State subsidiaries retained Blue Cross Blue Shield treatment under section 833

Plain-English summary

An existing Blue Cross and Blue Shield organization proposed moving a small federal government insurance business into five newly formed, wholly owned state insurance subsidiaries. The parent would supply capital, employees, administrative services, guarantees, branding, and business practices, while each subsidiary would operate only in its licensed state. The restructuring would not reduce or materially change high-risk individual or small-group coverage, and the parent had no plan to sell interests in the subsidiaries. The IRS treated the transaction as a permitted split-up that did not materially change the parent's operations or structure under section 833(c)(2). Each new subsidiary therefore would be treated as an existing Blue Cross or Blue Shield organization for section 833 purposes.

Ruling snapshot

• Question: Would separating the government insurance business into five state subsidiaries preserve section 833 treatment for the parent and subsidiaries?
• Outcome: Approved.
• Key authorities: IRC §§ 832 and 833.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201642026 Third Party Communication: None
Release Date: 10/14/2016 Date of Communication: Not Applicable
Index Number: 833.00-00, 833.03-00,
833.03-01, 833.03-03 Person To Contact:
----------------------, ID No. ------------------
---------------------- Telephone Number:
---------------------------------------------------------- --------------------
--------------------------------------------- Refer Reply To:
------------------------------------ CC:FIP:B04
------------------------------ PLR-135305-15
Date:
April 26, 2016

Parent = ---------------------------------------------------------------------------------------
-------------------------------------------
Subsidiary = ----------------------------------------------------
State 1 = ----------
State 2 = ---------------
State 3 = -----------------
State 4 = -------------
State 5 = ---------
Agency = -----------------------------------------------------------
Government = ---------------------------------------------------------------------------------------
Business ----------------------------------
x-year = ----------------
Rating System = -------------------------------------
z% = -----
Newco 1 = ---------------------------------------------------------------------------------------
-----------------------------------------
Newco 2 = ---------------------------------------------------------------------------------------
--------------------------------------
Newco 3 = ---------------------------------------------------------------------------------------
-------------------------------------------
Newco 4 = ---------------------------------------------------------------------------------------
-------------------------------
Newco 5 = ---------------------------------------------------------------------------------------
---------------

Dear --------------:

This is in response to an October 19, 2015 letter from your authorized representative
(with supplemental submissions dated January 20, 2016, February 22, 2016, and March
PLR-135305-15 2

21, 2016) requesting rulings concerning the application of § 833 of the Internal Revenue
Code to the proposed transaction, described below (the “Proposed Transaction”).

FACTS

Parent is a State 1 mutual legal reserve company and the common parent of an
affiliated group of corporations (the “Consolidated Group”) that file a consolidated U.S.
federal income tax return. Parent is a Blue Cross and Blue Shield (BCBS) organization
that operates BCBS plans in State 1, State 2, State 3, State 4, and State 5. Parent
markets, underwrites, and services health insurance contracts. In general, Parent sells
these contracts through both its own employees and independent brokers.

The Agency has approved Parent to sell Government Business contracts to individuals.
Government Business is subject to uniform federal government standards. In general,
Government Business contracts have x-year term. The federal government reimburses
Parent for the Government Business health risks it insures. The reimbursement rates
are affected by Parent’s performance ratings determined pursuant to Agency’s Rating
System.

Government Business is a small component (less than z% of total premium income) of
Parent’s insurance business. Parent conducts Government Business directly in State 1,
State 2, State 3, and State 4, but Parent conducts Government Business in State 5
through Subsidiary. Subsidiary is a directly, wholly-owned subsidiary of Parent that is
not an “existing Blue Cross or Blue Shield organization” as that term is used in
§ 833(c)(2). All of the underwriting, claims, actuarial, investment management,
membership additions, cancellations, customer billing, hospital and physician claim
processing, and other administrative functions relating to Subsidiary’s Government
Business are managed by Parent employees.

Proposed Transaction

Parent’s business motivations for the Proposed Transaction include (1) establishing and
maintaining a separate Rating System performance rating for Government Business in
each state and (2) mitigating legal liability risks associated with Government Business.

