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"Insurance Risk" Defined by IRS

Insurance Risk Definition HT
March 07, 2016

By P. Bruce Wright and M. Kristan Rizzolo
Sutherland Asbill & Brennan LLP

The Internal Revenue Service (IRS) has recently published LTR 201609008, which held that an organization was not an insurance company and thus failed to meet the requirements of Section 501(c)(15) of the Internal Revenue Code of 1986, as amended (the "Code") to qualify as a tax-exempt entity.

In brief, according to the facts documented in the IRS publication, the taxpayer wrote a number of different policies over what appears to be a 3-year period. All of the policy periods are not included in the lengthy ruling. In each year, the taxpayer/insurer wrote between 11 and 13 policies, participated in a pooling agreement, and assumed third-party reinsurance.

Of particular interest is the ruling's focus on whether the different types of coverages provided by the captive involve insurance risk. The ruling finds only two of the coverages, weather-related business interruption and excess directors and officers liability, which involve insurance risk. The ruling concludes that the following coverages, among others, involve only business or investment risk, not insurance risk.

a.         Special Risk—Product Recall

b.         Excess Pollution Liability

c.         Special Risk—Loss of Major Customer

d.         Excess Intellectual Property

e.         Excess Employment Practices Liability

f.          Excess Cyber Risk

g.         Special Risk—Loss of Services of Key Employee

In reaching its conclusion that the organization is not an insurance company for federal tax purposes, the ruling does not appear to take into account recent Tax Court cases that address the insurance risk and risk distribution issues.

Editor's note: A more detailed analysis of this letter ruling and its implications will be published in the May issue of Captive Insurance Company Reports.

P. Bruce Wright and M. Kristan Rizzolo are partners in the Tax Department at the law firm of Sutherland Asbill & Brennan LLP, situated in New York and Washington, D.C., respectively.

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