Benjamin Alarie, business law professor, University of Toronto
23 September 2021

Computer says no: Reserve Mechanical will fail

Reserve Mechanical Corporation’s  captive insurance case appeal will most likely fail, according to a legal professor. Benjamin Alarie, a professor and Osler Chair in business law at the University of Toronto, Canada, says that there is a 77 percent chance the business’s appeal will be dismissed.

The calculation is based on machine-learning models developed by legal technology company Blue J, which Alarie co-founded. Using a systematic analysis of earlier decisions, Alarie claimed that the technology achieves 94 percent accuracy in modelling how the courts will resolve insurance arrangement cases.

Writing with Blue J senior legal research associate Bettina Xue Griffin for  Tax Notes, Alarie argues that the court will address three key issues: How important the status of the reinsurer is (rather than the insurer itself) in determining whether the direct insurer should be considered a valid insurance company for tax purposes;  the weight to be placed on the use of actuarial methods to determine the amount of the premiums to be paid to the captive insurer; and that put on the relative importance of there being “a circular flow of funds” in the arrangement.

The model addresses the latter two, drawing on 100 cases involving insurance arrangements. Analysts determined the key factual attributes courts have examined in applying the legal test for insurance arrangements and assembled a data set of these that were present or absent in each of these cases.

“Given the findings of fact reached by the Tax Court, the Blue J Tax machine-learning model of insurance arrangement determinations predicts with 77 percent confidence that Reserve’s appeal to the Tenth Circuit will be dismissed,” the article states.

“As a legal matter, for Reserve to succeed on appeal, it must establish that (1) it did adequately redistribute risk and (2) that its transactions were insurance in the commonly accepted sense. It is unlikely that Reserve will satisfy either requirement.”

Alarie and Griffin warned that the decision “is expected to have implications for captive insurers and particularly for captive insurers that participate in risk redistribution through risk pools”.

Reserve Mechanical Corporation was the wholly-owned subsidiary of Peak Casualty Holdings, a Nevada limited liability company whose operations included cleaning used mining equipment. The initial decision of the Tax Court found that Reserve’s transactions with Peak were not insurance transactions and that Reserve was not entitled to a federal income tax exemption. The Tenth Circuit heard oral arguments on May 4, and its decision is pending.