When an employer stays fully liable for its own employees' health claims and just pre-funds an account the insurer draws from to pay them, are those claim payments and the insurer's admin fee taxed as insurance 'gross direct premiums' in Connecticut?

Plain-English summary

Connecticut taxes insurance companies on the premiums they take in — specifically on their "net direct premiums," which starts from "gross direct premiums" (Conn. Gen. Stat. §§ 12-201, 12-202). A domestic health insurer wanted to offer employers a new kind of arrangement and asked whether the money flowing through it counted as taxable premiums.

The arrangement is what the benefits industry calls an ASO ("administrative services only") or self-funded plan:

• For all claims below a liability limit (set at 110% or more of the actuarially expected claims), the employer — not the insurer — is solely liable to its employees and to health-care providers.
• The employer sets up and pre-funds a claims payment account. The insurer processes claims and pays them only from that account, acting as the employer's agent. If the account runs dry, the insurer owes nothing; it is never on the hook to employees or providers below the limit.
• The insurer charges an administrative fee for this claims-processing service.
• Separately, the insurer does agree to cover claims above the liability limit out of its own pocket. The insurer conceded that the premium for that piece is a taxable gross direct premium — that part wasn't in dispute.

The question: are the below-the-limit claim payments (made from employer money) plus the administrative fee "gross direct premiums" received by the insurer?

DRS ruled they are not. A "premium" is consideration paid for a contract of insurance, and insurance means assuming a risk of loss (Conn. Gen. Stat. § 38a-1(10); § 1-1(a) directs reading statutes by common usage). On the below-the-limit claims the insurer assumes no risk at all — it doesn't indemnify the employer, it just pays out the employer's own pre-deposited funds as its agent. No risk transfer means no premium. So neither those pass-through claim payments nor the administrative fee are taxable gross direct premiums.

DRS reinforced this by looking to California, which taxes premiums on nearly identical language. Treating the out-of-state statutes as in pari materia interpretive guidance, DRS followed two California Court of Appeal decisions — Aetna Life Insurance Co. v. State Board of Equalization (1992) and Prudential Insurance Co. of America v. State Board of Equalization (1993) — which held that claims an insurer pays from employer-provided funds are not taxable premiums. Those cases carefully distinguished the California Supreme Court's earlier Metropolitan Life decision, and DRS was careful not to commit to the same result on materially different Metropolitan Life-type facts.

What this means for you

Insurers offering ASO / self-funded administration

If your contract leaves the employer solely liable for claims and you merely administer and pay them out of employer-funded accounts, Connecticut does not treat that money — or your administrative fee — as taxable premium. The dividing line is risk: money you receive for assuming the risk of loss is premium; money you handle as a paying agent is not.

Self-funded employers

Pre-funding your own claims account through an insurer-administrator doesn't turn your claims dollars into the insurer's taxable premiums. The tax consequences follow who bears the risk — here, you do, below the limit.

Watch the stop-loss / excess layer

The insurer conceded that the premium for covering claims above the liability limit (true excess or stop-loss coverage, where the insurer bears the risk with no reimbursement right) is a taxable gross direct premium. A single contract can therefore have a non-taxable administrative layer and a taxable risk-bearing layer. Separate and characterize them.

The same logic recurs under other Connecticut taxes

DRS reached a parallel conclusion years later in Ruling 99-1 under the health care center tax: administrative-services-only claim payments and admin fees paid by a self-insured employer were not "direct subscriber charges" either. The "who actually bears the risk" question travels across Connecticut's insurance-style taxes.

Common questions

Q: Are administrative fees on a self-funded health plan subject to Connecticut insurance premiums tax?
A: No, not in this ruling. Because the insurer assumed no risk on the below-the-limit claims (it only administered and paid them from employer funds), the admin fee and the pass-through claim payments were not "gross direct premiums" under § 12-201.

Q: What makes something a taxable "premium"?
A: Consideration paid for the insurer assuming a risk of loss. Insurance under § 38a-1(10) requires that the insurer take on the risk. No risk assumed, no premium.

Q: Is any part of this kind of contract taxable?
A: Yes — the premium for coverage of claims above the liability limit, where the insurer genuinely bears the risk. The insurer conceded that piece is a taxable gross direct premium.

Q: Why did DRS cite California cases?
A: Connecticut courts hadn't construed this language, and California taxes premiums under nearly identical wording. Statutes on the same subject in other states are in pari materia — a helpful interpretive guide. DRS followed the Aetna and Prudential decisions and distinguished Metropolitan Life.

