28 June 2018Accounting & tax analysis

Capstone hits back at US Tax Court opinion in Reserve case

Capstone Associated Services, the operator of Reserve Mechanical's risk pool entity Pool Re Insurance, has issued  a second statement on the US Tax Court case following the opinion issued by Judge Kathleen Kerrigan.

The tax court had ruled that Pool Re Insurance was not a "bona fide insurance company" because it did not provide risk distribution.

Capstone said the court "appears to have rejected established norms, introducing newly articulated concepts that formed the basis for what the court considers insurance for federal income tax purposes," Capstone said in its first commentary of the Reserve decision, dealing specifically with coverages and losses.

Capstone had criticised the court's view of actual losses being necessary for coverage, suggesting that the court appeared to conclude that if a business had not experienced an actual loss in an area of coverage, then no non-tax reason exists for the acquiring insurance.

"In the court’s view, a business apparently must have experienced an uninsured loss before it can later be covered by insurance," said Capstone.

"In the case of Reserve’s insureds, whose facilities were located within one of the country’s largest Superfund sites, the court appears to have viewed the absence of a prior pollution claim as negating the ability of the insureds to deduct prospective pollution coverage."

Capstone went on to say that because that was no proof that any of the policies covered losses previously experienced, the court concluded that no-non tax reason existed for the insurance.

"That an insured must have experienced losses before it can legitimately obtain coverage would appear to be fundamentally inconsistent with longstanding practices," Capstone argued. "The court’s analysis appears to suggest that unless a business has been flooded, flood coverage is not insurance for federal income tax purposes. The same goes for fire insurance. Does this extend as well to key man life insurance or theft coverage? The court’s apparent requirement for an insured to show prior losses has no basis in the business community or the insurance industry. What is being insured against is the fortuitous risk of future losses, not the fear of a reoccurrence."

Capstone also took issue with court's supposed characterisation of coverages as "excess insurance".

"The court appears to have concluded that the captive policies, which did not duplicate any commercial coverages, were not obtained for non-tax reasons because the insured had never exhausted the commercial policies in any year, despite the commercial policies covering distinct and separate risks from the policies issued by the captive," it explained.

Capstone also felt the court had erroneously concluded that the coverages stated as "excess" over any other scheduled policies were improperly designed because they were "excess".

"The court’s repeated focus on this “excess” issue – in rejecting Reserve’s policies as valid insurance – was misplaced given the fact that each and every one of the direct policies issued by Reserve covered insurance risks for which the insureds had no underlying coverage. Each of the direct policies issued by Reserve represented the primary (first layer) coverage and did not provide coverage that was “excess” over any other commercial or captive insurance. The court concluded that this “excess” language, even in the absence of a duplicative underlying commercial policy, was fatal to a finding of insurance for federal income tax purposes."

Capstone again took issue with the court rejecting the testimonies of seven of the expert and fact witnesses present.

"At least seven expert and fact witnesses testified that Reserve’s policies were insurance policies as commonly understood for insurance purposes, with the testimony of these witnesses being uncontested at trial with respect to at least 11 of the 14 policies," Capstone said.

Finally, Capstone disagreed with the court's supposed emphasis on 'cookie cutter' policies.

"The court viewed the policies as “cookie cutter” rather than, apparently, being individually manuscripted and negotiated one at a time," explained Capstone.

"Despite it being ubiquitous in the insurance industry for policy contracts to be based on forms, the court apparently viewed this as being yet another “fatal factor” in her analysis in rejecting the contracts as insurance."

More on this story

Law & regulation
2 March 2020   Reserve Mechanical Corp has filed an opening brief with the Tenth Circuit Court of Appeals challenging the US Tax Court’s rulings related to its captive insurance case.

More on this story

Law & regulation
2 March 2020   Reserve Mechanical Corp has filed an opening brief with the Tenth Circuit Court of Appeals challenging the US Tax Court’s rulings related to its captive insurance case.