Risk distribution
Risk distribution (or sharing), "involves the party onto whom risk is shifted distributing a portion of that risk among others." The Joint Committee on Taxation stated that the, concept of risk-distribution . . . relies on the law of large numbers. That is, within a group of a large number of individual insureds who share a similar type of risk of loss, only a certain number will actually suffer the loss within any defined period of time. When a loss is suffered by any insured, each individual insured makes a contribution through the payment of premiums toward indemnifying the loss suffered.
The underlying facts and circumstances influence whether there is sufficient risk distribution in a given transaction. In Technical Advice Memorandum 200323026,
a parent company and operating subsidiaries made payments to a related foreign captive for pollution liability coverage. Approximately two thirds of the coverage was for one of the operating subsidiaries, which "operated a small number of plants, most of which engaged in the same operations and used and stored the same chemicals."
The Service concluded that "only limited" risk distribution was present. It distinguished the Tax Court's holding in The Harper Group v. Commissioner, in which payments to an insurance captive qualified as deductible insurance premiums although as much as 71 per cent of the premiums were for related party risks. In The Harper Group the 71 per cent covered more than one related policyholder and the coverage involved "an extensive variety of cargo shipments throughout the world by a variety of means and vessels." In contrast, "two thirds of the premiums in the present case represent the pollution liability of a single insured with similar operations in a handful of locations."
