Risk Pools Risk Distribution Safe Harbor Captive Insurance





Risk Pools


Risk Pools are generally used in the captive insurance sector to allow each participating captive insurance company to lay off a portion of its risk to like captives, so as to minimize the captive's particular exposure to the particular risk.

However, risk pools are often used for the purpose of creating third-party insurance so that businesses that cannot meet the multiple-insured safe harbor for risk distribution, can instead meet the 50% third-party safe harbor. These risk pools are typically embodied in insurance companies that are owned by the captive manager, but may also be owned by independent purveyors of third-party risk.

In recent years, risk pools that used primarily to create third-party risk have come under heavy scrutiny by the IRS, with the Service's primary challenge being that such pools are "insufficiently risky" and in many cases are little more than a vehicle for premiums to briefly stop over while (non-existent) risk distribution is claimed.

At any rate, a captive considering participation in a risk pool should thoroughly vet the risk pool through independent counsel and not merely swallow the promoter's representations that risk distribution will be provided.


IRS Global Settlement Initiative

  • IRS News Release IR-2019-157 -- IRS offers settlement for micro-captive insurance schemes; letters being mailed to groups under audit.
  • IRS News Release IR-2020-26 -- IRS takes next step on abusive micro-captive transactions; nearly 80 percent accept settlement, 12 new audit teams established.
  • IRS News Release IR-2020-226 -- IRS again warning about consequences for captive owners in abusive transactions who do not come forward voluntarily.





Avrahami v. Comm'r, 149 T.C. No. 7 (Aug. 21, 2017).


Reserve Mechanical Corp. v. Comm'r, T.C. Memo. 2018-86, 2018 WL 3046596, T.C.M. (RIA) 2018-086, 2018 RIA TC Memo 2018-086 (June 18, 2018).


Syzygy Ins. Co. v. Comm'r, T.C. Memo. 2019-34 (April 10, 2019).



Foreign Insurance Excise Tax - Audit Technique Guide, April 2008


Foreign Insurance Excise Tax - Audit Technique Guide, April 2008 (no longer published by the IRS apparently).


NOTE: This document is not an official pronouncement of the law or the position of the Service and cannot be used, cited, or relied upon as such. This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.


Chapter 9 - Pooling of Risks


When risks are substantial or unusual, a company may not be able to obtain insurance through a regular insurance company. Pooling arrangements may be used to secure insurance in these situations.

Pooling Defined

Pooling is defined as an organization of insurers or reinsurers through which particular types of risks are underwritten with premiums, losses, expenses, and profits shared in agreed ratios. This is also known as an “association” or “syndicate”. An example of pooling would be a group of six unrelated roofing companies within a geographical area coming together to form an offshore insurance company.

Reasons for Pooling Arrangements

Two reasons why pooling arrangements may be formed are as follows:

  • The type of industry pooled does not lend itself to outside insurance, and/or
  • A refusal of insurance companies to accept certain risks.

Type of Industry

Pooling arrangements are established along an industry line such as in construction, the legal profession, or petroleum. Each of these industries has its own risks which are specific to that type of industry. For example, petroleum companies are exposed to risks of damage from pollution, wild oil or gas well fires, and the transportation of fuel oil, to name a few.

Refusal of Others to Accept Risk

Based upon the type of risk and the probability that the risk will occur, traditional insurance companies may refuse to insure the risk or set the premiums at such a high amount that it is not economically feasible to insure the risk. By grouping together in a pooling arrangement, the risks can be insured and/or lower premiums can be secured.

Pooling Characteristics

In order for a pooling arrangement to be treated as true insurance the following characteristics generally must be present:

  1. The pooling arrangement is comprised of economically unrelated shareholders and their subsidiaries and/or affiliates.
  2. None of the shareholders own a controlling interest.
  3. The risk of loss for each shareholder must be shared with all shareholders.
  4. The insurance company provides insurance coverage only to the shareholders and their affiliates. No outside third party coverage is provided.
  5. Premium rates are established according to customary industry rating formulas. The insurance company may take into account the unique risks of the insureds in establishing its rates.
  6. There must be a shifting of risk and distribution of the risk of loss.

