Public agency captive insurer's income was excluded

Plain-English summary

A public agency whose participants were public charter schools formed a captive insurance company to provide the agency with reinsurance. The captive's income came from premiums paid by the agency and investment earnings, and its assets would return to the agency or another qualifying governmental organization upon dissolution. The IRS found that providing reinsurance to the public agency served an essential governmental function, that the income accrued to a state or political subdivision, and that private interests benefited no more than incidentally. It ruled that the captive's income from the specified reinsurance policies was excluded from gross income under Section 115(1).

Ruling snapshot

• Question: Was the captive insurer's income from reinsuring the public agency excluded under Section 115(1)?
• Outcome: approved
• Key authorities: IRC § 115(1); Rev. Ruls. 77-261 and 90-74

Full text (IRS public release)

Internal Revenue Service                                Department of the Treasury
                                                        Washington, DC 20224

Number: 202413009                                       Third Party Communication: None
Release Date: 3/29/2024                                 Date of Communication: Not Applicable
Index Number: 115.00-00
                                                        Person To Contact:
---------------                                         --------------------, ID No.
                                                        Telephone Number:
                                                        --------------------
                                                        Refer Reply To:
                                                        CC:EEE:EOET:EO3
                                                        PLR-113710-23
                                                        Date:
                                                        January 04, 2024




Taxpayer          = ------------------------------
Authority         = -----------------------------------------------------
                    -----------------------------------------------------
                    ----------------------------------------
State 1           = ---------
State 2           = -------------
State 2 Act       = -----------------------------------------------------
Liability Type 1 = --------------------------------------------
Liability Type 2 = ----------------------------------------
Liability Type 3 = -----------------------------------




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

This is in response to your letter dated June 22, 2023, and additional information
submitted on July 28, 2023, December 1, 2023, and December 21, 2023, in which
Taxpayer requested a private letter ruling involving § 115 of the Internal Revenue
Code.1

                                               FACTS

Taxpayer was formed by Authority as a State 1 nonprofit corporation to be a captive
insurance company that provides reinsurance coverage to Authority. Authority is

1
The Internal Revenue Code of 1986, as amended, to which all subsequent “section” references are
made unless otherwise indicated.

PLR-113710-23                                 2

Taxpayer’s sole member, and Taxpayer’s articles of incorporation and bylaws provide
that only Authority may be a member of Taxpayer.

Authority was formed pursuant to State 2 Act and is a public agency under State 2 Act
whose income is excludable from gross income under § 115(1). The participants in
Authority are independent public charter schools approved by a State 2 local school
district, a State 2 county board of education, or State 2 Board of Education.

Authority’s purpose is to provide its participants with a way to acquire insurance
coverage that would otherwise be unavailable or too expensive for its participants to
obtain by allowing participants to collectively purchase or finance insurance coverage
and providing means for the participants to share risk, pool reserves, self-insure, or self-
reinsure.

Authority underwrites insurance policies for various types of risks faced by its
participants. It assumes coverage related to the policies by administering risk-based
insurance pools. Where the pool coverage is insufficient, Authority reinsures its policies
through third-party commercial insurers. Taxpayer represents that because these third-
party insurance policies can be expensive and have burdensome requirements,
Authority created Taxpayer to reduce reliance on third-party commercial insurance
policies by having Taxpayer provide a portion of the reinsurance requirements of
Authority. Taxpayer does not provide services to anyone other than Taxpayer.

Taxpayer currently underwrites reinsurance policies for Liability Type 1 and Liability
Type 2 for Authority. Authority currently uses third-party commercial insurance
providers for its reinsurance needs involving Liability Type 3, but Taxpayer plans to offer
Authority underwriting for reinsurance policies for Liability Type 3.

Under each reinsurance agreement, Authority pays premiums to Taxpayer and in return
it receives reinsurance coverage from Taxpayer. Taxpayer’s board of directors invests
these premiums to earn additional income. Taxpayer’s only sources of income are this
investment income and the premiums received from Authority. This income is used by
Taxpayer to pay the reinsurance policy and other operational expenses of Taxpayer,
including a range of professional services it represents it cannot otherwise effectively or
responsibly provide internally. All payments to third-party service providers are at arm’s
length for fair market value. These professional services include insurance-based
accounting and finance solutions, policy documentation, claims management and
administration, and various compliance services.

Taxpayer’s articles of incorporation provide that Taxpayer’s net assets are distributable
to its sole member, Authority, upon dissolution. In the event that when Taxpayer
dissolves, Authority no longer exists or fails to be an organization whose income is
excludable from its gross income under § 115, Taxpayer’s articles of incorporation
provide that its net income will go to one or more organizations whose income is
excludable from gross income under § 115.

