In a legal memorandum, the IRS concluded that an arrangement between members of a taxpayer group and the group's affiliated insurance company involving foreign currency fluctuations does not constitute insurance.

The IRS noted that it had concluded that similar contracts were not insurance in ILM 201511021 but reconsidered the analysis because of the holding in R.V.I. Guaranty Co. v. Commissioner, 145 T.C. 209 (2015).

The taxpayer group conducts global business through many subsidiaries and includes a captive insurance company. The parent company entered into contracts with the captive insurance company to mitigate risk in foreign currency exchange rate fluctuations through indemnification of loss of earnings caused by the fluctuations. Endorsements extending the coverage were issued monthly. The contracts have many features found in insurance policies, and an outside actuary performed an actuarial review.

Case law provides three elements for determining whether a captive insurance arrangement is insurance for federal income tax purposes, according to the IRS. An arrangement must address insurable risks; it must shift the risk of loss to the insurer, who then spreads the risk over the several policyholders; and it must be “insurance” in the commonly accepted sense.

The foreign currency fluctuations at issue satisfy the insurable risk prong, the IRS concluded. However, because the taxpayer did not provide enough information about the arrangement, it is not clear whether the insurer had sufficiently spread the risk among all participants, the IRS added.

Further, the arrangement may not be insurance in the commonly accepted sense because the coverage limit is facially ambiguous, the premiums may not comport with either arm’s-length or commercial insurance practices, the coverage could allow for a payout despite currency gains during a particular transaction, and the sequential overlap of contracts within the arrangement may allow for multiple recoveries for a particular participant, according to the IRS.

Foreign Currency Contracts Aren't Insurance