Opinion ID: 6340618
Heading Depth: 3
Heading Rank: 1

Heading: Quota-Share Arrangement

Text: Beginning with the quota-share arrangement, the Tax Court addressed only the six factors that it found to be “the most relevant.” Id. at 39. 12 First, it determined that the “arrangement looks suspiciously like a circular flow of funds.” Id. at 41 (internal quotation marks omitted). It said that because Reserve never “had any losses or expenses in connection with its purported quota share liabilities[,] . . . the end result for each tax year . . . was that Reserve would receive payments from PoolRe in exactly the same 12 The Tax Court did not address three factors—comparable commercial coverage, adequate capitalization, and a separate account for claim payments. Neither party complains about the failure to address those factors. 44 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 45 amount as the payments that PoolRe was entitled to receive from Peak . . . for the stop loss coverage.” Id. Second, the Tax Court concluded “that the amounts that PoolRe was to pay Reserve under the quota share arrangement were not determined at arm’s length or using objective criteria.” Id. at 42. It explained: The perfect matching of payments under the corresponding stop-loss endorsements and quota share policies (from insureds to PoolRe, and from PoolRe to captives) indicates that the quota share arrangement was not the product of arm’s-length considerations. Peak’s risks that were insured through PoolRe were different from the risks that PoolRe ceded to Reserve under the quota share policies. The risks that PoolRe purported to assume under the stop loss endorsements related to various unrelated business activities and the policies covering various unrelated lines of insurance. Reserve has not shown that the risks were comparable in scale. Id. at 41. The court noted that Reserve had not produced “evidence which shows the risks of other Capstone entities, . . . [such as] evidence regarding their industries, locations, operations, types of risk, and exposure to risk.” Id. at 42. Third, for similar reasons, the Tax Court concluded that the quota-share premiums were not actuarially determined. Not only was there “no evidence to support the calculation of the premiums,” but it was concerned that “all participants in the quota share arrangement agreed to direct their affiliated insureds to pay the same percentage of direct written premiums to PoolRe.” Id. at 42–43. Such a “one-size-fits-all” approach appeared inconsistent with actual actuarial determination. Id. at 43. As for whether the quota-share policies insured an actual and insurable risk, the Tax Court stated that “PoolRe was removed far from any actual risk associated with the business or operations of Reserve’s insureds.” Id. at 44. Before obtaining insurance from 45 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 46 Reserve, Peak had “never suffered any losses that would even come close to triggering the stop loss coverage provided for in the stop loss endorsements.” Id. The fifth factor was whether PoolRe was licensed and regulated as an insurance company. The Tax Court observed that “Reserve executed both its 2008 and 2009 reinsurance agreements with PoolRe before it obtained an insurance license in Anguilla,” and there was no evidence that PoolRe was a licensed insurer before then. Id. at 45. Sixth, the Tax Court found that “Reserve has not established that PoolRe was created or operated for legitimate nontax reasons.” Id. It said that “[a]ll the facts and circumstances in this case indicate that Reserve did not enter into the quota share arrangement with the intention of distributing its risk.” Id. Instead, “[t]he only purpose PoolRe served through the quota share arrangement was to shift income from Peak to Reserve.” Id. The Tax Court concluded that “the facts surrounding Reserve’s quota share policies with PoolRe establish that those agreements were not bona fide insurance agreements.” Id. “PoolRe’s activities as they relate to [the Reserve] policies,” it said, “were not those of a bona fide insurance company.” Id. at 46. One aspect of the Tax Court’s analysis must be emphasized. Contrary to what is suggested in some briefs filed in this court, the Tax Court did not criticize risk pools as a general matter. Instead, its findings were specific to the PoolRe risk pool.