IRS Rules that Retroactive Reinsurance is not Reinsurance for Tax Purposes

(Co-authored with Susan J. Hotine and Peter H. Winslow)

In PLR 200711017 (Dec. 14, 2006), the IRS National Office ruled that loss portfolio reinsurance (which is generally accounted for as retroactive reinsurance under SSAP 62) between two related insurance companies does not qualify as insurance for tax purposes, even though the reinsurance satisfied the criteria for risk transfer under SSAP 62 for property and casualty reinsurance and even though the state insurance department confirmed that reinsurance accounting treatment is correct. Because the agreement between the companies covered only loss reserves related to insured events that already had occurred, the ruling notes that “the element of fortuity is absent” and concludes that the agreement transfers only a timing and investment risk. Noting that the taxpayer could not procure an arrangement with similar terms in the commercial reinsurance market because, in part, if the companies were unrelated, the same statutory accounting treatment would not be available, the ruling also concludes that the reinsurance agreement is not insurance in the commonly accepted sense “as envisioned by the caselaw.”

The ruling considers an agreement between a reinsurance company and its parent (another reinsurance company) under which the subsidiary company transferred or ceded its liability for losses (including loss adjustment expenses and incurred-but-not-reported losses) to its parent company, for losses occurring no later than a specific year that was several years before the agreement.