Opinion ID: 6340618
Heading Depth: 2
Heading Rank: 4

Heading: Tax Dispute

Text: On its income-tax returns Peak deducted the premiums it paid Reserve. The Tax Code generally treats a business’s payment of insurance premiums as a tax deductible “ordinary and necessary expense[]” of doing business. I.R.C. § 162(a); see 4 Couch on Insurance, supra, § 63.5 (internal quotation marks omitted). But there was no corresponding taxable income reported by Reserve. Reserve paid no income tax on the premiums it received, claiming that it qualified under § 501(c)(15) as a tax-exempt insurance company receiving premiums under $600,000 per year. 37 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 38 The IRS sent Reserve a Notice of Deficiency challenging this claim, disputing that Reserve was tax exempt under § 501(c)(15). The notice said that Reserve’s “purported insurance and/or reinsurance transactions lack[ed] economic substance,” and that the money it had received was “not paid to an insurance company and . . . [was] not paid for insurance.” Aplt. App., Vol. 6 at 1592. As a result, the IRS assessed Reserve for taxes for 2008, 2009, and 2010. It classified Reserve’s income as FDAP income, which is “[F]ixed or [D]eterminable [A]nnual or [P]eriodical gains, profits, and income” that is “received from sources within the United States,” but “not effectively connected with the conduct of a trade or business within the United States.” I.R.C. § 881(a). FDAP income is subject to a 30% tax rate. See id. Reserve contested the assessment, arguing that it was in fact an insurance company and that if it was not, the purported premiums it received were a nontaxable capital contribution to the company. The case was tried to the Tax Court, which affirmed the IRS. Reserve appeals. III. APPLICABLE LAW AND THE TAX COURT’S DECISION THAT RESERVE WAS NOT AN INSURANCE COMPANY Under § 501(c)(15) of the Tax Code, “[i]nsurance companies (as defined in section 816(a)) other than life” are tax exempt if “(I) the gross receipts for the taxable year do not exceed $600,000, and (II) more than 50 percent of such gross receipts consist of premiums.” I.R.C. § 501(c)(15)(A)(i). The core question before the Tax Court was whether Reserve was an insurance company. I.R.C. § 816(a) defines insurance company as “any company more than half of the business of which during the taxable year is the 38 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 39 issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies.” But no part of the Code defines the term insurance. Unfortunately, this is not because the definition is obvious. Indeed, the meaning can depend on the context. See Robert E. Keeton & Alan I. Widiss, Insurance Law: A Guide to Fundamental Principles, Legal Doctrines and Commercial Practices § 1.1, at 5 (1988) (“There is no single conception of insurance that is universally applicable for use in disputes involving questions of law.”). At the core of the notion of insurance, however, are risk transfer and distribution. The insured transfers its risk of loss to the insurance company, and the insurer distributes that risk by charging premiums to many insureds. See id. at 4 (“[R]isk transference and risk distribution are among the basic characteristics of almost all insurance transactions.”); Grp. Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205, 211 (1979) (“The primary elements of an insurance contract are the spreading and underwriting of a policyholder’s risk.”); Beech Aircraft Corp. v. United States, 797 F.2d 920, 922 (10th Cir. 1986) (“‘Risk-shifting’ means one party shifts [its] risk of loss to another, and ‘risk-distributing’ means that the party assuming the risk distributes [its] potential liability, in part, among others. An arrangement without the elements of riskshifting and risk-distributing lacks the fundamentals inherent in a true contract of insurance.”); Stearns-Roger Corp. v. United States, 774 F.2d 414, 415 (10th Cir. 1985) (“[F]or there to be ‘insurance’ there must be a shifting of the risk of loss or a spreading of the risk.”). 39 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 40 The Supreme Court decision in Helvering v. Le Gierse, 312 U.S. 531 (1941), illustrates that a transaction must display the basic attributes of insurance and that substance trumps form. A woman of 80 purchased a life-insurance policy and an annuity at the same time from the same life insurance company. The two contracts were formally treated as distinct transactions, but neither would have been purchased without the other. She paid $4,179 for an annuity that provided an annual payment of $589.80 throughout her life, and she paid $22,946 for a life-insurance contract that would pay $25,000 upon her demise. To obtain the policy she did not have to submit to a physical examination or answer the typical questions. She died a month later. The government claimed that the $25,000 payment under the contract could not be excluded from her taxable estate as lifeinsurance proceeds. The Court agreed. It observed that “Congress used the word ‘insurance’ in its commonly accepted sense,” and that “[h]istorically and commonly