New blow for small captives in Reserve Mechanical
“The secret to a valid
captive insurance programme
is to insure real risks.”
Captive Management, who said that
much like Avrahami, this case will be
studied for years.
“The secret to a valid captive
insurance programme is to insure
real risks and act like an insurance
company,” said Queen. “That is the
big takeaway from the new holding
issued by the US Tax Court in the
matter of Reserve Mechanical Corp v
Commissioner, TC Memo 2018-86.”
As Queen highlighted, each policy had
contained language indicating that the
coverages offered by the policy were
excess over any other valid insurance
policies. The insured maintained third
party insurance contracts to provide
‘real’ insurance for the insured entities.
During the three years at issue, the
policies paid out only a single claim.
“Said claim had no documentation,
no investigation, and basically
functioned as a reimbursement for the
insured parties,” said Queen.
The opinion also suggested that
IN A DECISION that may place small
captive insurance companies under
further scrutiny, the US Tax Court has
ruled in favour of the Internal Revenue
Service (IRS) in the case of Reserve
Mechanical Corp v Commissioner.
Following the case of Avrahami
v Commissioner, this new case
concerns an underground mining
company—Peak Mechanical &
Components—that set up a captive
insurance company to insure a variety
of enterprise risks.
In order to comply with the IRS’s
various risk distribution requirements,
the captive participated in a complex
risk-pooling arrangement in order to
secure at least 30 percent third party
premium in the captive. The risk pool,
PoolRe Insurance, was operated by
Capstone Associated Services.
On June 18, Judge Kerrigan
determined that the captive was not a
valid insurance arrangement based on
language issues in its coverages, and
the fact there was only one single claim
in the three years at issue, along with
ineffective risk distribution.
Captive International spoke with
Matthew Queen, general counsel and
chief compliance officer at Venture
risk distribution had artificially been
created through a risk-less risk pool.
“While the premium mathematics
complied with captive court precedent,
the failure to operate in a manner
befitting a standard insurance company
indicated that the risk pool was really
designed to assist with creating a tax
shelter instead of a valid insurance
arrangement,” Queen commented.
Reserve and Capstone Associated
have both criticised the Court’s opinion,
and in particular the Court’s reliance in
deciding this on the Avrahami opinion.
They said the opinion does “a
disservice” to the captive industry
and “bona fide captive insurance
companies like Reserve”.
In their statement, they said: “Reserve
had no loans, participated in a
diversified pool, assumed unaffiliated,
third-party reinsurance, reported
and paid substantial losses, and had
policies that were designed to meet
the needs of the underground mining
business that it insured.
“Additionally, a series of recognised
experts, including an insurance
commissioner, two credentialled
actuaries, an independent auditor,
a nationally-renowned insurance
economist and an underwriter, all
testified on behalf of Reserve with
scant testimony from the government’s
witness—whose testimony the
government admitted was discredited
on the stand.
“Oddly, the Court rejected the
p rof e s s i o n a l ly - a d m i n i s t e red
pooling arrangement which involved
hundreds of third party insureds and
hundreds of policies as being ‘circular’,
evidencing an unexpected rejection of
a fundamental industry standard risk-sharing
mechanism dating back more
than a century.
“The Court rejected Reserve’s third-party
reinsurance programme which
was fully in evidence because the more
than 100,000 underlying direct written
policies from a recognised admitted
carrier were not put into evidence but
were only the subject of unchallenged
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