The Internal Revenue Service (IRS) issued a private letter ruling on December 11, 2009, resolving a taxpayer’s question as to whether its business as a captive reinsurer is “insurance” for tax purposes. The IRS provides private letter rulings upon individual taxpayer request in which the IRS interprets and applies tax law to a taxpayer’s specific set of facts. Private letter rulings bind only the IRS and the taxpayer in regards to the specific set of facts involved in the ruling.

In this case, a group of individuals formed a captive which ultimately reinsured risks associated with entities owned by the same individuals, as well as risks associated with entities owned by unrelated individuals but in the same industry. The fronting insurer retained retained some risk and reinsured a portion of the risk with unrelated reinsurer A. Reinsurer A in turn retained some of the risk and in turn reinsured a portion of the risk with an offshore segregated cell company, Reinsurer B. Reinsurer B in turn ceded a portion of the risk to the captive through a quota share reinsurance arrangement. This arrangement allowed the captive to share a proportional amount of the losses covered by the contracts of insurance underwritten by the fronting insurer. The IRS concluded that there was risk shifting and risk distribution because even thought the insureds were in the same industry, the number of unrelated parties involved was sufficient to achieve the level of risk distribution necessary to be treated as insurance for tax purposes.

The cite for this private letter ruling is 200950017, which may be found at the IRS website here. Please contact our tax partner, G.Scott Nebergall, if you have any questions about this ruling.