percentage of unrelated business insured by the captive ranged from 29% to 99%, you have proposed * * *

[7] The basis of our losses in the aforementioned cases has been the "significant" amount of unrelated business insured by the captives, and the courts have distinguished these cases from previous cases we have won on this fact. The courts have not, however, told us how much unrelated business is sufficient to qualify the related party business as insurance. Despite this lack of guidance from the courts, we think it is very unlikely that the Tax Court would hold for the petitioner in this case if the Tax Court agrees with our assessment of the amount of unrelated business.

[8] We interpret petitioner's description of its accounting method to mean that it waits until it has received all of the information reported to it for a particular accident year to determine its earned premiums for that accident year, even if the information is received several years after the end of the accident year. That is, petitioner seems to be arguing that it is entitled to wait until the original insurer has ascertained its actual total losses incurred for a particular year, and therefore its total premiums earned for (as opposed to in) that accident year before petitioner is required to report its premiums earned for and in that accident year.

[9] You have not asked for our views on the taxpayer's method of accounting, but we agree with your determination that this method of accounting appears to conflict with the provisions of section 832 as well as with the "annual accounting" rule. In addition, the taxpayer's method of accounting is not the "underwriting year" method of accounting for reinsurers described in the insurance literature. 2 * * * This will probably require expert statistical advice.

 

CONCLUSION

 

 

[10] We agree your settlement proposal is reasonable on the facts of this case, and we have no objection to a resolution of the case on such a basis. If you have any questions, please call * * * at (202) 622-7870.

[11] This document may include confidential information subject to the attorney-client and deliberative process privileges, and may also have been prepared in anticipation of litigation. This document should not be disclosed to anyone outside the IRS, including the taxpayer(s) involved, and its use within the IRS should be limited to those with a need to review the document in relation to the subject matter or case discussed herein.

By: Daniel J. Wiles

 

Field Service Division

 

 

Attachment: Copy of reinsurance accounting article

 

FOOTNOTES

 

 

1 In AMERCO, petitioner's expert, Nail Doherty, advised the Tax Court that a captive probably needed at least 20% unrelated business to provide insurance to the related parties.

2 We have enclosed a copy of a chapter from Strain, Property -- Liability Insurance Accounting, that addresses reinsurance accounting. It defines "underwriting year" as "similar to the calendar year method used in the U.S. since both methods include underwriting experience from a twelve-month period. The difference, however, is that the calendar year method includes experience starting on January 1 of a given calendar year and ending on December 31. The underwriting year, on the other hand includes experience for twelve months starting with the inception date of the reinsurance treaty."

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Institutional Authors
    Internal Revenue Service
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    business expense deduction, captive insurance companies
  • Industry Groups
    Insurance
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 1999-2475 (4 original pages)
  • Tax Analysts Electronic Citation
    1999 TNT 95-22
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