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

The Reinsurance Transaction
To illustrate the nature of the dealership offshore reinsurance transaction, assume that a consumer
purchases a credit life policy for $800. This form of insurance, credit life, is more prevalent in the
dealership reinsurance arrangements.
The dealership, acting as an agent for a regulated United States insurance company, sells an $800
credit life contract to a consumer. The dealership retains $240 as commission income. The
remaining $560 is sent to the regulated United States insurance company to purchase the credit
life policy. The dealership reports commission income of $240.
The "insurance company" may be serving as a "fronting company." A fronting company is one
which assumes the original risk in the policy and passes that risk to the reinsurance company.
Normally, the fronting company charges a fee of, assume $35, for an arrangement similar to our
example. The fronting company will then reinsure, by transferring the risk and the remaining
$525, to the offshore captive reinsurance company owned by the dealer.
The insurance policy and the reinsurance agreement create the impression that business is being
conducted "offshore." Upon request, the dealer will provide the agent with the reinsurance
treaties and other documents that suggest foreign transactions. However, agents should follow
the flow of the funds and will usually find that the funds never leave the dealership’s hometown.
The reinsurance company may in form be in the Caribbean but in reality carries on its "business" at
the dealership’s hometown bank. They usually do not have their own separate business location.
Their address is usually the same as the dealership’s or the dealer’s residence. Usually, the bank
account includes the name of the dealer who has control over it.
It is important to remember that most producer owned reinsurance companies often do not
reinsure any risk other than that of contracts written by dealerships owned by the sole shareholder
of the reinsurance company.
Any claims the consumer may make will be against funds collected by the fronting company and
retained by the reinsurance company/hometown bank account. The dealer may have access to
these funds. These reinsurance companies are not regulated, the dealer may hold these funds in
any form; the dealer may invest, declare a dividend, or take a loan.
If a Form 1120-PC is filed, reserves calculated by representatives of the promoter may be used to
reduce the reinsurance companies income under IRC section 832. The William T. Wright case,
below, informs us of dealership offshore reinsurance companies who consistently overstated
reserves. (Please see Appendix). The premium income earned by a non-life insurance company
may be tax exempt if it remains below $350,000. With overstated reserves and paid out claims,
companies would never pay taxes. Effectively, all income earned by these transactions was not
taxed.
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