An arrangement in which an unrelated company assumes risks from only one company does not qualify as insurance. In Revenue Ruling 2005- 40, situation 1, a courier transport company that owned and operated a fleet of vehicles paid a premium to an unrelated company to assume the risks of loss arising from the use of the vehicles in its business. The premium was an arms-length amount determined “according to customary insurance industry rating formulas” and the assuming company held enough capital to fulfill its obligations under the agreement.
There were no guarantees nor loans of premiums back to the courier transport company. The courier transport company was not obligated to pay additional premiums if the actual risks exceeded the premiums paid and it was not entitled to a refund if the actual losses were less than the premiums paid in any period. The parties conducted themselves in a manner that was “consistent with the standards applicable to an insurance arrangement between unrelated parties,” except that the recipient of the premiums assumed risks only from the courier transport company.
The Service concluded that the arrangement did not qualify as insurance reasoning that although the “arrangement may shift the risks of [the courier transport company], the risks [were] not distributed among other insureds or policyholders.” The facts were the same in situation 2, except that in addition to assuming the risks of the courier transport company the unrelated company assumed risks from another fleet owner that conducted a courier transport business. The second fleet owner was unrelated to the first. The amounts earned and risks transferred from the second fleet owner constituted 10 percent of the total earnings of and risks borne by the assuming company.
The Service concluded that the arrangement between the original courier transport company and the assuming company did not qualify as insurance because there was an “insufficient pool of other premiums to distribute [the courier original transport company’s] risk.” In situation 3 the courier transport business was conducted through 12 wholly owned limited liability companies (LLCs). Each LLC transfers risks and pays a specified premium to an unrelated company. The premium paid by each LLC was an arms length amount determined “according to customary insurance industry rating formulas” and the assuming company held enough capital to fulfill its obligations under the agreement. There were no guarantees nor loans of premiums back to a given LLC.
The LLC would not be obligated to pay additional premiums if the actual risks exceeded the premiums paid and it was not entitled to a refund if the actual losses were less than the premiums paid in any period. The parties conducted themselves in a manner that was “consistent with the standards applicable to an insurance arrangement between unrelated parties,” except that the recipient of the premiums only assumed risks from the LLCs.
Each of the LLCs was a “disregarded entity” under regulation section 301.7701-3, and therefore treated as branches or divisions of the LLCs’ owner. The Service concluded that the arrangements did not qualify as insurance because it covered the risks of only one entity, the LLCs’ owner.
In situation 4 , each LLC elected to be treated as an association. The Service concluded that the arrangement between each LLC and the unrelated assuming company was insurance, because each LLC transferred risks to the assuming company and distributed the risks with those of the other LLCs.
