gehringj /
13 December 2018Analysis

Conditional licensing: a faster way to do captives

Delaware has taken a number of significant steps in the past year to bolster its captive insurance regulations and boost the attractiveness of the domicile, most notably with the introduction of its new conditional licensing programme, a first of its kind.

On October 16, Governor John Carney signed into law House Bill 334, an act to amend Title 18 of the Delaware Code relating to captive insurance, to authorise the insurance commissioner to issue conditional certificates of authority to captive insurance company applicants, which authorises the captive to conduct business while the commissioner completes the review of the application materials.

Steve Kinion, director of Delaware’s captive insurance bureau, says the key point of this new legislation is to make the process of setting up a captive in Delaware much faster.

“It is speed to market, being able to have a licence to conduct business on the same day that the application for a captive insurance company is submitted to the regulator,” says Kinion,

The rationale behind this development is that Delaware formerly used to accept most of its licences at year end. The total number of captive insurance licence applications received in 2017 in Delaware was 117, 64 of which (54.7 percent) were submitted in December. This would mean that regulator would process those licences in either January or February of the subsequent year.

Delaware insurance commissioner Trinidad Navarro had charged the captive insurance department with creating a more efficient process.

“Navarro did not like the system we had been operating under,” says Kinion. “He decided we needed a new system; a new way of doing business in Delaware. And that’s what we decided to do.”

Kinion believes this programme was needed in Delaware, where captive managers have wanted to get a licence so their customers or clients can be active in the insurance market as quickly as possible.

“As a captive regulator, I consistently receive calls—especially in the third quarter of any year—asking how fast they can get a licence, and if they give an application today, how quickly can they process it. That is a common question I receive all the time,” he says. “Well, now the answer is ‘today’.”

Conditions and benefits

While the conditional licensing programme makes the process of setting up a captive much faster, there are some conditions, explains Kinion.

One of those is that not every captive management firm can use the programme. After reviewing the firms that do business with the domicile, Delaware has decided that only 30 of them can have the privilege of using the conditional licence system.

“It is a selective process based on the past performance of the captive management firm,” says Kinion.

The 30 captive management firms are all US operations that have been selected as a result of good past performance, and going through a know your customer (KYC) process.

“I’ve been a captive director for nine years, soon to be 10. I know many of these firms and the people in them—and they have provided us with good products in the past.”

Prior to this programme, Kinion suggests, the process for licensing would have taken between 30 and 45 days, dependent on the application itself.

Once the conditional licence has been granted to a captive, there is a six-month period during which the regulator will review the captive and decide whether it will be issued a permanent licence; during this time the captive is free to start writing business.

In the event that a captive’s licence is not adequate, the permanent licence will not be issued, and the conditional may be summarily withdrawn.

Kinion believes this programme will have a positive effect on the Delaware captive insurance market, as it allows managers to provide captive licences for their clients much more quickly.

“This takes some of the pressure off the regulators,” he adds.

“If you are a captive manager and have an application that is worthy, complete and ready to go, and you are one of those 30 selected managers—then the captive can be set up as soon as you have that application submitted.”

State of the market

Delaware has been one of the fastest-growing captive insurance domiciles, with 117 new licences—captives, series captives and cells—issued in 2017, second only to North Carolina that year, which had 134.

By comparison to major offshore domiciles, Bermuda issued 17 and the Cayman Islands issued 33 that year.

Perhaps more significantly, Delaware grew its premiums written by captives by $8.1 billion in 2017, which was primarily reinsurance premium.

Kinion explains that a component of the premium is direct, but large captives providing reinsurance are the most prevalent.

However in 2018, Kinion explains, the Delaware market was not as robust as in 2017, and 2017’s number of formations was a little below average compared to figures in the past.

“The overall captive insurance market is either at a plateau or in a slight decline,” he says.

Kinion suggests there are a couple of reasons for this in the US, one of which is the lower tax rate from tax reforms.

“Taxes should never be the sole reason for setting up a captive, but it is still a reason. With the new tax rate, the value of the deductions for premiums paid to the captive insurer is lower, for instance,” he says.

Another factor slowing down the rate of new formations is the increased scrutiny on captives from recent US Tax Court cases, for example Reserve Mechanical and Avrahami, and upcoming cases such as Caylor, Wilson and Syzygy.

“These days all regulators need to be more wary and cautious in light of recent Tax Court rulings, especially for captives that make the 831(b) election,” says Kinion.

“Regulators are looking a bit more closely at various aspects of applications, such as pooling arrangements. This is not to imply we don’t look at those things, but now you have to keep a closer eye.”

Delaware has a large number of captives that make the 831(b) election. While 831(b) captives have existed since 1986, they have come under increased scrutiny from the Internal Revenue Service after being labelled a ‘transaction of interest’ in Notice 2016-66 in November 2016.

One of the advantages of an 831(b) captive is that earnings from premiums are not subject to federal income taxes, and only interest income is taxed. The maximum annual premium was $1.2 million, but this increased to $2.2 million on January 1, 2017.

Kinion believes there are still growth opportunities in the type of captives in Delaware, albeit at a slower rate.

“Right now the captives world is in the state of watching to see what occurs with these Tax Court cases,” he adds.

House Bill 289

While conditional licensing speeds up the process in which a captive can start writing business in Delaware, it is not the only piece of legislation put forward this year to bolster the domicile’s captive market.

On May 24, Carney signed into law House Bill 289, which amends Title 18 of the Delaware Code relating to the filing of annual statements and payment of premium taxes for captive insurance entities.

Dubbed by Kinion as the ‘More Time Bill’, the legislation will require captive insurers to file their annual statements and pay premium taxes on or before April 15 of each year, as opposed to March 1 in previous years.

The significance of this additional six weeks is that it gives captive managers more time to prepare the filing made to Delaware.

“That doesn’t sound like much, but for the captive management world it’s very significant,” says Kinion.