1. Q: What is reinsurance?
A: Reinsurance is insurance for insurance companies. It is the transfer of part of the hazards, or risks, that a direct writer assumes, by way of an insurance contract or legal provision on behalf of an insured, to an additional insurance company, the reinsurer, that has no direct contractual relationship with the insured.
2. Q: What is a direct writer?
A: A direct writer is an insurance company that initially underwrites the risk, and then, may transfer the insurance it has written to another insurance company or reinsurance company.
3. Q: What is an operating company?
A: An operating company would be known as the insured. The operating company transfers its risk to the direct writer for a premium. This process is the same as the operating company transferring their risk using a general liability or worker’s compensation policy.
4. Q: Who determines the risk and the premium to be charged?
A: SRA believes each producing company has risks that are unique. This risk needs to be assessed by SRA and the owners of the operating company. Once the risk is determined, the premium would be assessed by the underwriting direct writer.
5. Q: What types of risk can be transferred to the direct writer?
A: Multiple risks may be transferred to the direct writer including: professional liability, non-merchantable warranty, supply chain interruption, data breach, food borne illness, brand protection, contingent business interruption & dispute resolution. The risk must be fortuitous and not considered to be a business risk.
6. Q: What makes this transaction a legitimate tax deduction for the owners of the operating company?
A: In order for this to be a legitimate tax deduction there must be actual risk shifting and risk distribution. SRA utilizes risk shifting through the direct writer. The risk distribution is handled in the reinsurance agreement made between the direct writer and the reinsurance company. The reinsurance company will have 50% affiliated risk under a facultative clause and 50% unaffiliated risk is shared on a pro-rata basis across all reinsurance companies which have reinsured the same risk under a treaty clause.
7. Q: How does the operating company show this tax deduction?
A: This deduction would be a line item 162 deduction. This deduction would be treated no differently than the premium paid on a general liability or worker’s compensation policy.
8. Q: What are the legal precedents for this arrangement?
A: SRA relies on several IRS ruling and private letter rulings. To find more detail, visit our Tax Resources page at www.theriskalternative.com.
9. Q: How much of the premium, that is written to the direct writer, is ceded into the reinsurance company?
A: The direct writer will cede at least 90% of the premium. The administrator of the direct writer does not charge any other fees for: ceding premium, handling claims, handling loan documents, or any other quarterly processing requirements.
10. Q: What are the start-up costs to own and maintain a reinsurance company?
A: The administrator of the direct writer charges $5,000 to form a reinsurance company. This charge will go toward the chartering fees and legal documents for the formation of the reinsurance company. Stock certificates will be provided for the individuals or entities that will own the reinsurance company. The filing for the reinsurance company will be handled by the administrator of the direct writer as well. The ongoing fees to maintain a reinsurance company are typically $5,000 annually; this fee is paid to the administrator of the direct writer. Out of that fee the reinsurance company’s annual charter renewal fees are paid, and an 1120PC tax return is completed.
11. Q: What is the minimum and maximum premium that should be ceded into the reinsurance company?
A: To take advantage of owning a reinsurance company the minimum premium that would need to be ceded into the reinsurance company is $80,000 annually. The maximum you can cede into a reinsurance company, for tax purposes, is limited to $2.2 million annually. The premium ceded into the reinsurance company has to be appropriate for the amount of risk being insured.
12. Q: What is the entity design of the reinsurance company?
A: The reinsurance company is structured as a C-Corp and is domiciled in the Modoc Tribe’s sovereign reservation land in the state of Kansas. The administrator applies for the C-Corp’s Employer Identification Number and is subject to U.S. federal taxation. It files a U.S. Federal 1120PC tax return.
13. Q: How are the premiums being ceded to the reinsurance company not considered taxable income to the reinsurance company?
A: The IRS Code Section 831-B effectively allows a small casualty insurance company to receive up to $2.2 million per year in premiums without paying income taxes on the ceded premium. Taxes are only paid when the profits are distributed to shareholders. Under this structure the significant advantage is that a reinsurance company is able to accumulate a surplus from underwriting profits whereas non-insurance entities must pay tax in the year it receives the income.
14. Q: What is underwriting profit?
A: Underwriting profit is exclusive to the insurance industry. Underwriting profit consists of the earned premium remaining after losses have been paid and administrative expenses have been deducted. It does not include any investment income earned on the held premiums. Investment income from the premium reserves will be taxed at C-Corp tax rates.
15. Q: How do I access the reserves from the reinsurance company?
A: Access to reserves can occur in three ways:
- Declare a dividend, and distribute the reserve at a reduced tax rate.
- Upon liquidation, distribution may be taxed as a long term capital gain, reduced tax rate.
- Make loans to shareholders. No tax event occurs, but the note must be a performing loan and be documented under a loan agreement