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Part I

Section 162.--Trade or Business Expenses

26 CFR 1.162-1: Business Expenses.
(Also §§ 801, 831)

Rev. Rul. 2008-8

ISSUES

Under the facts described below, do the arrangements entered into
between X
and Cell X, and between the subsidiaries of Y and Cell Y, of
Protected Cell Company constitute insurance for federal income tax purposes? If
so, are amounts paid by X
to Cell X and by the subsidiaries of Y to Cell Y
deductible as "insurance premiums" under § 162 of the Internal Revenue Code?
FACTS

Protected Cell Company
is a legal entity formed by Sponsor under the
laws of Jurisdiction A. Pursuant to the laws of Jurisdiction A, Protected Cell
Company has established multiple accounts, or cells, each of which has its own
name and is identified with a specific participant, but is not treated as a legal
entity distinct from Protected Cell Company
. Sponsor owns all the common
stock of Protected Cell Company
. All of the non-voting preferred stock
associated with each cell is owned by that cell’s participant or participants. The

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terms “common stock” and “preferred stock” as used in the Protected Cell
Company and cell instruments do not necessarily reflect the federal income tax
status of those instruments.
Each cell is funded by its participant’s capital contribution (the amount
paid by the participant for the preferred stock associated with its cell) and by
"premiums" collected with respect to contracts to which the cell is a party. Each
cell is required to pay out claims with respect to contracts to which it is a party.
The income, expense, assets, liabilities, and capital of each cell are accounted
for separately from the income, expense, assets, liabilities, and capital of any
other cell and of Protected Cell Company
generally. The assets of each cell are
statutorily protected from the creditors of any other cell and from the creditors of
Protected Cell Company
. Protected Cell Company maintains non-cellular assets
and capital representing the minimum amount of capital necessary to maintain its
charter. Each cell may make distributions with respect to the class of stock that
corresponds to that cell, regardless of whether distributions are made with
respect to any other class of stock. In the event a participant ceases its
participation in Protected Cell Company
, the participant is entitled to a return of
the assets of the cell in which it participated, subject to any outstanding
obligations of that cell.
A company like Protected Cell Company
is sometimes referred to as a
protected cell company, a segregated account company or segregated portfolio
company.
Situation 1.

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X
, a domestic corporation, owns all the preferred stock issued with respect
to Cell X. Each year, X enters into a 1-year contract, or arrangement, whereby
Cell X
"insures" the professional liability risks of X, either directly or as a reinsurer
of those risks. The amounts X
pays as "premiums" under the annual
arrangement are established according to customary industry rating formulas. In
all respects, X and Cell X conduct themselves consistently with the standards
applicable to an insurance arrangement between unrelated parties. In
implementing the arrangement, Cell X
may perform any necessary administrative
tasks, or it may outsource those tasks at prevailing commercial market rates. X
does not provide any guarantee of Cell X's performance, and all funds and
business records of X and Cell X are separately maintained. Cell X does not
loan any funds to X
. Cell X does not enter into any arrangements with entities
other than X. Taking into account the total assets of Cell X, both from capital
contributions and from amounts received pursuant to the annual arrangement
with X
, Cell X is adequately capitalized relative to the risks assumed under that
arrangement.
Situation 2

The facts are the same as in Situation 1, except that Y
, a domestic
corporation, owns all the preferred stock issued with respect to Cell Y
. Y also
owns all of the stock of 12 domestic subsidiaries that provide professional
services. Each subsidiary in the Y
group has a geographic territory comprised of
a state in which the subsidiary provides professional services. The subsidiaries
of Y
operate on a decentralized basis. The services provided by the employees

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of each subsidiary are performed under the general guidance of a supervisory
professional for a particular facility of the subsidiary. The general categories of
the professional services rendered by each of the subsidiaries are the same
throughout the Y group. Together the 12 subsidiaries have a significant volume
of independent, homogeneous risks.
Each year, each subsidiary of Y enters into a 1-year contract, or
arrangement, with Cell Y whereby Cell Y "insures" the professional liability risks
of that subsidiary, either directly or as a reinsurer of those risks. The amounts
charged each subsidiary as "premiums" under the annual arrangements are
established according to customary industry rating formulas. None of the
subsidiaries have liability coverage for less than 5% nor more than 15% of the
total risk insured by Cell Y
. Cell Y retains the risk that it insures from the
subsidiaries. In all respects, Y, Cell Y, and each subsidiary, conduct themselves
consistently with the standards applicable to an insurance arrangement between
unrelated parties. In implementing the arrangement, Cell Y
may perform all
necessary administrative tasks, or it may outsource those tasks at prevailing
commercial market rates. Neither Y
nor any subsidiary of Y guarantees Cell Y's
performance, and all funds and business records of Y
, Cell Y, and each
subsidiary, are separately maintained. Cell Y
does not loan any funds to Y or to
any subsidiary of Y. Cell Y does not enter into any arrangements with entities
other than Y
or its subsidiaries. Taking into account the total assets of Cell Y,
both from capital contributions from Y
and from amounts received pursuant to the
annual arrangements with the subsidiaries of Y
, Cell Y is adequately capitalized

