REVENUE RULING 83-172
1983-2 C.B. 107

[IRS Annotation]
Tax classification; insurance company; other than life or mutual. A group that has been created for the purpose of providing self-insured workmen's compensation under state law is taxable as an insurance company under the provisions of section 831 of the Code, even though it is not recognized as an insurance company under state law.

Rev. Rul. 83-172

ISSUE
Is a group that has been created for the purpose of providing self-insured workmen's compensation under the laws of state X taxable as an insurance company under the provisions of section 831 of the Internal Revenue Code, even though it is not recognized as an insurance company under the laws of state X?

FACTS
Under the statutes of state X, employers of common interest (same or similar business) may apply for the privilege of self-insuring their risk under the state X workmen's compensation act (Act).

Those employers desiring to band together to form a group for the purpose of participating in such a program must make an application to state X's commerce agency by filing an indemnity agreement (Agreement).

In 1980, 40 employers of common interest formed a group for the purpose of applying for the privilege of self-insuring their risk under state X's Act. No single employer in the group provided more than 5 percent of the total risk insured by the fund.

Under the rules of state X, the group elected a board of trustees, composed of members of the group, for the purpose of administering the "fund" to be established.

The trustees, according to state statute, filed the prescribed Agreement. This Agreement jointly and severally bound the group and each of its members to comply with the provisions of the state X Act and the rules and regulations of the commerce agency. Individual applications of each member (employer) of the group applying for coverage in the fund were attached.

Under the terms of the Agreement, the fund and each of its members jointly and severally agreed to pay premiums and assessments, based on appropriate classifications and rates, into a designated cash reserve fund out of which claims and awards were to be paid. Also, they agreed that there would be no disbursements out of this fund by way of dividends or distributions of accumulated reserves to the respective members, except at the direction of the trustees after application and approval by the commerce agency of state X.

The fund Agreement also provided that the members of the fund would jointly and severally assume and discharge, by payment, any lawful awards against any member of the group entered by the agency and sustained by the courts. Thus, under the terms of the Agreement the trustees were authorized to make additional assessments to obtain the funds necessary to permit the discharge of fund obligations on behalf of the members. Members refusing to pay assessments and levies made by the trustees for which they are subsequently found liable by the commerce agency would be subject to legal action.

The commerce agency of state X granted approval of the group for self-insurance.

The trustees submitted to state X the minimum security deposit for the group. The security deposit was determined according to a formula established by the commerce agency. Each member of the group was required to contribute its proportionate share of the security deposit based on what its normal annual premium would be according to the National Council Experience Rating Plan (issued by the National Council on Compensation Insurance), adjusted by the formula established by the commerce agency.

LAW AND ANALYSIS
Section 1.801-3(a)(1) of the Income Tax Regulations defines the term "insurance company" to mean a company whose primary and predominant business activity during the tax year is the issuing of insurance or annuity contracts, or the reinsuring of risks underwritten by insurance companies. Thus, though its name, charter powers, and subjection to state insurance laws are significant in determining the business that a company is authorized and intends to carry on, it is the character of the business actually done in the taxable year that determines whether a company is taxable as an insurance company under the Code.

Section 831(a) of the Code provides that taxes computed under section 11 are imposed for each tax year on the taxable income of every insurance company.

Historically, insurance involves risk shifting and risk distributing, and sharing and distribution of the insurance risk by all the parties insured is essential to the concept of true insurance. See Helvering v. Le Gierse, 312 U.S. 531 (1941), 1941-1 C.B. 430; and Rev. Rul. 60-275, 1960-2 C.B. 43. Thus, where there is an economic shift and distribution of the risk "insured," the contract is one of insurance.

Here the members of the group are not economically related or commonly controlled and the economic risk of loss is being shifted and distributed among the members who comprise the insured group. See Rev. Rul. 78-338, 1978-2 C.B. 107, holding that premiums are deductible under section 162 of the Code provided that they are reasonable in amount for the insurance coverage obtained and provided they are based on sound actuarial principles. State X calls the arrangement [108] under the Agreement "self-insurance," however, since the requisite risk distribution and risk shifting is present, the arrangement is not considered self-insurance for purposes of subchapter L of the Code.

The Agreement or "contract" is one of insurance. Therefore, the group comes within the definition of an insurance company in section 1.801-3(a)(1) of the regulations. The fact that state X does not consider the group an insurance company for purposes of X's laws is not determinative. State law creates legal interests and rights. The federal tax law designates which of these interests or rights will be taxed. See J. Earl Morgan, Executor v. Commissioner, 309 U.S. 78 (1940), 1940-1 C.B. 229.

HOLDING
The group is taxable as an insurance company under section 831 of the Code.