insurance involves risk-shifting and risk-distributing.” Id. at 539–40. In those respects the decedent had not acquired insurance. The Court said that the desirability of life insurance stems from its being “a device to shift and distribute risk of loss from premature death,” id. at 539, but the combination of the decedent’s two contracts “fail[ed] to spell out any element of insurance risk,” id. at 541. It noted that “annuity and insurance are opposites”—“[f]rom the company’s viewpoint, insurance looks to longevity, annuity to transiency.” Id. Through the combination of the two contracts, said the Court, “the one neutralizes the risk customarily inherent in the other.” Id. It concluded that the risk assumed by the insurance company “was an investment risk similar to the risk assumed by a bank; it was not an insurance risk.” Id. at 542. 40 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 41 We cannot anticipate every nuance that may arise and provide a comprehensive explication of what is required for a purported insurer to satisfy § 816(a), but this court has previously followed the approach of Le Gierse. See, e.g., Stearns-Roger Corp., 774 F.2d at 415. Taking our lead then from that Supreme Court decision, we think that to be a “company more than half of the business of which . . . is the issuance of insurance . . . contracts,” I.R.C. § 816(a), the company must deal in the transference and distribution of risk and it must do so as a “business,” conducting itself through practices that one would expect from a reasonably ordered insurance enterprise. In our view, the Tax Court has captured the essence of the statutory requirement in the tests that it has employed to determine whether a taxpayer is an insurance company under § 816(a). In this case it stated that “[c]ourts have looked to four criteria in deciding whether an arrangement constitutes insurance: (1) the arrangement involves insurable risks; (2) the arrangement shifts the risk of loss to the insurer; (3) the insurer distributes the risk among its policy holders; and (4) the arrangement is insurance in the commonly accepted sense.” Reserve, at 33 (citing Harper Grp. v. Comm’r, 96 T.C. 45, 57–58 (1991), aff’d, 979 F.2d 1341 (9th Cir. 1992), and AMERCO & Subs v. Comm’r, 96 TC 18, 38 (1991), aff’d 979 F.2d 162 (9th Cir. 1992)); see also Caylor Land & Dev., Inc. v. Comm’r, 121 T.C.M. (CCH) 1205 (2021) at –32; Avrahami v. Comm’r, 149 T.C. 144, 177 (2017). Neither party objects to this framework. The Tax Court held that Reserve’s policies failed to satisfy requirements (3) and (4). We begin with risk distribution. 41 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 42 A. Risk Distribution Risk distribution is “essential” to insurance. Le Gierse, 312 U.S. at 539; see Comm’r v. Treganowan, 183 F.2d 288, 291 (2d Cir. 1950) (describing risk distribution as “the very essence of insurance” (internal quotation marks omitted)); Keeton & Widiss, supra, § 1.3, at 12 (“When insurance is considered from the viewpoint of an insurer or of society, it is appropriately viewed as a system for distribution[.]”). “Insuring many independent risks,” that is, independent in the sense that the likelihood of a loss under one policy is independent of the likelihood of a loss under a separate policy, “in return for numerous premiums serves to distribute risk.” Clougherty Packing Co. v. Comm’r, 811 F.2d 1297, 1300 (9th Cir. 1987); see Beech Aircraft Corp., 797 F.2d at 922. The success of insurance derives from the “law of large numbers.” Clougherty Packing Co., 811 F.2d at 1300. When, as is assumed when writing insurance policies, the risk of an adverse event to each insured is random, with a chance of, say, X% per year, there is always the possibility that fate will strike a cruel blow and a number of adverse events will occur at the same time or in quick succession. The insurer may have to pay out much more in claims than it anticipated when it set the premiums on the policies, perhaps jeopardizing its financial solvency. The law of large numbers is no more than an expression of a simple computation using the mathematics of probability—when there are a sufficiently large number of independent risks each having an annual probability of occurrence of X%, there is an extraordinarily small likelihood that the percentage of insureds that suffer a loss during a year will deviate significantly from X%. (If a coin is tossed a million times, it is highly unlikely that the percentage of heads will differ appreciably from 50%.) 42 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 43 Thus, insuring a large number of independent risks protects the insurer against financial calamity. See Keeton & Widiss, supra, § 1.3 at 12–13 (“As the number of ventures included in a group or ‘pool’ is increased, there is a greater likelihood that the favorable and the harmful experiences will tend to be balanced – that is, grouping a large number of ventures in a pool increases the probability that the losses suffered by all the ventures will be spread over time.”). By writing policies for enough independent risks, an insurer can predict “the frequency and amount of loss within this larger group . . . [and] set the premium at a level that will cover the losses, cover the insurer’s overhead and expenses, and earn a profit.” 