The Reserve Mechanical US Tax Court case offers the captive insurance industry many opportunities to mature, according to Ryan Work, vice president, government relations at Self-Insurance Institute of America (SIIA).
The opinion in the Reserve Mechanical v Commissioner of Internal Revenue was that PoolRe, a risk pool operated by Capstone, did not effectively provide risk distribution and was therefore not a “bona fide insurance company”.
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.
Work disagreed with the court’s stance on several issues in the case and said SIIA was concerned by a number of factors, including the stance on pool reinsurance products and the court’s singular use of the Avrahami case vis a vis past captive cases.
He added: “The idea, which was mentioned by the court in its opinion, that a policy without a claim in five years does not constitute insurance is also concerning.”
Work said he was surprised by the court’s ruling but that it represented an opportunity for the industry to grow and adapt.
He explained: “Every setback is also an opportunity and I think and there is no doubt that in different court cases, whether the industry wins or loses, that people are dissecting them and figuring out what the Internal Revenue Service (IRS) is looking at and what they can do better as a captive owner or manager.”
“The IRS is going to lean more and more on cases like Reserve and Avrahami, and I think in the future as people tighten up their captives they need to ensure that they’re following the highest standards they can.”
“At the same time we all, including the IRS and the courts, have to realise that each captive is different and we can’t treat a future captive case like it’s the same structure as Avrahami or Reserve.”
Work suggested that the upcoming change in commissioner could impact the IRS’s current campaign against captive insurance.
Charles Rettig, who has been nominated as the next IRS commissioner, appeared before the US Senate for his confirmation hearing on the 28 June.
Work said: “I can’t say one way or another specific to captives, but in Charles Rettig’s confirmation process in the Senate a couple of weeks ago he said that he would review whether the IRS’s campaigns are appropriately designating limited IRS resources, and whether they’re focusing on things that, at the end of the day, aren’t priorities for them.”
“It will be interesting in the next few months to see how Rettig approaches these types of issues within the Service whether some of these campaigns are repriotised.”
According to Work, the Reserve case represents one step on a longer path toward a point where the IRS, the industry and the court all share an understanding about the captive market.
He commented: “My hope is eventually we are going to get to an endgame where the Service and the court better understands the captive market and, in turn, the market matures in the way it needs to.”
“There is a dichotomy in US Tax court about their opinions of tax-favoured entities in general, not necessarily just for captive cases, if you go back to previous cases and you see different circuits of the US Tax Court having vastly different opinions.”
“I think in a lot of tax cases, depending what circuit you get, they’re going to have different opinions on captives, which is why it is important to see if there is going to be an appeal process in this case and what that might mean.”