The Tennessee Captive Insurance Association (TCIA) has provided a detailed response to the most recent IRS Notice which proposed new “micro-captive” regulations.
Captive Intelligence reported in April the IRS had proposed new regulations for “micro captives” at the same time as obsoleting Notice 2016-66, having had it struck down by the courts in March 2022.
The proposed regulations for 831(b) captives have divided opinion across America’s captive landscape, with some saying they could destroy the industry, while others have branded it a refreshing change.
Under the Notice, the IRS proposed regulation which would see certain micro-captive transactions deemed “listed transactions” and other micro-captive transactions labelled “transactions of interest”.
The TCIA believes that under the current listed transaction proposals, a micro-captive could meet all four parts of the framework established by federal case law and still qualify as a listed transaction.
“If a micro-captive meets the four parts of the framework established by federal law, it is an insurance company under federal law and entitled to make an election under IRC § 831(b) by act of congress,” the TCIA said.
“The IRS does not have the authority to overturn federal case law precedent via IRS regulations.”
The full comments from the TCIA can be found here.
65% loss ratio
As part of the IRS Notice, the majority of captives that record a loss ratio under 65% would be considered a “listed transaction”.
The 65% loss ratio calculation and limit has attracted the attention of many across the US captive market since it is not uncommon for captives, whether taking the 831(b) tax election or not, and commercial insurers to perform at or better than that level.
The TCIA noted that under the McCarran Ferguson act, states have the authority to regulate insurance unless Congress specifically passes a law stating otherwise, and therefore, only an act of Congress can establish a loss ratio requirement.
“The IRS should not attempt to impose a 65% loss ratio on micro-captive transactions as only Congress has the authority to impose loss ratios on the insurance industry under the McCarran Ferguson act,” the TCIA said.
The TCIA also said that the proposed regulation presents a situation whereby a micro-captive will always be severely restrained in its ability to charge actuarially sound rates in order to build adequate reserves to weather any catastrophic claims events.
“Under the proposed regulation, micro-captives, in order to be non-abusive, will be impaired from charging actuarially sound premiums by the 65% loss ratio requirement, severely limiting in micro captives’ ability to build reserves and surplus.”
The TCIA believes that by setting a minimum loss ratio, the IRS is disregarding the primary risk management purpose of a captive insurance company and is indirectly encouraging captive policyholders to engage in more risky behavior in order to justify the 65% loss ratio.
“The IRS should recognise the risk management value of captive insurance companies,” the TCIA said.
Discriminatory
The TCIA argue that the proposed regulation unfairly discriminates between similarly situated companies simply because an election is made, and two insurance companies, operating identically, will receive vastly different treatment if one elects to be taxed as an 831(b) and the other does not.
“If both companies have a 20% owner and loss ratios [lower] than 65%, but only one insurance company makes an 831(b) election, then just by checking a box, one company will be a listed transaction and the other will not.”
The response from the TCIA follow comments from The Self-Insurance Institute of America (SIIA), which said the proposals will “severely limit access to captive insurance programs for small- and medium-sized businesses in the US”.