Citations and references

Statutes:

• Conn. Gen. Stat. § 12-201 (definitions of "gross direct premiums" and "net direct premiums")
• Conn. Gen. Stat. § 12-202 (tax on net direct premiums received by domestic insurance companies)
• Conn. Gen. Stat. § 12-210 (imposes the same tax on non-domestic insurance companies)
• Conn. Gen. Stat. § 1-1(a) (statutes construed according to commonly approved usage)
• Conn. Gen. Stat. § 38a-1(10) (definition of "insurance" — assumption of a risk of loss)

Cases cited:

• Aetna Life Insurance Co. v. State Board of Equalization, 11 Cal. App. 4th 1207, 15 Cal. Rptr. 2d 26 (1992) (claims paid from employer funds not taxable premiums)
• Prudential Insurance Co. of America v. State Board of Equalization, 21 Cal. App. 4th 458, 26 Cal. Rptr. 2d 287 (1993) (same)
• Metropolitan Life Insurance Co. v. State Board of Equalization, 32 Cal. 3d 649 (1982) (distinguished by Aetna and Prudential)
• Connecticut Assn. of Clinical Laboratories v. Connecticut Blue Cross, Inc., 31 Conn. Supp. 110 (1973)
• Connecticut Humane Society v. Freedom of Information Comm'n, 218 Conn. 757 (1991) (in pari materia interpretation)
• Texaco, Inc. v. Groppo, 215 Conn. 134 (1990); AirKaman, Inc. v. Groppo, 221 Conn. 751 (1992); Texaco Refining & Marketing Co. v. Commissioner, 202 Conn. 583 (1987) (canons of tax-statute construction)

Related ruling (described in prose, not linked):

• Ruling No. 99-1 (parallel result under the health care center tax: ASO claim payments and admin fees are not "direct subscriber charges")

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 95-13

Original ruling text

Ruling 95-13, Insurance Premiums Tax / Gross Direct Premiums

FACTS:

A health insurance company ("the Insurer"), which is a domestic insurance company, as defined in Conn. Gen. Stat. §12-201, intends to enter into a new type of contract with employers. Under such a contract, the Insurer will, with respect to claims incurred up to a predetermined annual liability limit ("the liability limit"), perform, for an administrative fee, employee health benefit claims processing and other administrative services as an agent for and on behalf of the employer. The liability limit is set at 110% (or more) of the actuarially determined expected claims.

The employer is solely liable for all claims below the liability limit and must establish and fund a claims payment account from which the Insurer may draw funds to cover claims paid on behalf of the employer. The Insurer is obligated to pay such claims only to the extent that the employer has sufficient funds in its claims payment account to cover the payment of such claims. The Insurer is not liable to health care providers or to employees of the employer for payment of any claims up to the liability limit even if the employer fails to pay those claims. The employer is solely liable to health care providers or to its employees for payment of such claims (endnote 1) .

The Insurer assumes sole liability for payment of any claims in excess of the liability limit and has no right to reimbursement for payment of such claims. The Insurer concedes that the premium that it receives from the employer for undertaking this obligation is included in its gross direct premiums, as defined in Conn. Gen. Stat. § 12-201, and is subject to the tax on net direct premiums that is imposed by Conn. Gen. Stat. § 12-202. The employer has no liability to others for payment of claims in excess of the liability limit.

ISSUE:

Where an employer is solely liable to its employees and to health care providers for the payment of employee health benefit claims but, under a contract with an insurance company, those claims are to be paid by the insurance company solely from funds that are provided in advance by the employer, whether those payments, and the administrative fees charged by the insurance company to the employer for employee health benefits claims processing, are gross direct premiums, as defined in Conn. Gen. Stat. § 12-201, that are received by the insurance company.

DISCUSSION:

Conn. Gen. Stat. § 12-202 imposes on domestic insurance companies "a tax on the total net direct premiums received by such company ... from policies written on property or risks located or resident in this state...." (endnote 2) '''[N]et direct premiums' means gross direct premiums less the following items: (1) Returned premiums, including cancellations, and (2) dividends paid to policyholders on direct business, not including any dividends paid on account of the ownership of stock.'' Conn. Gen. Stat. § 12-201. '''[G]ross direct premiums' means all receipts of premiums from policyholders and applicants for policies, whether received in the form of money or other valuable consideration, but excluding annuity premiums and considerations and premiums received for reinsurances assumed from other insurance companies ....'' Id .

While the Connecticut courts have not had occasion to construe these provisions of chapter 207, they must "be construed according to the commonly approved usage of the language ..." Conn. Gen. Stat. § 1-1(a). "Premium" means "the consideration paid in money or otherwise for a contract of insurance ..." Webster's Third New International Dictionary 1789 (1981). '''Insurance' means any agreement to pay a sum of money, provide services or any other thing of value on the happening of a particular event or contingency or to provide indemnify for loss in respect to a specified subject by specified perils in return for a consideration. In any contract of insurance, an insured shall have an interest which is subject to a risk of loss through destruction or impairment of that interest, which risk is assumed by the insurer and such assumption shall be part of a general scheme to distribute losses among a large group of persons bearing similar risks in return for a ratable contribution or other consideration." Conn. Gen. Stat. § 38a-1(10) (endnote 3) .

