14 August 2013Analysis

Home field advantage

It remains unclear whether captive insurance companies are to be included in the Nonadmitted and Reinsurance Reform Act (NORA), but even amid uncertainty the captive industry is sitting up and taking notice of the piece of legislation included in the Dodd-Frank Act. Self-procurement taxes, once occasionally levied but often ignored, now threaten to hit many captives domiciled outside of the parent company’s home state right where it hurts: the wallet. And, with an ever-increasing number of states embracing the captive concept, it’s making less and less sense to take the risk.

Gary Osborne, president at USA Risk Group, told US Captive: “A lot of the advantages that homes states can offer have come about because of the NRRA. It has drawn attention to state taxes on captives, which has raised the profile of self-procurement taxes. As more and more domiciles are opening for business states are saying, ‘well, we’ve got all of those captives out there. If they don’t come back to us maybe we can collect the taxes on them’.”

Captive insurance is a good business for the state, and often states return the favour by protecting captives from other states sniffing for tax revenue. That safety, plus the other advantages being close to headquarters can impart, makes many a captive owner willing to forgo more experienced domiciles for the comforts of home.

The proliferation of new captive domiciles, according to Richard Smith, president of the Vermont Captive Insurance Association (VCIA) and a major force in the lobby to clarify the NRRA, is down to revenue. He said, “Domiciles come in because they see captive insurance as a niche market that creates jobs and helps provide general revenues. Overall it’s an excellent business for states.”

Just as captives coming home is good business for states, settling at home can be good business for captives. According to Jerry Messick, managing director at Elevate Captives and the first president of the Oklahoma Captive Insurance Association (OCIA), “The difference in direct procurement tax in most states, which is often greater than 2.5 percent to 3 percent of premium versus a 0.4 percent tax on direct premium, can make a huge impact on the profit and loss of any captive. Combined with not requiring an expensive out-of-state board meeting, as some domiciles will require at least one local board meeting, and a low cap on overall premium tax, these are major savings on overhead.”

Osborne had a laundry list of other home state advantages. He cited the ease of having meetings and issuing policies, the opportunity to handle the resident director role internally, the simplicity of recordkeeping without the need to share information between multiple states and the diminished role of a captive manager as major pluses to domiciling a captive in the same state as the company’s headquarters. He said, “Normally you’ll want to have all of the work to be done in the state in which you’re licensed, so now that you’re in your home state you may be able to do more yourself and in your own offices.”

Michael Mead, a founding member of the newly-formed Texas Captive Insurance Association (TCIA), also counted stability as a major boon. He asserted, “The principal advantage presented by Texas’s entry into the captive market will be for companies wrestling with NRRA issues. While these issues are by no means settled, the lack of certainty causes many captive owners to elect to be domiciled in their home state regardless of the ultimate resolution.”

"It may cost you $10,000 to $15,000 more to deal with an inexperienced regulator, but for a single parent that isn't going to be a big issue."

But there are reasons to be wary, according to Smith. “It’s a doublesided coin,” he explained. “On the one hand I think competition between domiciles is good for the industry and it normalises the use of captives, which is recognised in the fact that you’ve seen more and more states adopt captive provisions. On the other hand, my biggest concern is states that don’t have the regulatory expertise licensing captives which shouldn’t be licensed. In small numbers it may not be a huge deal, but if we have a trend where over-reach becomes common, that won’t be good for the industry at all.”

Messick, who represents the captive industry in one of these newer domiciles, admits that as a newcomer to the industry education is top priority for Oklahoma. He said, “Naturally there is a void of knowledge about captives in our state. In educating the owners to the different advantages, we also expand on their base knowledge about captives in general. We’ll be doing our first ‘Captives 101’ course for a large number of owners, especially from the oil and gas industry, which of course is a very large segment of our commerce.”

While experienced domiciles with gold-standard reputations and rich histories may have a leg-up when it comes to service providers and cooperative regulators, Osborne suggested that those factors may not be such a solid competitive advantage. “It may cost you $10,000 to $15,000 more to deal with an inexperienced regulator, but for a single parent that isn’t going to be a big issue. If domiciling in a less experienced home state takes care of a $1,000,000 potential tax problem it doesn’t take much of a risk assessment to figure out that it’s probably a worthwhile risk to take.

“We established a captive in Oklahoma in 2012 for that reason. We were looking at Vermont but then there was a fairly sizeable procurement tax in Oklahoma, the company’s home state, so we went ahead and became its first captive.

Osborne continued: “Most states will allow companies to work with service providers based in Vermont or South Carolina. The captive we established in Oklahoma is currently being handled by the South Carolina office of USA Risk. The location of your manager isn’t a big issue and you can usually find a law firm with captive experience able to work in those states.”

Smith, however, isn’t so sure that the home state advantages outweigh the disadvantages. This is particularly true, according to Smith, because not many captives were charged a self-procurement tax in the first place. He asserted, “When companies create captives their tax exposure is part of the decision matrix, but it's one part of many. My hope and expectation is that when we’re able to get clarification on the NRRA at the federal level, the churn that it has created in the captive industry will diminish. Not that I think it’s been huge, but I don’t think it’s been good.”

Regardless of when and how the NRRA question is resolved, Messick says, states won’t stop throwing their hats in to the captive ring. He told US Captive: “While I believe the NRRA will ultimately prove not to include captive insurance companies, the direction of expanding captive statutes in states that historically haven’t had them will only expand.” Messick believes that the enhanced state revenue and job opportunities created by captives are just too good a business for states to overlook or opt out of. He continued: “Allowing captives in the state creates excellent jobs while keeping overheads low. It’s a business-oriented service the state can provide with a very large return on its investment, with or without NRRA considerations.”

Osborne added: “The non-home states are behind the lobby to get captives excluded from the NRRA, and I can’t blame them, but I’m not sure that it’s going to go away. I would say that 50 percent of larger captives are leaning towards domiciling in or redomiciling to their home state at this point. You may see companies who aren’t willing to redomicile completely but have a major presence in an aggressive state.

“Those captive owners might at least form a branch of their existing captive in their home state to locate their in-state business there. I see this trend accelerating. It’s just too much of a no-brainer as long as home state regulators aren’t too difficult to deal with.”

Even Smith has seen some captives redomicile, but just because they hear the call of the home state doesn’t mean they’re abandoning Vermont completely. “It’s all anecdotal from my perspective,” he said, “but I know that a few captives have moved out of Vermont because of the home state issue. I also know that there have been a number that have licensed captives in their home state but kept their Vermont captives to serve as reinsurers, so they’re still banking on the expertise of Vermont regulators.”

According to Osborne, any major balance of power shift will take a long time to achieve. He said, “I think Vermont is going to continue to see its 30 or 40 captive formations a year, but you’re going to see a much more diverse spread of domiciles behind it.”

As far as Texas is concerned, according to Mead, established domiciles can keep their out-of-state captives. Texas is after its own. “We don’t see the addition of Texas as a captive domicile as changing the larger market,” he said. “That is not the intent of the legislation. We are helping Texas-based companies and beginning the process of creating a viable domicile.”

Looking into the future, Smith doesn’t see certain death for domiciles like Vermont in the growth of the home state advantage. “My guess is that we’ll see a number of states with captive laws on the books, and for companies headquartered in the state that may or may not work well for the reasons I’ve outlined. Then you’ll have other states that will lose interest completely and captives will drift away. It’s probably going to be a mixed bag.”