Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

Considerations for Forming a Producer Owned Reinsurance Company
Formation of a reinsurance company requires an assessment of several factors. Some of the more
important include: capital requirements, the regulatory environment, financial reporting, formation
costs, security of assets and the time needed to form the reinsurance company.
Capital requirements in the United States have increased over the years. Since a reinsurance
company only assumes business from other companies, it may not have to meet the higher
capitalization that would qualify it to write insurance in the dealership’s state.
In addition to statutory financial accounting and investment restrictions, there are a few business
constraints. Most states have set a maximum amount of risk on any one life, based on a
percentage of the prior yearend capital and surplus. There are also limitations on stockholder
dividends.
There is a type of reinsurance company called an "exotic." This structure allows dealers to
participate in a reinsurance program with limited capital contributions and to diffuse the annual
cost of operations.
In contrast to a domestic reinsurance setting, offshore reinsurance companies are typically more
attractive to auto dealers because they offer minimal capitalization requirements and a relaxed
regulatory environment. Formation can be accomplished in a shorter period of time and the cost
of operation is modest. Some offshore sites allow all of the reinsurer’s assets to be held in the
United States. The level of financial reporting is greatly reduced. The Turks and Caicos Islands
have become the location of choice in which to incorporate offshore.
The decision to incorporate offshore is rarely due to the differences in United States versus
foreign tax laws. Most offshore PORC’s elect to be treated and taxed under United States tax
laws. IRC section 806 provides certain tax benefits attributable to a small life insurance company.
In addition, IRC section 831(b) provides an election for a non-life insurance company, known as a
small casualty company, to be taxed only on investment income if premiums are between
$350,000 and $1,200,000.
Typically, dealers sell dealer obligor extended service contracts as part of their sales of new and
used vehicles. These contracts provide for the repair of any covered function of the vehicle
during the term of the contract. The contract is between the customer and the dealer who is
obligated to perform or pay for the repairs. The dealer may then arrange with an unrelated
insurance company to provide insurance coverage for the risks covered by the extended service
contracts sold by the dealer with the dealer being the insured party.
The dealer also establishes a reinsurance company for the sole purpose of reinsuring the risk
insured by the unrelated insurance company for extended service contracts sold by the dealer.
The reinsurance company is owned or controlled by the same person that owns or controls the
automobile dealership. It does not maintain the staffing and facilities common to operating
businesses. It is undercapitalized and/or the fronting company is indemnified from loss by another
entity in the economic family, e.g. the dealership or the dealership’s owner. Its business is
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