Case Law: Harper Group and Includible Subsidiaries v. Commissioner

In Harper Group and Includible Subsidiaries v. Commissioner [(1991) 96 T.C. 45], Harper owned thirteen subsidiaries and primarily conducted an air freight operations company.  Harper formed an insurance subsidiary in Hong Kong, named Rampart, to provide mainly marine legal liability insurance to customers of a Harper subsidiary and directly to two of the Harper subsidiaries.  Rampart obtained partial reinsurance for its potential liability to the customers.  The premiums derived from customers was equal to approximately 30 percent of Rampart's total premium received in any given year.

The tax court in Harper stated that to determine whether insurance deductions are proper, a three-pronged test must be satisfied: (1) whether the arrangement involves the existence of an insurance risk; (2) whether there was both risk shifting and risk distribution; and (3) whether the arrangement was for insurance in its commonly accepted sense.  The court found that an insurance risk did exist, there was risk shifting, and insurance existed in its commonly accepted sense. 

More notably, the court also held that risk distribution was present even though the captive received 70 percent of its premiums from two Harper subsidiaries and 30 percent of its premiums from unrelated third parties.  The court stated that "in Amerco and Subsidiaries and Republic Western Insurance Company v. Commissioner, we held that where unrelated insured comprise over 50 percent of a captive insurance company's business, there was risk distribution; in Gold Oil Corporation v. Commissioner, we held that where less than 2 percent of a captive insurance company's business comes from unrelated insureds, there was no risk distribution.  Here, the relatively large number of unrelated insured comprise approximately 30 percent of Rampart's business; such a level of unrelated insureds, in our opinion, constitutes a sufficient pool of insureds to provide risk distribution [Harper Group and Includible Subsidiaries v. Commissioner, supra 96 T.C. 45]."

The court held that payments by Harper to Rampart were in form, as well as substance, insurance payments and that such payments were deductible.

Finally, in Rev. Rul. 2001-31 [2001-26 C.B. 1348], the IRS stated that the "economic family" doctrine would no longer be applied to captive insurance arrangements.  However, the IRS indicated that id would continue to challenge captive insurance arrangements based on the "facts and circumstances of each case."