As described below, Parent proposes to undertake, pursuant to one overall plan, the
following steps:

1. Parent will form five new insurance companies: (i) Newco 1, a State 1
   corporation, (ii) Newco 2, a State 2 corporation, (iii) Newco 3, a State 3
   corporation, (iv) Newco 4, a State 4 corporation, and (v) Newco 5, a State 5
   corporation (collectively the “Newcos”). Parent will capitalize the Newcos with
   sufficient capital for each to satisfy relevant minimum capital requirements, as
   needed to conduct Government Business, and will transfer the State 1, State 2,
   PLR-135305-15 3

   State 3, and State 4 Government Business it conducts to the respective state
   Newco. Subsidiary will make a constructive distribution of its Government
   Business to Parent and Parent will transfer that business to Newco 5. Each
   Newco will be licensed as an insurance company solely in its respective state
   and will be engaged in Government Business.

2. Parent will continue to perform its historic administrative functions through its
   own employees. Each Newco will enter an arm’s length administrative services
   agreement (the “ASA”) with Parent pursuant to which Parent will provide each
   Newco all claims processing and payment, premium price setting, internal audit,
   legal, financial reporting, facilities, voice and data communication, data
   processing and other technology, banking and investment management, general
   administrative, procurement, compliance, security, human resources, and other
   management, operational and administrative services.

3. Parent will guarantee each Newco’s obligations for the insurance contracts they
   issue.

4. Each Newco will commence Government Business in the state in which it resides
   and is licensed. Each of the Newcos, except Newco 5, will offer to renew
   Government Business contracts issued by Parent as those contracts expire and
   will seek new Government Business using the capital provided by Parent.
   Newco 5 will seek new Government Business using capital provided by Parent,
   and also will seek to renew existing Government Business contracts issued by
   Subsidiary as those contracts expire.

Parent will be the sole shareholder of each Newco. Each Newco will have its own
board of directors and officers, but will not have any direct employees. Therefore, each
Newco will rely on Parent’s employees to perform all of its operational and
administrative functions. It is expected that each Newco will join the Consolidated
Group upon its formation.

Additional Representations

Parent makes the following additional representations:

1. Parent is a BCBS organization that was in existence on August 16, 1986.

2. Parent was exempt from tax for its last taxable year beginning before January 1,
   1987.

3. Parent has not changed its health benefits coverage for individuals or small
   groups or its capital structure since August 16, 1986, in any way that would
   PLR-135305-15 4

   result in a material change in operations or structure as described in the
   legislative history to § 833.

4. Parent is an “existing Blue Cross or Blue Shield organization” as that term is
   used in § 833(c)(2).

5. Parent has no plan or intention to dispose of any ownership interest in any
   Newco to an unrelated party.

6. Each Newco's operations will be limited to conducting Government Business
   and other health insurance business.

7. Each Newco will be licensed to conduct insurance business in the state in which
   it resides and will be regulated by the insurance commissioner or other
   insurance regulatory body for that state.

8. Each Newco will be licensed by the BCBS Association and use the BCBS
   Association trademark and name for the respective state in which it resides.

9. Parent’s Management intends to allocate Parent's existing adjusted surplus
   between and among Parent and the respective Newcos based on the relative
   number of policyholders in each entity. Such allocation methodology will not
   favorably impact the § 833(b) deductions to be claimed by the Consolidated
   Group (including the Newcos) in the year of such allocation relative to the
   § 833(b) deduction that would be claimed by Parent in the absence of the
   Proposed Transaction.

10. It is intended that the business practices of each Newco will be consistent with
    Parent’s past practices, and will resemble Parent in all material respects
    (including using the BCBS Association trademark and name), so that the
    Proposed Transaction will not cause any change to high-risk individual or small
    group coverage, individually or in the aggregate, relative to such coverage if
    Parent had continued to directly conduct the transferred business.

11. None of the Newcos intend to terminate their high-risk coverage of individuals or
    small groups or materially change the eligibility, terms, or conditions under which
    high-risk coverage is offered relative to the terms and conditions under which it
    is offered in the market place.

12. Parent will continue to provide high-risk coverage of individuals and small groups
    following the Proposed Transaction.

REQUESTED RULINGS
PLR-135305-15 5

Parent request rulings that the Proposed Transaction will not be considered a material
change in its operations or structure under § 833(c)(2) and that, after the Proposed
Transaction, each Newco will be treated as an “existing Blue Cross or Blue Shield
organization” for purposes of § 833.