1 Daniel W. Gerber et al., New Appleman on Insurance Law Library Edition § 1.01 (2021). The Tax Court began by finding that Reserve’s direct written policies for Peak, RocQuest, and ZW did not themselves distribute risk. It said that because “most or all of the risk of loss was associated with the business operations of just one insured [Peak],” “the number of insureds and the total number of independent exposures were too few to distribute the risk that Reserve assumed under [those] policies.” Reserve, at 36. Reserve does not challenge this determination. The court therefore turned to Reserve’s contention that it distributed risk through the arrangements with PoolRe. It noted that Reserve relied on Harper, a Tax Court case holding that a particular captive insurer had “‘a sufficient pool of insureds to provide risk distribution’” when “approximately 30% of the captive’s business came from insuring unrelated parties.” Id. at 38 (quoting Harper Grp., 96 T.C. at 60). It pointed out that when it had previously held that risk distribution had been achieved through insuring unrelated 43 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 44 parties, it had “determined that the transactions with the unrelated parties were insurance transactions for Federal income tax purposes.” Id. Therefore, the court said, “[b]efore we can determine whether Reserve effectively distributed risk through these agreements, we must determine whether PoolRe was a bona fide insurance company.” Id. It set forth nine factors that the Tax Court had previously considered in making such a determination: (1) whether [the purported insurance company] was created for legitimate nontax reasons; (2) whether there was a circular flow of funds; (3) whether the entity faced actual and insurable risk; (4) whether the policies were arm’s-length contracts; (5) whether the entity charged actuarially determined premiums; (6) whether comparable coverage was more expensive or even available; (7) whether it was subject to regulatory control and met minimum statutory requirements; (8) whether it was adequately capitalized; and (9) whether it paid claims from a separately maintained account. Id. at 38–39 (quoting Avrahami, 149 T.C. at 185, with numbering added).
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.
Turning to the credit-coinsurance contract, the Tax Court summarily rejected Reserve’s contention that it provided risk distribution. It said that Reserve had “failed to 46 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 47 provide evidence that the vehicle service contracts, which formed the basis for the reinsurance that PoolRe re-ceded in the coinsurance contracts, actually existed.” Id. at 46–47. And it found that even if there were valid coinsurance contracts, PoolRe assumed a “de minimis” amount of risk from CreditRe and the amount ceded to Reserve was also de minimis. Id. at 47. Thus, “the coinsurance contracts were not bona fide reinsurance agreements.” Id. B. Insurance in the Commonly Accepted Sense As an alternative basis for rejecting Reserve’s appeal, the Tax Court held that Reserve’s policies “did not constitute insurance in the commonly accepted sense.” Id. at 48. The Tax Court considered the following factors: “[1] whether the company was organized, operated, and regulated as an insurance company; [2] whether it was adequately capitalized; [3] whether the policies were valid and binding; [4] whether the premiums were reasonable and the result of an arm’s-length transaction; and [5] whether claims were paid.” Id. at 48. These are all factors that the Tax Court had previously considered over the years. See, e.g., Avrahami, 149 T.C. at 191; R.V.I. Guar. Co., Ltd. v. Comm’r, 145 T.C. 209, 231 (2015); Harper, 96 T.C. at 60; Securitas Holdings, Inc. v. Comm’r, 108 T.C.M. (CCH) 490 (T.C. 2014) at ; see also Caylor, 121 T.C.M. (CCH) 1205 at –40. Reserve does not challenge that approach on appeal. First, the Tax Court said that although Reserve had observed the necessary formalities in incorporating under the law of Anguilla and complying with the insurance regulations of that country, it had not been operated as an insurance company. The court observed that “[o]ther than the feasibility study that Capstone produced, there is no 47 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 48 evidence that any due diligence was performed for the policies that Reserve issued.” Reserve, at 50. And it noted that the feasibility study was not complete until after Reserve issued its policies for 2008 and 2009, that many of the background documents attached to the study covered periods after Reserve had been incorporated and issued policies, and that the study said nothing about RocQuest and ZW even though those entities were covered under the policies. Also, Reserve’s operations (like its planning and incorporation) “were managed entirely by Capstone.” Id. Reserve had no employees of its own and Zumbaum—who was Reserve’s 50% owner, president, and chief executive