On May 8, 2014, the IRS released Rev. Rul. 2014-15 (available here). The ruling provides guidance to the growing number of employers electing to insure or re-insure employee benefits through captive insurance arrangement. The ruling considers an arrangement by a corporation (CORP-X) to provide health insurance benefits to CORP-X’s retirees through a captive arrangement. The benefits are provided on a voluntary basis (CORP-X has no obligation to provide the benefits) through a Voluntary Employees Beneficiary Association (VEBA) plan funded by CORP-X. The VEBA acquires insurance coverage for the retiree health benefits from an unrelated insurance company. The IRS ruling states that the participation of the unrelated insurance company in the arrangement is a condition of an exemption from certain prohibited transaction provisions of ERISA. The unrelated insurance company reinsures 100% of the risk with a captive insurance company wholly-owned by CORP-X. The re-insurance contract is the captive’s only contract.
While the IRS has never defined “insurance” in its code or regulations, the IRS follows the definition of insurance set forth in the US Supreme Court case of Helvering v. Le Gierse, 312 U.S. 531, 539 (1941). In that case, the court held that in order for an arrangement to constitute insurance for federal income tax purposes, the arrangement must include risk shifting and risk distribution. In the most recent ruling, the IRS takes the position that the risk being insured is a benefit provided to the retired employees and their dependents; specifically, the risk being insured is not CORP-X’s risk. Therefore, the risk being insured by the captive is considered to be 100% “unrelated” to the risk of CORP-X (the captive’s parent). As 100% of the risk in the captive is unrelated, the arrangement satisfies the test for risk distribution. As a result of such risk distribution and other facts set forth in the ruling, the IRS concludes that (i) the reinsurance contract between the captive and the unrelated insurance company is an insurance contract, and (ii) the captive is an insurance company.