If a state authority issues bonds to pay catastrophe insurance claims, they would not qualify as private-activity bonds because they would be backed with generally applicable taxes and not private payments, the Internal Revenue Service concluded in a recent private-letter ruling.

The issuer was not identified in the ruling, which stated that the premium surcharges and additional assessments backing the bonds would be “taxes of general application” since they would be applied to a broad group of people.

Tax-exempt bonds are considered private-activity bonds if more than 10% of the bond proceeds are used by private parties and more than 10% of the debt service comes from private payments.

Bonds also are PABs if the lesser of 5% or $5 million of the proceeds is used to make loans to non-governmental borrowers.

In addition, private-activity bonds are only tax-exempt if the proceeds are used to finance certain types of “qualified” projects, such as airports, sewage facilities, or housing.

In this case, the IRS found the bonds would meet the private-use test because the proceeds would be used by private commercial businesses and residences to rebuild after a catastrophe. However, they would not meet the private-payments test or the loan test.

If the premium surcharges and assessments were imposed on a specific group, they could have been considered private payments, which would make the bonds taxable.

The ruling was dated July 19, but was not publicly released until this week. As is standard with private-letter rulings, the IRS redacted all information identifying the parties involved before releasing it to the public.

Officials with the Florida Hurricane Catastrophe Fund said in April that they had asked the IRS for a private-letter ruling on whether they could issue tax-exempt debt to cover their insurance claims.

But on Tuesday, Jack Nicholson, the CAT fund’s chief operating officer, said it had withdrawn its request for a ruling.

Under the arrangement described in the letter requesting the ruling, the state created an association to provide catastrophe insurance to applicants who would otherwise be unable to obtain similar insurance in the private market. Every property insurer in the state is required to be a member of the association to conduct business there and must make annual contributions to it.

Each year, a portion of the association’s equity is transferred to a catastrophe reserve trust fund, which is used to pay insurance claims. But if a catastrophe results in claims exceeding that fund, a state issuer is authorized to issue two types of bonds to pay them.

One type would be backed by special premium surcharges assessed on all policyholders and assessments charged to all property insurers in the state. The other would be backed only by the assessments on property insurers.

The question posed to the IRS was whether the bonds could be tax-exempt.

Though the IRS determined bond proceeds would be used by private parties, it also determined the bonds would not be backed by private payments. Since the surcharges and assessments would be applied to a broad base of persons, levied solely for the purpose of raising revenue for a governmental purpose, and applied at a uniform rate, they would be considered general taxes and not considered private payments, the IRS said.

The agency said the private loan-financing test would not be met because the claim payments would not be loans, but rather payments made as a result of a previously obtained contractual right.

The issuer was authorized to issue a third type of bond to cover insurance claims, which would be repaid by revenues obtained from future insurance premiums. However, it did not seek a ruling from the IRS on the tax-exempt status of those bonds.

Private-letter rulings are supposed to be applicable only to the issuers that request them and to the particular facts and circumstances underlying the requests. The IRS explicitly states that the rulings cannot be cited or used as precedent in other tax matters. Nevertheless, market participants often look to the rulings for insight into the agency’s thinking, particularly on tax matters where little guidance exists and questions have arisen.

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