officer—knew “virtually nothing about its operations,” and at trial showed “very little knowledge of provisions in the policies that Peak and his other entities held with Reserve.” Id. It further found that there was “no evidence that Reserve performed any due diligence with respect to the reinsurance agreements that it executed with PoolRe,” that “[n]othing in the record indicates that Reserve or anyone performing activities on Reserve’s behalf evaluated [the risks assumed by Reserve under the quota-share agreement] before executing the quota share policies,” and that no one with a financial interest in Reserve considered whether the quota-share or credit-coinsurance agreements would actually distribute risk. Id. at 51–52. The Tax Court also found that Reserve handled “in an irregular manner” its only claim—the one for loss of a major customer. Id. at 53. It said that “no supporting documentation accompanied the claim notice”; that Reserve never insisted on documentation of “the occurrence or the amount of the claimed loss”; that Reserve issued its first claim payment before Peak and Reserve executed their settlement agreement, and 48 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 49 then issued another payment months after the settlement agreement without executing an addendum to the settlement agreement “reflecting this payment until years after the tax years in issue”; and that all the payments from Reserve to Peak were signed by a Peak employee. Id. at 52. The Tax Court concluded that “Reserve was not operated as an insurance company in the commonly accepted sense.” Id. at 53. It saw no virtue in Capstone’s management of Reserve, saying that “Capstone directed Reserve’s activities and directed a series of transactions between its managed entities so that Reserve appeared to be engaged in the business of issuing insurance contracts.” Id. (emphasis added). As for the second factor—adequate capitalization—the Tax Court observed that “[g]enerally [its] caselaw holds that meeting the statutory requirements of the captive’s domicile jurisdiction is sufficient to show that the captive was adequately capitalized.” Id. And it concluded that because “Reserve met the minimum capitalization requirements of Anguilla,” this factor favored Reserve. Id. 13 The Tax Court next found that “Reserve’s direct written policies contained the necessary terms to make them valid and binding insurance.” Id. at 54. But it noted that the policies were “cookie cutter”—“[t]he policies on their face indicate[d] that they were the copyrighted material of Capstone, and Capstone employees testified at trial that they 13 Reserve had plenty of capital if, as may well have been the case, the probability of a covered loss was extremely low. But, given the low probability that an attachment point would ever be satisfied, Reserve could not count on any reinsurance backup in case of a major loss that it could not pay out of its own funds, and it would take several years of accumulating premiums before Reserve could have sufficient capital to pay more than one policy-limits loss out of its own funds. 49 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 50 administered many of the same policies for all of their clients”—and “were not reasonably suited to the needs of the insureds, particularly Roc[Q]uest and ZW, both of which had extremely limited operations.” Id. at 54 (internal quotation marks omitted). The Tax Court also reiterated that Reserve’s only claim—the loss-of-a-major-customer claim—was paid in full without any “due diligence to determine whether the claim was actually covered by the relevant policy.” Id. at 55. The court concluded that the third factor—whether the policies were valid and binding—was a “neutral factor.” Id. The fourth factor considered by the Tax Court was whether Reserve’s premiums were reasonable and the result of arm’s-length transactions. The court acknowledged that “Capstone calculated Reserve’s premium using objective criteria and what appear to be actuarial methods,” id. at 61, and that to make his recommendations for premium pricing, McNeel used a spreadsheet showing the premiums charged by other Capstone entities for various lines of coverage and “pricing indications” from Mid-Continent, id. at 55. But the court said that “[d]espite [this] methodology . . . a number of factors indicate that the premiums that the insureds were required to pay under the direct written policies were not reasonable in relation to the risk of loss.” Id. at 56. It observed that Peak’s policies with Reserve caused a dramatic increase in Peak’s insurance expenses: Peak’s 2007 insurance expenses had been $95,828, but its Reserve premiums were more than “$412,089, and this was in addition to the premiums that Peak continued to pay for third-party commercial insurance.” Id. And it noted that despite this immense increase in cost, Reserve’s policies would be excess to any other policy that covered the same loss because of the other-insurance clauses in every Reserve policy. 