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

(FIR)’s capital contribution was a $1,000 receivable from (D).
(M) set up (FIR) in an "office" that was no more than a prop. (FIR)’s actual presence in Nevada
was nonexistent.
The reinsurance agreements structured for (D)’s benefit by (M) allowed (D) to "avoid tax and
prepare for his retirement" in three distinct areas:
1. Credit Life Contracts
(M) had reinsurance agreements drawn up between (CBL) and (L). (L) was a company
controlled by (M). Then (M) had a reinsurance agreement drawn up between (L) and (FIR).
Each agreement provided for payment to the reinsurer of 100 percent of the premiums.
Modifications to this arrangement needed to be in writing.
A reinsurer assumes the risk of the ceding company who gives up the risk. This principle
applies to the case as follows:
Agreement [1] - Contract between (CBL) and (L)
(CBL) cedes (gives up risk) to (L)
(L) re-insures (assumes risk) of (CBL)
Agreement [2] - Contract between (L) and (FIR)
(L) cedes (gives up risk) to (FIR)
(FIR) re-insures (assumes risk) of (L)
(CBL) charged (L) a ceding fee of 10 percent for reinsuring (CBL)’s original business. (L)
charged (FIR) a total fee of 11 percent, retaining 1 percent on the (L) and (FIR) reinsurance
agreement. (L) also received a 10 percent "float" because (CBL) ceded monthly to (L),
whereas (L) ceded to (FIR) quarterly.
State law required (CBL) to hold reserves for payments of future claims. Under the
agreements, (CBL) required (L) to maintain reserves on deposit. (L) required (FIR) to
maintain reserves on deposit. The reserve requirements were "met" through a $500,000 letter
of credit from (DLRS). Per statements of (D), (DLRS) had no connection with (FIR).
(FIR) deducted from income, reserves required by (L). (D) expressed a goal to establish
"reserves in an amount necessary to cover the projected income of (FIR)." (M) intervened on
(D)’s behalf.
(M) had no prior training or expertise to compute the separate reserves needed for both credit
life and credit disability. (M) erroneously overstated the reserves for both. The effect of these
erroneous computations was a negative surplus (i.e., (FIR) owes more than it is worth) and
understated (FIR) income.
D-2