5

relative to the risks assumed under those arrangements.
LAW
Section 162(a) of the Code provides, in part, that there shall be allowed as
a deduction all the ordinary and necessary expenses paid or incurred during the
taxable year in carrying on any trade or business. Section 1.162-1(a) of the
Income Tax Regulations provides, in part, that among the items included in
business expenses are insurance premiums against fire, storms, theft, accident
or other similar losses in the case of a business.
Neither the Code nor the regulations define the terms insurance or
insurance contract. The United States Supreme Court, however, has explained
that in order for an arrangement to constitute insurance for federal income tax
purposes, both risk shifting and risk distribution must be present. Helvering v.
LeGierse, 312 U.S. 531 (1941).
Risk shifting occurs if a person facing the possibility of an economic loss
transfers some or all of the financial consequences of the potential loss to the
insurer, such that a loss by the insured does not affect the insured because the
loss is offset by the insurance payment. Risk distribution occurs when the party
assuming the risk distributes its potential liability among others, at least in part.
Beech Aircraft Corp. v. United States
, 797 F.2d 920, 922 (10
th
Cir. 1986). Risk
distribution “emphasizes the broader, social aspect of insurance as a method or
dispelling the danger of a potential loss by spreading its cost throughout a
group”, Commissioner v. Treganowan, 183 F.2d 288, 291 (2d Cir. 1950), and
“involves spreading the risk of loss among policyholders.” Ocean Drilling &

6

Exploration Co. v. United States
, 24 Cl. Ct. 714, 731 (1991) aff’d per curiam, 988
F.2d 1135 (Fed. Cir. 1993). Risk distribution necessarily entails a pooling of
premiums, so that a potential insured is not in significant part paying for its own
risks. See
Humana, Inc. v. Commissioner, 881 F.2d 247, 257 (6
th
Cir. 1989).
A transaction between a parent and its wholly-owned subsidiary does not
satisfy the requirements of risk shifting and risk distribution if only the risks of the
parent are insured. See Stearns-Roger Corp. v. United States, 774 F.2d 414
(10
th
Cir. 1985); Carnation Co. v. Commissioner, 640 F.2d 1010 (9
th
Cir. 1981),
cert. denied 454 U.S. 965 (1981). However, courts have held that an
arrangement between a parent and its subsidiary can constitute insurance when
the parent’s premiums are pooled with those of unrelated parties if (i) insurance
risk is present, (ii) risk is shifted and distributed, and (iii) the transaction is of the
type that is insurance in the commonly accepted sense. See
, e.g., Ocean Drilling
& Exploration Co.; AMERCO, Inc. v. Commissioner, 979 F.2d 162 (9
th
Cir. 1992);
Rev. Rul. 2002-89, 2002-2 C.B. 984. An arrangement between an insurance
subsidiary and other subsidiaries of the same parent may qualify as insurance for
federal income tax purposes, even if there are no insured policyholders outside
the affiliated group, provided the requisite risk shifting and risk distribution are
present. See, e.g.
, Humana, Inc. v. Commissioner, 881 F.2d 247 (6th Cir. 1989);
Kidde Industries v. U.S., 40 Fed. Cl. (1997); Rev. Rul. 2002-90, 2002-2 C.B. 985.
The qualification of an arrangement as an insurance contract does not
depend on the regulatory status of the issuer. See, e.g., Commissioner v.
Treganowan, 183 F.2d 288 (2d Cir. 1950) (arrangement with stock exchange