50 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 51 The Tax Court also noted apparent irregularities in the pricing of the policies. For example, the 2008 regulatory-changes policy (discussed earlier in this opinion) provided coverage for occurrences during only one month and charged a $64,899 premium for $1 million in coverage, while the 2009 and 2010 versions of the policy charged a lower premium, $47,588, and offered $500,000 in coverage for a one-year coverage period. There was “no explanation” for this inconsistency. Id. at 57. In addition, the Tax Court questioned Peak’s assertion that it required unique pollution coverage from a captive insurer because one of its operations is located on a Superfund site. The court noted that “Peak itself did not engage in mining practices that spread pollutants, and it already had systems in place to control the fluid runoff when it cleaned equipment used in polluted mines.” Id. Moreover, Peak had operated at the same location “continuously for over 10 years,” and there was “no evidence that Peak had ever incurred costs during that time for excess pollution liability.” Id. Continuing this analysis, the Tax Court expressed doubts about Zumbaum’s testimony on the need to create Reserve. Zumbaum testified that one reason Peak wanted to create a captive was because it was unhappy with how its current commercial-liability insurer handled a claim for roof damage. But “no documentation was produced to substantiate” this point, id., and Peak continued to keep its policies with the commercialliability insurers. Also, Zumbaum “did not know which of Peak’s policies with Reserve would have covered a loss like the one that was not covered by [its commercial insurer].” Id. at 58. And although Reserve contended that Peak risked substantial liability if one of its mining parts malfunctioned, “[t]here [was] no convincing evidence that legitimate 51 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 52 concerns about this kind of liability should have been greater in 2008 than in previous years.” Id. For example, the feasibility study “provided no information on the probability of a loss event that the direct written policies covered.” Id. at 59. The court added that Reserve “failed to explain why Peak would maintain its full set of third-party commercial insurance coverage, which it contends was insufficient, even after it paid roughly 400% more for additional coverage from Reserve.” Id. at 58. The Tax Court also pointed out that Zumbaum’s testimony about Peak’s business projections was inconsistent with the documentary evidence. Zumbaum testified that Peak was interested in obtaining additional insurance coverage because it expected that its business would “continue growing during the next few years.” Id. But “the rating worksheets that Capstone produced for calculating Reserve’s premiums reflect that Peak’s projected sales stayed the same for all of the tax years in issue,” and as it turned out, “Peak actually had fewer employees in 2010 than it did in 2008.” Id. After “conclu[ding] that any purported concerns about increased risks for the insureds were unfounded,” id. at 59, the court noted that in determining whether premiums charged by captive insurers were reasonable, it looked to whether “the amounts agreed upon by the parties were the result of arm’s-length negotiations,” id. at 60. It said: “In determining whether an arrangement constitutes insurance in the commonly accepted sense we consider more than whether the premiums chosen can be arrived at by actuarial means. We consider whether the facts demonstrate that the terms of the arrangement were driven by arm’s-length considerations.” Id. By that measure, Reserve failed to make its case. The Tax Court found that “the facts and circumstances of 52 Appellate Case: 18-9011 Document: 010110683986 Date Filed: 05/13/2022 Page: 53 this case demonstrate that the direct written policies were not the result of arm’s-length negotiations.” Id. at 61. In its view, “no unrelated party would reasonably agree to pay Reserve the premiums that Peak and the other insureds did for the coverage provided by the direct written policies.” Id. It summarized: “Although Capstone calculated Reserve’s premiums using objective criteria and what appear to be actuarial methods, the absence of a real business purpose for Reserve’s policies leads us to conclude that the premiums paid for the policies were not reasonable and not negotiated at arm’s length.” Id. Turning to the fifth factor—the payment of claims—the Tax Court observed that Reserve did pay the single claim for loss of a major customer. And although it noted that “the circumstances surrounding the payment of [the loss-of-a-major-customer] claim were unusual,” it ultimately determined that this factor “weigh[ed] slightly in Reserve’s favor.” Id. The Tax Court said that on balance the evidence favored a conclusion “that Reserve’s transactions were not insurance transactions in the commonly accepted sense.” Id. at 62. It placed particular emphasis on (1) Reserve’s not being operated as a bona fide insurance company, (2) the lack of a legitimate business purpose for the policies, and (3) the large increase in payments for new insurance while still maintaining prior coverages. See id.