Will Rev. Rul. 2014-15 expand the use of captive insurance companies?

• Author: Bakale, Anthony S.

On May 9, the IRS issued Rev. Rul. 2014-15, which analyzes an economic arrangement to determine whether it constitutes insurance. The proper characterization of an arrangement may determine whether the issuer qualifies as an insurance company for federal income tax purposes and when amounts paid under such an arrangement are deductible. This ruling is significant because rising health care costs are causing many companies to strongly consider self-insured medical plans using captive insurance companies.

Facts

A domestic corporation provided health care benefits to a large group of retired employees and their dependents through a voluntary employees' beneficiary association (VEBA). The corporation made contributions to the VEBA to insure the costs of the health benefits, and these contributions were deducted in accordance with Secs. 419 and 419A. Neither the corporation nor the VEBA was legally obligated to provide these benefits and could cancel coverage at any time.

The VEBA entered into an insurance contract with an unrelated insurance company to cover the cost of providing these benefits. The contract provided that the insurance company would reimburse the VEBA quarterly for payments it made related to claims made by the covered retirees. The unrelated insurance company was taxable as a life insurance company under Sec. 801 and was regulated by the relevant state insurance commissioner. In an effort to keep contract premiums affordable, the insurance company entered into a reinsurance contract with a wholly owned subsidiary of the domestic corporation (a captive insurance company). The subsidiary was regulated under state law as an insurance company, and the reinsurance contract was regulated as insurance. The subsidiary was paid premiums by the insurance company and, in turn, reinsured 100% of the insurance company's liability under the contract with the VEBA.

Premium payments were considered made on an arm's-length basis in accordance with applicable insurance industry standards. The subsidiary maintained adequate capital to fulfill its obligations under the contract. Neither the former employer nor the VEBA was required to reimburse the subsidiary for its obligations under the reinsurance contract. The subsidiary was not required to loan any premium payments back to the VEBA or to the former employer. In all respects, the parties conducted themselves consistently with an insurance arrangement between unrelated parties.

Law

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