Government health system captive insurer's income excluded

Plain-English summary

A state health system formed a nonprofit captive insurer to provide insurance and risk-mitigation services solely to the system and entities it controls. The insurer's income comes from member premiums and investments and is used for administrative costs and insured losses. The system alone may receive distributions, and dissolution assets must go to the system, the state, a political subdivision, or another entity whose income is excluded under IRC § 115(1). The IRS concluded that lowering insurance costs for the state health system performs an essential governmental function and that private benefits are only incidental. It ruled that the captive insurer's income is excluded from gross income under § 115(1).

Ruling snapshot

• Question: Is the captive insurer's income excluded because it performs an essential governmental function and its income accrues to a state or political subdivision?
• Outcome: Approved, income is excluded from gross income under IRC § 115(1)
• Key authorities: IRC § 115(1); Rev. Rul. 77-261; Rev. Rul. 90-74

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202532004 Third Party Communication: None
Release Date: 8/8/2025 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-120495-24
Date:
May 01, 2025

Legend

Taxpayer = ------------------------------------------------------------------------------------------

System = ------------------------------------------------
University = ---------------------------
Hospital = ---------------------------------------
Center = ------------------------------------------------
Employer = ------------------------------------------
State = ----------
State 2 = -----------
Act = -----------------------------------------------------------------------------------------

Act 2 = -----------------------------------------------------------------------------------------

Fund = -----------------------------------------------

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

This letter responds to a letter from your authorized representative, dated October 17,
2024, and subsequent documentation dated February 4, 2025 and March 25, 2025,
requesting a ruling that Taxpayer’s income is excludable from gross income under
section 115(1) of the Internal Revenue Code (Code). Taxpayer represents the facts as
follows.

FACTS

System is an integral part of State. State established System under Act. System’s
mission is to provide patient care in specialized services not widely available elsewhere,
PLR-120495-24 2

and to provide care to medically indigent citizens of State. Act provides that the
provision of health care services is an essential governmental function that protects and
promotes the health and welfare of the citizens of State. Act also provides that the
education of medical and health science professionals and the performance of medical
and related research are essential to promote this essential governmental function. Act
permits System to provide self-insurance and create a self-insurance entity to support
its essential governmental function.

University is a state university located in State. Center is a University campus. Hospital
is a teaching hospital for Center.

System and University formed Employer to provide System with an integrated faculty
practice plan and clinical enterprise. Employer’s principal activities are providing clinical
services to Hospital’s patients and supporting University’s educational, research, and
public service missions. The physicians who constitute the medical staff of System and
System’s subsidiaries are employees of Employer. Employer pays salaries to the
physicians for their provision of medical care to Hospital’s patients. Employer has a
ruling that concludes its income is excludable from gross income under section 115(1)
of the Code.

Taxpayer is a nonprofit mutual benefit corporation. System formed Taxpayer under the
laws of State 2 to reduce System’s costs of providing health care services to System’s
subsidiaries in order to protect System’s financial integrity. Taxpayer provides captive
insurance and risk-mitigation services solely to Taxpayer’s members. Taxpayer
provides its members with general liability insurance, primary medical professional
liability insurance, and employee benefit liability insurance. All members of Taxpayer
are required to pay annual premiums to Taxpayer, calculated at fair market value for the
insurance coverage Taxpayer provides. Taxpayer’s organizational documents provide
that Taxpayer is intended to have the status of an organization whose income is
excludable from gross income pursuant to section 115(1) of the Code, and that its
authority and activities are limited accordingly. Taxpayer’s organizational documents
forbid Taxpayer from taking any action that would cause its income to be includible in
gross income.

Taxpayer’s membership consists of two classes, Class A and Class B. All members are
insureds of Taxpayer, and every insured is a member of Taxpayer.

System is Taxpayer’s sole Class A member. System has the exclusive right to receive
distributions from Taxpayer, so long as System continues to be an integral part of State,
or a political subdivision thereof.

Employer is currently Taxpayer’s sole Class B member. Taxpayer’s organizational
documents allow additional organizations to become Class B members. Taxpayer’s
organizational documents require that Class B members be entities (i) that constitute an
integral part of State, or a political subdivision of State; (ii) whose income is wholly
PLR-120495-24 3

excludable from gross income under section 115 of the Code; or (iii) whose income is
exempt from taxation under section 501(a) of the Code by virtue of being describe in
section 501(c)(3) of the Code. Any Class B member admitted by virtue of being
described in section 501(c)(3) of the Code must be either a governmental unit or an
affiliate of a governmental unit, as described in Rev. Proc. 95-48. Class B members
must be either wholly owned subsidiaries of System or wholly owned subsidiaries of
such wholly owned subsidiaries of System. System, therefore, must be the direct or
ultimate parent of, and wholly control, each Class B member. Class B members have
no right to vote as members of Taxpayer. Class B members are not entitled to receive
dividends or distributions from Taxpayer.

System must approve any Class B members of Taxpayer. System must appoint and
remove the directors of all Class B members. System has the power to approve
expenses and budgets and authorize debt of all Class B members. The assets of all
Class B members must be distributed to System, or a similarly organized entity
approved by System if such Class B member dissolves.