Note: The facts and circumstances of the case along with the six characteristics above are to be considered when determining whether a pooling arrangement is true insurance. Also, coordination with the income tax agent on the case is necessary.

Pooling Example

A pooling arrangement is established in Bermuda to insure the risks of six unrelated bridge construction companies against the damages incurred should a bridge fail due to faulty construction. Each of the six owns an equal amount of the insurance company, and has provided an equal amount of capitalization for the insurance company.

Premiums for casualty insurance are determined in accordance with regular insurance standards with adjustment for the type of bridges being constructed and other industry risks specific to each company. The insurance company accepts only the risks of the six construction companies.

In this example, as long as the risk of loss is shifted and distributed, the arrangement would be treated as true insurance. Excise tax would be imposed on the premium payment from each of the entities to the Bermuda insurance company.

Risk-shift and Risk-distribution

As discussed in Chapter 6 concerning captive insurance companies, in order for insurance to exist, there must be risk-shift and risk-distribution. If the members of the pool do not commingle the premium funds and share in the losses, there is no risk-shift and no risk-distribution. Essentially, each of the members is self-insuring through their personal capital accounts.

This is brought forth in the case of Helvering v. LeGirse, 312 U.S. 531 (1941), and also in Rev. Rul. 60-275, 1960-2 C.B. 43.

In the case of pooling, as long as the risk of each of the insureds is shifted or distributed amongst the other members of the pool, insurance exists. Insurance would not exist if each of the pooling members paid funds into their own capital account and their loss transactions are paid out of only that member’s capital account.

In this latter case, none of the members bear any risk of loss for another member’s risks. The damage payments would be paid out of the individual member’s capital account; therefore, the risk of loss remains with that member. Therefore, it is important to ensure that there is risk-shift and risk-distribution for all members of the pool. The taxpayer will need to be questioned as to how premium payments are made to the pool (do they go to a commingled account or to the taxpayer’s account?) and how losses are paid out (are they paid out of a commingled account or from the taxpayer’s account?). A copy of the financial statements of the pool should be requested from the taxpayer and reviewed to verify that the funds are commingled.

Effect on Income Tax

When there is a lack of risk-shift and risk-distribution, no insurance is deemed to exist and the taxpayer is allowed a refund of previously paid excise tax on the premiums paid. Although the adjustments are not in favor of the Government on the excise tax side, adjustments on the income tax side include issues such as the disallowance of the insurance premium expense deduction. Again, it is important that the excise agent work closely with the income agents on the case to coordinate the determination of whether true insurance exists.

Pooling as a Form of Captive Insurance

Pooling arrangements for insurance are a form of captive insurance. Although there is more than one insured and the insureds are not related according to stock ownership, the pool will not accept risks outside the type of industry risks being insured. Thus, it is only the risks of the pooling insureds which are accepted. The number of members in the pool can vary from as few as two to an infinite number depending upon the type of industry and the number of insureds interested.

As long as none of the shareholders owns a controlling interest in the entity and the premium funds are commingled, there is a pool. If one entity owns a controlling interest, there is no pool. Instead, there is a partnership or a parent-subsidiary relationship with outside ownership interests.

Pooling and Section 953(d) Elections

Under the requirements of making a section 953(d) election, the foreign corporation (foreign insurance company) must be a controlled foreign corporation with ownership by a United States shareholder equal to or more than 25 percent. There must be a controlling interest. However, in a pool situation, none of the shareholders can own a controlling interest. Therefore, pools can not obtain and hold a section 953(d) election. Premiums paid to a pool located in a country not holding and meeting the requirements of an exemption under a treaty with the United States are taxable.




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