Capstone has released a second response to the opinion of the US Tax Court in the Reserve Mechanical Corporation v Commissioner of Internal Revenue case.
The court’s opinion was that PoolRe was not a “bona fide insurance company” and did not effectively provide risk distribution.
This absence of risk distribution meant that the transactions of Reserve Mechanical, for whom PoolRe was listed as the stop-loss insurer, in the tax years in issue (2008, 2009 and 2010) were not insurance transactions.
In Capstone’s response, it asked whether captive insurance exists after the decision, and offered a series of commentaries on the tax court’s decision in the Reserve case.
The first commentary focused on the Capstone’s dispute of the court’s view that if a business had not experienced actual losses in an area of coverage, then no non-tax reason exists for acquiring insurance.
Capstone argued that this would “appear to be fundamentally inconsistent with longstanding practices” and “no basis in the business community or the insurance industry”.
The statement added: “What is being insured against is the fortuitous risk of future losses, not the fear of a reoccurrence.”
According to Capstone, in the case of Reserve’s insureds, which has facilities located within one of the country’s largest Superfund sites, the court appears to have looked on the absence of prior pollution as negating the ability of the insureds to deduct prospective pollution coverage.
Capstone added: “Because there was no proof that any of the insurance policies covered losses previously experienced, the court concluded that no non-tax reason existed for the insurance.”
“By extension, broad-based business interruption coverage and employment practices liability insurance–both provided through Reserve–would not in the court’s view be insurance given that there was no history of prior losses.”
The second commentary discussed the court’s characterisation of coverages as ‘excess insurance’.
In the commentary, Capstone suggested that the court had erroneously concluded that the captive coverages, which were distinct from and didn’t duplicate any commercial coverages, were not obtained for non-tax reasons because the insured had never exhausted the commercial policies in any year, despite the commercial policies covering distinct and separate risks from the policies issued by the captive.
Capstone claimed that the court’s focus on this excess issue was, misplaced as each and every one of the direct policies Reserve issued covered insurance risks for which the insured had no underlying coverage.
In the statement, Capstone added: “Each of the direct policies issued by Reserve represented the primary (first layer) coverage and did not provide coverage that was “excess” over any other commercial or captive insurance.”
“The court concluded that this excess’ language, even in the absence of a duplicative underlying commercial policy, was fatal to a finding of insurance for federal income tax purposes.”
Capstone also felt that despite the court taking testimony from seven experts and three witnesses from Reserve’s side and only one expert witness from the government’s side the court decision appeared to be taken on “its own understanding of the insurance industry without discussing the evidence presented”.
Additionally, it argued that the decision “appears to have rejected established norms, introducing newly articulated concepts that formed the basis for what the court considers insurance for federal income tax purposes”.
The third and final commentary in the statement emphasised Capstone’s surprise in the court’s apparent requirement that to be valid insurance the policies should be individually drafted and not be based on forms.
Capstone explained: “The court appeared to call for an unrealistic approach in requiring that policies be individually manuscripted and negotiated for each insured.”
“In these regards, the court has a wholly different understanding of how a business should conduct itself regarding insurance issues.”
Capstone argued that the court had apparently viewed policy contracts being based on forms as another “fatal factor”, while they suggested this was ubiquitous in the insurance industry.
It also referenced the court’s issue that the policies were copyrighted, and stated: “The court did not address how it is possible to pool or share risk among unaffiliated insureds using a hodgepodge of individually negotiated contractual coverages.”
“The court appeared to call for an unrealistic approach in requiring that policies be individually manuscripted and negotiated for each insured.”
“In these regards, the court has a wholly different understanding of how a business should conduct itself regarding insurance issues.”
Click here to read the full commentary.