Taxpayer represents that Act 2, a State law, mandates that physicians employed by
Employer be insured. Taxpayer further represents that Act 2 requires State, acting
through University, Center, and Employer, to provide and pay for such insurance on
behalf of Employer’s employed physicians. Currently, System purchases such
insurance from third-party insurance providers to comply with the requirements of Act 2.
System created Taxpayer to provide captive insurance services to System and entities
controlled by System in place of such third-party insurance providers.

Act 2 requires certain healthcare providers in State to maintain minimum professional
liability coverage from a State-approved carrier. Act 2 also creates Fund to provide
professional liability coverage for claims that exceed the required minimum coverage.
In addition to purchasing minimum professional liability coverage, health care providers
in State are required by Act 2 to pay an annual premium surcharge to the State-
approved carrier, which the carrier then pays into Fund. The board of governors of
Fund may issue a certificate of self-insurance to certain healthcare providers if the
board of governors is satisfied that the healthcare provider possesses and will continue
to possess the ability to pay any judgment for which liability exists equal to the amount
of basic coverage required of a healthcare provider obtained against such applicant.
Self-insurers are not required under Act 2 to maintain minimum coverage with a carrier
but are still required to pay the surcharge to Fund. Act 2 deems Employer and its full-
time physician faculty to be a self-insurer for the purposes of Act 2, and mandates that
Employer must pay the annual surcharge on behalf of its employed physicians.

Other than the initial funding of Taxpayer by Taxpayer’s members, Taxpayer’s income is
derived solely from premiums paid by its members in exchange for insurance coverage,
as well as income generated by Taxpayer’s investments. Taxpayer’s income is used to
fund its administrative expenses and cover the losses of its members under Taxpayer’s
insurance programs. Administrative expenses include payments to third-party service
PLR-120495-24 4

providers for professional services, including accounting, policy documentation, claims
management and administration, and compliance. All payments to outside service
providers must be at arm’s length and for fair market value.

Taxpayer’s organizational documents state that no private person or entity can receive
any net earnings from Taxpayer’s operations, except as reasonable compensation for
services rendered to or on behalf of Taxpayer.

Upon dissolution, Taxpayer must distribute its remaining assets to System, so long as
System constitutes an integral part of State or a political subdivision thereof. If System
fails to constitute an integral part of State or a political subdivision thereof, remaining
assets must be distributed to State, a political subdivision of State, or an entity whose
income is excludable from gross income under section 115(1) of the Code.

LAW

Section 115(1) of the Code 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 any political subdivision thereof.

Rev. Rul. 77-261, 1977-2 C.B. 45, holds that income generated by an investment fund
that is established by a state to hold revenues in excess of the amounts needed to meet
current expenses is excludable from gross income under section 115(1) of the Code,
because such investment constitutes an essential governmental function. The ruling
states that the statutory exclusion is intended to extend not to the income of a state or
municipality resulting from its own participation in activities, but rather to the income of
an entity engaged in the operation of a public utility or the performance of some
governmental function that accrues to either a state or political subdivision of a state.
The ruling explains that it may be assumed that Congress did not desire in any way to
restrict a state’s participation in enterprises that might be useful in carrying out projects
that are desirable from the standpoint of a state government and that are within the
ambit of a sovereign to conduct.

In Rev. Rul. 90-74, 1990-2 C.B. 34, the Internal Revenue Service ruled that the income
of an organization formed, funded, and operated by political subdivisions to pool their
casualty risks or other risks arising from obligations concerning employee negligence,
workers’ compensation statutes, and employee health is excludable from gross income
under section 115(1) of the Code because: 1) pooling risks of political subdivisions
constitutes an essential governmental function; 2) except for certain incidental benefits,
private interests do not participate in or benefit from the organization; and 3) the
organization’s income accrues to political subdivisions.
PLR-120495-24 5

ANALYSIS

State created System to provide patient care in specialized services not widely available
elsewhere, and to provide care to medically indigent citizens of State. System created
Taxpayer to serve as a replacement for commercial insurance carriers and to allow
Taxpayer’s members to pool their resources and to procure insurance services on a
more cost-effective basis. By reducing the costs to System in obtaining insurance for
System and entities wholly owned and controlled by System, Taxpayer performs an
essential governmental function. See Rev. Rul. 90-74.

Taxpayer’s income accrues to State or a political subdivision of State. Private interests
benefit only incidentally. Any benefit to employees of Taxpayer’s members is incidental
to the public benefit. See Rev. Rul. 90-74. In no event, including upon dissolution, will
Taxpayer’s assets be distributed to any entity that is not State, a political subdivision of
State, or another entity the income of which is excludable from its gross income by
application of section 115(1) of the Code.

RULING

Based on the information and representations submitted on behalf of Taxpayer, we
conclude that, because Taxpayer’s income is derived from the performance of an
essential governmental function, and because Taxpayer’s income accrues to State or a
political subdivision of State, Taxpayer’s income is excludable from gross income
pursuant to section 115(1) of the Code.

The ruling contained in this letter is based upon information and representations
submitted by 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 a ruling, it is subject to verification on examination.

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 Taxpayer. 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 Taxpayer’s authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
PLR-120495-24 6

attaching a statement to their return that provides the date and control number of the
letter ruling.

                                     Sincerely,

                                     Kenneth M. Griffin
                                     Chief
                                     Exempt Organizations Branch 3
                                     (Employee Benefits, Exempt Organizations,
                                     and Employment Taxes)

cc: -------------------------