The United States Tax Court denied deductions for premiums paid to off-shore insurance companies, and determined, among other things, that elections under IRC Section 831(b) were invalid, as the amounts paid did not qualify as insurance premiums for federal income tax purposes.
The fact pattern for this case is not indicative of how compliant captive insurance companies are currently structured or managed. The Tax Court found that the captive’s direct insurance arrangement fell short on risk distribution, as it failed to meet the minimum requirements for a valid structure. The Court also concluded that the terrorism coverage utilized in the policy was drafted in a manner that made claims highly unlikely. For this, and other reasons, the Court also found the risk pool was not a bona fide insurance company.
The Court also determined that the arrangement did not constitute insurance in the commonly accepted sense. In reaching this conclusion, the Court found that the pricing was not realistic, claims were not made until after an audit was initiated, claims were not addressed in an orderly fashion, and the insurance policies were internally inconsistent.
This Tax Court decision is great news for the captive industry as it brings clarity to the use of 831(b) arrangements and helps highlight features of non-compliant programs. It provides a clear picture of what “not to do” when structuring and managing a micro-captive arrangement, and also provides additional clarity and reaffirmation of many of the best practices employed by Oxford Risk Management Group.