On October 29, the U.S. Tax Court held, in Securitas Holdings, Inc. v. Commissioner, T.C. Memo 2014-
225, that a captive insurance arrangement qualified as an insurance arrangement and the insurance
premiums paid were deductible for federal income tax purposes. In so holding, the Tax Court held
both that (i) a parental guarantee by itself did not prevent the shifting of risk and (ii) the existence of
risk distribution was determined by examining the number of independent risks and not the number of
Securitas AB, a publicly traded Swedish company, owned, through a U.S. holding company, an affiliated
group of U.S. corporations and a U.S. captive insurance subsidiary. The U.S. captive insurance
subsidiary insured workers compensation, automobile, employment practice, general and fidelity risks
of the U.S. corporations and then reinsured those risks with an Irish reinsurance company owned by
Securitas. A majority of the premiums earned by the captive insurance subsidiary during one year were
paid by a single entity. The performance of the captive insurance subsidiary was guaranteed by the
U.S. holding company.
The IRS challenged this captive insurance arrangement arguing there was no risk shifting and no risk
distribution. Risk shifting requires the economic risk of loss be shifted from the insured entity to the
insurance company. The IRS argued the parental guarantee meant the economic risk of loss remained
on the insured entities and not on the captive insurance subsidiary. The Tax Court, relying on its
recent decision in Rent-a-Center v. Commissioner, held that a guarantee, by itself, is not enough to
justify disregarding a captive insurance arrangement. Instead, the entire insurance arrangement
(including any reinsurance arrangements) should be examined. In Securitas, there was adequate risk
shifting because the insurance policies were reinsured and the performance of that reinsurer was not
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guaranteed. As a result, the U.S. subsidiaries shifted their economic risk of loss from to the U.S.
captive insurance company, which then shifted the risk of loss to the Irish reinsurer.
The IRS also argued the arrangement did not have sufficient risk distribution to constitute insurance for
federal income tax purposes. Risk distribution requires the insurance company to insure a large pool of
independent risks in order to minimize the risk that a single claim will exceed the amount taken in as
premiums. Traditionally, the IRS has looked to the number of entities that have been insured and not
the number of independent risks. Relying on expert testimony, the Tax Court disagreed, holding that it
is the number of exposures that creates risk distribution and not who owns the exposures.
The Securitas decision is favorable for taxpayers considering captive insurance arrangements because it
supports the position that risk distribution can be achieved with only a few entities provided there are
sufficient independent risks.