LAW AND ANALYSIS

Section 833 provides that a qualifying BCBS organization is entitled to: (1) treatment as
a stock insurance company; (2) a special deduction under § 833(b); and (3)
computation of unearned premium reserves under § 832(b)(4) based on 100 percent,
and not 80 percent, of unearned premiums. To qualify for the provisions of § 833, §
833(c)(1) provides that an organization must be (A) an “existing Blue Cross or Blue
Shield organization” as defined in § 833(c)(2).

Section 833(c)(2) defines “an existing Blue Cross or Blues Shield organization” as any
Blue Cross or Blue Shield organization if --

   (A) such organization was in existence on August 16, 1986;

   (B) such organization is determined to be exempt from tax for its
   last taxable year beginning before January 1, 1987; and

   (C) no material change has occurred in the operation of such
   organization or in its structure after August 16, 1986, and before the
   close of the taxable year, among other requirements, that no
   material change has occurred in the operations of such
   organization or in its structure after August 16, 1986, and before the
   close of the taxable year.

Also, to the extent permitted by the Secretary, any successor to an organization
meeting the requirements of the preceding sentence, and any organization resulting
from the merger or consolidation of organizations each of which met such requirements,
shall be treated as an existing Blue Cross or Blue Shield organization. Section
833(c)(2).

The legislative history describes the principles that the Secretary shall apply in
determining whether a material change in operations or structure has occurred:

   First, the merger or split up of 1 or more existing Blue Cross/Blue Shield
   organizations will not constitute a material change in operation or structure.

   Second, if an existing Blue Cross/Blue Shield organization acquires
   a new line of business or is acquired by another business (other
   than a health business), the acquisition does not constitute a

PLR-135305-15 6

   material change in operations or structure if (1) the assets of the
   other business are a de minimis percentage (i.e., less than 10
   percent) of the assets of the existing Blue Cross/Blue Shield
   organization at the time of the acquisition, or (2) the taxpayer can
   clearly demonstrate to the Secretary of the Treasury that, based on
   all the facts and circumstances, the acquisition does not constitute
   a material change in operations or structure of the existing Blue
   Cross/Blue Shield organization.

   Third, a material change in operations occurs if an existing Blue Cross/Blue
   Shield organization drops its high risk coverage or substantially changes the
   terms and conditions under which high risk coverage is offered…

HR Conf No 99-841, 99th Cong, 2nd Sess (Sept 18, 1986).

Neither § 833 nor the related legislative history specifically addresses the Proposed
Transaction. However, by explicitly stating that the “split up of 1or more existing Blue
Cross/Blue Shield organizations will not constitute a material change in operation or
structure,” the legislative history articulates Congressional intent to permit an existing
Blue Cross or Blue Shield organization to transfer its business to multiple wholly-owned
“successor” subsidiaries provided they continue to operate the existing Blue Cross or
Blue Shield organization’s business.

Parent is “an existing Blue Cross or Blue Shield organization” as defined in § 833(c)(2).
For valid business reasons, rather than conducting Government Business directly in
each of the states and through Subsidiary in State 5, Parent will transfer the
Government Business it conducts to separate Newcos that will operate exclusively in
each of those states. In other words, Parent will “split up” Parent’s Government
Business by state and operate the Government Business through five wholly-owned
subsidiaries. The Newcos will succeed to Parent’s existing Government Business (and
generate new business as part of conducting Government Business) using the capital
received from Parent, Parent’s employees, and the BCBS trademark and name.
Furthermore, the business practices of each Newco will be consistent with Parent’s past
practices and will resemble those of Parent in all material respects.

Parent has no plan or intention to dispose of any of its shares in any of the Newcos to a
third party and each Newco will join the Parent Consolidated Group. Restructuring
Parent’s business pursuant to the Proposed Transaction will not eliminate, reduce, or
change any high-risk individuals or small group coverage, individually or in the
aggregate. Accordingly, the Proposed Transaction will not extend the benefits of
§ 833(b) beyond those available to Parent currently.

RULINGS
PLR-135305-15 7

Based on the facts presented and representations made, we conclude that pursuant to
§ 833(c)(2)(C), (1) the Proposed Transaction will not result in a material change in the
operations or structure of Parent and (2) as a result of the Proposed Transaction, each
Newco shall be treated as “an existing Blue Cross or Blue Shield organization.”

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                   Sincerely,



                                   Rebecca L. Baxter
                                   Senior Technician Reviewer, Branch 4
                                   (Financial Institutions & Products)

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