“It’s hard enough to manage and pay for our own problems without being on the hook to pay for someone else’s problems.”
If this statement accurately describes your view of your employee benefits program, than a recent Revenue Ruling by the Internal Revenue Service (IRS) may be good news for you and your business.
The National Law Review recently published an article titled “Internal Revenue Service (IRS) Rules Captive Reinsurance Arrangement Involving Retiree Medical Benefits Qualifies as Insurance for Federal Tax Purposes.” The article is co-authored by Attorneys Elizabeth Erickson, Nancy Gerrie, Amy Gordon, Kristen Hazel, Roger Jones and Brian Tiemann following their review of an advance copy of Revenue Ruling 2014-15 issued by the IRS on May 18, 2014. To read the entire article, CLICK HERE.
According to the article, “the Internal Revenue Service (IRS) ruled that an employer’s wholly owned captive insurance subsidiary could reinsure the employer’s retiree medical benefit risks and still qualify as insurance for federal tax purposes, even though the retiree medical reinsurance policy was the only business of the captive.” The IRS determined that the insured risks were those of the retirees and their dependents and not the risks of the employer or the employer’s voluntary employee benefit association (VEBA) that purchased the insurance policy reinsured through the captive. In short, this means that a captive insurance company can achieve adequate risk shifting and risk distribution without “sharing” risk with other businesses or entities. The article notes that “The ruling will serve as guidance for employers seeking to structure and implement similar captive reinsurance arrangements that are eligible for favorable federal tax treatment.”
The ruling concluded that a reinsurer of medical benefits through a VEBA meets the requirements to be classified as an insurance company according to Subchapter L of the Internal Revenue Code of 1986. Furthermore, the ruling concluded that a captive reinsurance arrangement between a fronting insurance carrier and the captive reinsurer qualifies as insurance for federal tax purposes. The rationale for this ruling is that the underlying risks being shifted to the captive reinsurer are risks of the retirees and their dependents and distribution is occurring among a large group.
This Revenue Ruling comes at a critical time as more and more businesses are struggling to take care of their employees and comply with PPACA (also known as Obama Care) without breaking the bank. Reinsuring employee benefits through a captive insurance company can give employers more control over their health care benefits offering and lower cost. This ruling may be particularly relevant for mid-size businesses (50 employees or more) as PPACA requires them to provide “minimum essential coverage” healthcare to all employees and dependents or face fines. Clearly, one of the pitfalls of purchasing commercial insurance is that PPACA is driving commercial insurers to cover pools of relatively unhealthy individuals. This “collectivization” is expected to spill over and significantly drive up healthcare costs for mid-size businesses opting for commercial insurance.
Consider the conclusion drawn by the article in National Law Review, “The ruling is significant for employers considering a captive reinsurance arrangement to manage risk with respect to employee benefits…even if the employee/retiree benefit risks constitute the captive’s only business, the risks are still sufficiently distributed to constitute insurance for federal tax purposes…[t]his is important to employers because amounts paid pursuant to the arrangement are therefore deductible as insurance premiums under the Code, and the captive is eligible to deduct its loss reserves when computing its taxable income.”