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"gratuity fund" treated as life insurance because the requisite risk shifting and risk
distribution were present). See also
Rev. Rul. 83-172, 1983-2 C.B. 107 (group
issuing workmen's compensation insurance taxable as an insurance company
even though not recognized as an insurance company under state law); Rev.
Rul. 83-132, 1983-2 C.B. 270 (non-corporate business entity taxable as an
insurance company if it is primarily engaged in the business of issuing insurance
contracts). The same principles apply to determine the insurance contract status
of an arrangement involving a cell of a protected cell company as apply to
determine the status of an arrangement with any other issuer.
ANALYSIS
In order to determine the nature of an arrangement for federal income tax
purposes, it is necessary to consider all the facts and circumstances in a
particular case, including not only the terms of the arrangement, but also the
entire course of conduct of the parties. Thus, an arrangement that purports to be
an insurance contract but lacks the requisite risk distribution may instead be
characterized as a deposit arrangement, a loan, a contribution to capital (to the
extent of net value, if any) an indemnity arrangement that is not an insurance
contract, or otherwise, based on the substance of the arrangement between the
parties. The proper characterization of the arrangement may determine whether
the issuer qualifies as an insurance company and whether amounts paid under
the arrangement may be deductible.
Under the facts presented, all the income, expense, assets, liabilities and
capital of Cell X
are separately accounted for and, upon liquidation, become the

8

property of X
, who is the sole shareholder with respect to Cell X. The amounts X
pays as premiums under the 1-year agreement to "insure" its professional liability
risks are held by Cell X
, together with any capital and surplus, for the satisfaction
of X
's claims. The premiums that Cell X earns from its arrangement with X
constitute 100% of its total premiums earned during the taxable year; the liability
coverage Cell X provides to X accounts for all the risks borne by Cell X. In the
event of a claim, payment will be made to X out of X's own premiums and
contributions to the capital of Cell X
; no amount may be paid out of any other cell
in satisfaction of any claims by X. The arrangement between X and Cell X is akin
to an arrangement between a parent and its wholly-owned subsidiary, which, in
the absence of unrelated risk, lacks the requisite risk shifting and risk distribution
to constitute insurance. Because Cell X
does not enter into arrangements with
any policyholders other than X, the arrangement between X and Cell X is not an
insurance contract for federal income tax purposes, and X
may not deduct
amounts paid pursuant to the arrangement as "insurance premiums" under
§ 162. See
Rev. Rul. 2005-40, 2005-2 C.B. 4 (arrangement lacks necessary risk
distribution, and therefore does not qualify as insurance, if the issuer of the
arrangement contracts with only a single policyholder); Rev. Rul. 2002-89,
2002-2 C.B. 984 (amounts paid by a domestic parent corporation to its wholly
owned insurance subsidiary are not deductible as insurance premiums if the
parent's premiums are not sufficiently pooled with those of unrelated parties).
All the income, expense, assets, liabilities and capital of Cell Y
likewise
are separately accounted for, and upon liquidation, become the property of Y
,

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who is the sole shareholder with respect to Cell Y
. Under the arrangements
between the 12 subsidiaries of Y and Cell Y, the subsidiaries shift to Cell Y their
professional liability risks in exchange for premiums that are determined at arms-
length. Those premiums are pooled such that a loss by one subsidiary is not in
substantial part, paid from its own premiums. The subsidiaries of Y
and Cell Y
conduct themselves in all respects as would unrelated parties to a traditional
insurance relationship. Had the subsidiaries of Y entered into identical
arrangements with a sibling corporation that was regulated as an insurance
company, the arrangements would constitute insurance and amounts paid
pursuant to the arrangements would be deductible as insurance premiums under
§ 162. See
Rev. Rul. 2002-90, 2002-2 C.B. 985. The fact that the subsidiaries'
risks were instead shifted to a cell of a protected cell company, and distributed
within that cell, does not change this result. Accordingly, the arrangements
between Cell Y
and each subsidiary of Y are insurance contracts for federal
income tax purposes; amounts paid pursuant to those arrangements are
insurance premiums, deductible under § 162 if the requirements for deduction
are otherwise satisfied.
HOLDINGS
In Situation 1, the annual arrangement between Cell X
and X does not
constitute insurance for federal income tax purposes. In Situation 2, the
arrangements between Cell Y
and each subsidiary of Y do constitute insurance
for federal income tax purposes; amounts paid pursuant to those arrangements
are deductible as insurance premiums under § 162 if the requirements for

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deduction are otherwise satisfied.
ADDITIONAL GUIDANCE
The Internal Revenue Service and the Treasury Department are aware
that further guidance may be needed in this area. Notice 2008-19, this Bulletin,
requests comments on further guidance that addresses when a cell of a
Protected Cell Company is treated as an insurance company for federal income
tax purposes.
DRAFTING INFORMATION
The principal author of this revenue ruling is Chris Lieu of the Office of the
Associate Chief Counsel (Financial Institutions & Products). For further
information regarding this revenue ruling contact Mr. Lieu at (202) 622-3970 (not
a toll-free call).