PLR-113710-23                                3


                                RULING REQUESTED

Taxpayer’s income from underwriting reinsurance policies for Authority for Liability type
1, Liability type 2, and Liability type 3 is excludable from gross income under § 115(1)
because Taxpayer’s income from these reinsurance activities is derived from its
exercise of an essential governmental function and such income accrues to a state or
any political subdivision thereof.

                                LAW AND ANALYSIS

Section 115(1) provides that gross income does not include income derived from any
public utility or the exercise of any essential governmental function and accruing to a
state or political subdivision thereof.

Rev. Rul. 77-261, 1977-2 C.B. 45, holds that the income from an investment fund,
established pursuant to State law for the temporary investment of cash balances of a
State and its participating political subdivisions, is excludable from gross income under
§ 115. That ruling reasons that the investment of positive cash balances by a state or
political subdivisions thereof to receive yield on the funds until needed to meet
expenses is a necessary incident of the power of the state or political subdivision to
collect taxes and other revenue for use in meeting governmental expenses. In addition
to concluding that income from such an investment activity was income from the
exercise of an essential governmental function, the ruling also concludes that since the
state and its participating political subdivisions had an unrestricted right to their
proportionate share of the investment fund's income, the fund's income accrued to
them.

Rev. Rul. 90-74, 1990-2 C.B. 34, holds that income of an organization formed, operated
and funded by political subdivisions of a state to pool their casualty risks is excluded
from gross income under § 115(1). The ruling also holds that income of such an
organization formed to pool risks in lieu of purchasing insurance to cover their public
liability, workers' compensation, or employees' health obligations is excluded under
§ 115(1) if private interests do not, except for incidental benefits to employees of the
participating state and political subdivisions, participate in or benefit from the
organizations.

Taxpayer was created to provide reinsurance for Authority with respect to certain risks.
Authority is a public agency pursuant to State Act whose income is excludable from
gross income under § 115 and all participants of Authority must be public charter
schools or government entities. By providing reinsurance to a public agency, Taxpayer
performs an essential governmental function. See Rev. Rul. 90-74.

Taxpayer’s income will be used solely to provide benefits to Authority. Upon Taxpayer’s
dissolution, its net assets will be distributed to Authority. In the event that when

PLR-113710-23                                  4

Taxpayer dissolves, Authority no longer exists or fails to be an organization whose
income is excludable from its gross income under § 115, Taxpayer’s income will go to
one or more organizations whose income is excludable from gross income under § 115.
Additionally, private interests do not benefit from Taxpayer’s activities more than
incidentally. Therefore, income of the Taxpayer accrues to a state or political
subdivision thereof within the meaning of § 115(1).

                                         RULING

Based on the foregoing, and assuming the accuracy of the facts and representations set
forth herein, we rule that Taxpayer’s income from underwriting reinsurance policies for
Authority for Liability type 1, Liability type 2, and Liability type 3 is excludable from gross
income under § 115(1) because Taxpayer’s income from these reinsurance activities is
derived from its exercise of an essential governmental function and such income
accrues to a state or any political subdivision thereof.

The ruling contained in this letter is based upon information and representations
submitted by or on behalf of Taxpayer and accompanied by a penalty of perjury
statement executed by an individual with authority to bind Taxpayer, and upon the
understanding that there will be no material changes in the facts. While this office has
not verified any of the material submitted in support of the request for a ruling, it is
subject to verification on examination. The Associate office will revoke or modify a letter
ruling and apply the revocation retroactively if there has been a misstatement or
omission of controlling facts; the facts at the time of the transaction are materially
different from the controlling facts on which the ruling was based; or, in the case of a
transaction involving a continuing action or series of actions, the controlling facts
change during the course of the transaction. See Rev. Proc. 2023-1, section 11.05.

This letter does not address the applicability of any section of the Code or Regulations
to the facts submitted other than with respect to the sections specifically described, and,
except as expressly provided in this letter, no opinion is expressed or implied
concerning the tax consequences of any aspects of any transaction or item of income
discussed or referenced in this letter. In particular, this letter does not render an opinion
on any activities other than Reinsurance Activity 1, Reinsurance Activity 2 and
Reinsurance Activity 3.

Because it could help resolve questions concerning federal tax status, this letter should
be kept in Taxpayer's permanent records.

A copy of this letter must be attached to any tax return to which it is relevant.
Alternatively, if Taxpayer files a return electronically, this requirement may be satisfied
by attaching a statement to the return that provides the date and control number of this
letter.

PLR-113710-23                                      5

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

This ruling letter is directed only to Taxpayer. Section 6110(k)(3) provides that it may
not be used or cited as precedent.



                                               Sincerely,




                                               Seth Groman
                                               Senior Counsel
                                               Office of the Chief Counsel
                                               (Employee Benefits, Exempt Organizations,
                                               and Employment Taxes)




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