Captive Insurance Groups File Brief Supporting Reserve Tax Case Appeal

Wooden blocks with TAX printed on them in background with a wooden gavel on top of graphs in the foreground

March 06, 2020

Wooden blocks with TAX printed on them in background with a wooden gavel on top of graphs in the foreground

A group of 10 state captive insurance associations joined by the Self-Insurance Institute of America (SIIA) filed a friend of the court brief supporting Reserve Mechanical Corp. in its appeal of a US Tax Court insurance tax case.

In its opinion, the Tax Court concluded that Reserve's transactions did not constitute insurance for federal income tax purposes.

Filing as the Coalition to Advance Captive Insurance, the group expressed concern about three issues in the court's original ruling in Reserve Mech. Corp. v. Commissioner, 2018 Tax Ct. Memo LEXIS 87 (T.C. June 18, 2018), favoring the Internal Revenue Service. The group expressed concerns about the ruling's findings regarding prior loss history, standardized versus manuscripted policies, and risk pooling.

The group contends that the Tax Court's requiring a policyholder to have suffered a similar previous loss before a policy can be recognized as legitimate insurance is a requirement that does not exist in insurance law. "This flawed analysis puts the taxpayer in the absurd position of only being able to buy insurance after it has suffered a loss," the brief said.

The Tax Court's criticism of standardized policies and suggestion that customized manuscripted policies would be necessary for the court to conclude that policies were valid "differs from the great weight of insurance law and practice, where standardized form contracts are the norm, and manuscripted policies the narrow exception," the brief said.

Finally, the brief takes issue with the court's assessment of the risk pool in the Reserve arrangement as an improper "circular flow of funds," noting that risk pools are used regularly and a risk pool does not fail regulatory and tax tests because the premium paid into the pool equals the dollars ceded to the reinsurer.

In addition to the SIIA, the group filing the brief supporting Reserve's appeal included the Alabama Captive Insurance Association, Arizona Captive Insurance Association, Delaware Captive Insurance Association, Georgia Captive Insurance Association, Hawaii Captive Insurance Council, Kentucky Captive Association, Missouri Captive Insurance Association, Montana Captive Insurance Association, North Carolina Captive Insurance Association, and Utah Captive Insurance Association.

March 06, 2020