With respect to claims below the liability limit, the Insurer is not required to indemnify the employer for employee claims. As the employer is solely liable for all claims below the liability limit and must establish and fund a claims payment account from which the Insurer may draw funds to cover claims paid on behalf of the employer, the Insurer has assumed no risk and is obligated to pay such claims only to the extent that the employer has sufficient funds in its claims payment account to cover the payment of such claims by the Insurer. Again, the Insurer is not liable to health care providers or to employees of the employer for payment of any claims up to the liability limit even if the employer fails to pay those claims. The employer is solely liable to health care providers or to its employees for payment of such claims.

This issue has also been addressed by the California courts. The State of California, like most states, imposes a tax on insurance premiums. While there is no evidence, as was the case in Connecticut Assn. of Clinical Laboratories v. Connecticut Blue Cross, Inc. , 31 Conn. Supp. 110 (1973), that the General Assembly copied language from another jurisdiction (or from California, in particular), "other similar acts, because they are in pari materia, are interpretively helpful ...." Connecticut Humane Society v. Freedom of Information Comm'n , 218 Conn. 757, 760 n.3 (1991) (citing 2A Sutherland, Statutory Construction §§51.06 and 52.03 (4th ed)). "Where a meaning of a statute is in doubt, reference to legislation in other states and jurisdictions which pertains to the same subject matter, persons, things, or relations, may be a helpful source of interpretive guidance." 2B Sutherland, Statutory Construction (Singer 5th ed.) § 52.03 (endnote 4) .

The California tax is imposed on insurance companies and is measured by "the amount of gross premiums, less return premiums, received in such year by such insurer upon its business done in this state, other than premiums received for reinsurance ...." Cal. Const. art. XIII, §28(b) and (c); Cal. Rev. & Tax. §§ 12201 and 12221. In a case involving an arrangement almost identical to the arrangement between the Insurer and the employer that is described in this Ruling, the California Court of Appeal for the First Appellate District concluded that payment of claims by the insurer from funds that were provided by the employer was not taxable as gross premiums received by the insurer. Ætna Life Insurance Co. v. State Board of Equalizatio n, 11 Cal. App. 4th 1207, 1213, 15 Cal. Rptr. 2d 26, 30 (1992). The California Court of Appeal for the Third Appellate District came to the same conclusion in Prudential Insurance Co. of America v. State Board of Equalization, 21 Cal. App. 4th 458, 26 Cal. Rptr. 2d 287 (1993). (endnote 5)

RULING:

Where an employer is solely liable to its employees and to health care providers for the payment of employee health benefit claims but, under a contract with an insurance company, those claims are to be paid by the insurance company solely from funds that are provided in advance by the employer, those payments, and the administrative fees charged by the insurance company to the employer for employee health benefits claims processing, are not gross direct premiums, as defined in Conn. Gen. Stat. §12-201, that are received by the insurance company.

Endnotes:

1. The Insurer offers optional protection against large claims that are incurred by any particular employee of the employer. The Insurer assumes sole liability for payment of any claims in excess of a predetermined annual liability limit per employee ("employee liability limit") and has no right to reimbursement for payment of such claims. The Insurer concedes that the premium that it receives from the employer for undertaking this obligation is included in its gross direct premiums, as defined in Conn. Gen. Stat. § 12-201, and is subject to the tax on net direct premiums that is imposed by Conn. Gen. Stat. § 12-202. The employer has no liability to others for payment of claims in excess of the employee liability limit.

2. Conn. Gen. Stat. §12-210 imposes the same tax on insurance companies other than domestic insurance companies.

3. This definition, while applying to the use of the term "insurance" in Title 38a of the Connecticut General Statutes, is particularly significant in that Title 38a pertains to insurance and in that it is in accord with the definition of the same term in Webster's Third New International Dictionary 1172 (1981) ("coverage by contract whereby for a stipulated consideration one party undertakes to indemnify or guarantee another against loss by a specified contingency or peril").

4. This principle, like the principle (here inapplicable) that "a latent ambiguity must ordinarily be resolved in favor of the taxpayer ... because the issue remains the imposition of tax liability rather than entitlement to an exemption or a deduction," Texaco, Inc. v. Groppo, 215 Conn. 134, 141, 574 A.2d 1293 (1990), is one of many--none of which is applied to the exclusion of others--that are followed by the Connecticut courts in construing tax statutes. See, e.g. , AirKaman, Inc. v. Groppo , 221 Conn. 751, 607 A.2d 410 (1992), Texaco Refining & Marketing Co. v. Commissioner , 202 Conn. 583, 522 A.2d 771 (1987).

5. These decisions carefully distinguish the facts and holding in Metropolitan Life Insurance Co. v. State Board of Equalization , 32 Cal. 3d 649, 652 P.2d 426, 186 Cal. Rptr. 578 (1982). That is not to say, however, that, were the facts substantially the same as, and not materially different from, those involved in Metropolitan Life Insurance Co., the Department would interpret Conn. Gen. Stat. § 12-201 in the same manner in which the California Supreme Court interpreted Cal. Const. art. XIII, §28 and Cal. Rev. & Tax. §§12201 and 12221.

LEGAL DIVISION

December 28, 1995