With captives becoming increasingly mainstream, the industry is attracting more attention from US regulators.
We spoke to Skip Myers, managing partner of the Washington DC office and co-chair of the insurance and reinsurance practice at law firm Morris, Manning & Martin, and found that regulation on the local and federal level are creating challenges. Greater regulatory oversight and healthcare reform are issues requiring closer attention from captives.
What is the greatest concern facing the captive sector at present?
Captives have become increasingly visible as a result of the rising number of states that have seen the benefits of captives, enacted captive legislation and increased activity in the space. This has helped to attract the attention of regulators and legislators. And as they say: ‘the nail that sticks up gets hammered’. For a long time captives were below the radar, but this has changed. Regulators are now looking to have greater control over the sector.
Captives have benefited over the years from being licensed in only one jurisdiction, which has enabled them to take advantage of experimentation and entrepreneurism among the various domiciles.This in turn has allowed them to choose their domicile and pursue the best fit. As a result of this entrepreneurial approach, the industry has blossomed, but success has brought the attention of the regulators who see that the traditional insurance market and its accompanying regulatory system has a major competitor in the alternative market. As beneficial as the alternative market can be, it is beyond the reach of some of the traditional regulators, and some regulators find this disturbing.
There is more activity going on at the National Association of Insurance Commissioners (NAIC) and in various states to get a handle on the captive industry and to find out where it is going and what it is, and there is certainly a lot of misinformation about what captives are. There is likely to be an attempt to make the regulation of captives more uniform, as there has been with the regulation of risk retention groups. Risk retention groups are necessarily USbased, but with captives some of them are domiciled offshore, so there is less clarity as regards how regulators can deal with such entities. Nonetheless, an examination is going on at the NAIC, and there has been information requested by the Federal Insurance Office about reinsurance and stop-loss insurance, and all of this can affect captives. So we need to be aware about potential regulatory changes.
Have clients come to you for advice regarding these measures? What recommendations are you making?
We have not seen any actual proposals, other than at the individual domicile level. The advice to the captive community is ‘get ready’. Things are changing—at least in terms of the regulatory atmosphere— and you need to be prepared first to educate the regulatory community about what captives do and how beneficial they are, and also be prepared to participate in any rule-making or legislative process that results from that in order to protect the captive position. That hasn’t come yet, but it will take some effort. It will involve not only effort from the captive community, but also from the regulators in the captive domiciles who understand captives to clarify and educate other regulators who might not be so well-informed.
What about the potential inclusion of captives under the surplus lines component of Dodd-Frank?
That’s a significant current concern. The surplus lines legislation was not passed with any intention of dealing with the captive industry and yet the language of it can be construed very broadly. If it does include captives in the definition of ‘non-admitted insurers’ then it could have a significant impact on the industry because it could result in ‘domicile shopping’. This could mean captives may consider redomestication if they can get a better deal from their home state where they may be obliged to pay their taxes. Some captives have even already redomesticated in anticipation of the Act. However, we still don’t know where all this is going and only the courts are going to be able to decide.
How big an issue has the Patient Protection and Affordable Care Act (PPACA) been for the sector?
It has been a significant issue. I think most people were surprised by the ruling of the Supreme Court. A lot of people thought that the court was going to over-rule the PPACA and so people weren’t too anxious to consider how they were going to seriously deal with its implications. Now that it has been upheld by the court—and although there is a possibility that it could be repealed—people are getting more focused on what role captives might play, in particular with regard to affordable care organisations (ACOs). They are an aggregation of different kinds of risks and that is where captives may come in. There are significant potential opportunities there.
PPACA shows the power of a single regulator—in this case the federal government—to affect how a business and its sector operates. A ruling or an interpretation of a regulation on the federal level can have a major effect on how businesses operate. If it is just a state decision and you don’t like it, you can move elsewhere. When the federal government is involved, where can you go?
What are the implications of PPACA for the captive sector?
The positive is that with the ACOs—and despite the lack of clarity regarding what exactly they are and how they will be deployed—there are likely to be a lot of opportunities for the captive sector, with such institutions considering self-insurance to cover their risks. On the negative side, as we have seen with requests for information regarding stop-loss coverage, there could be a federal regulation or mandate that limits the use of captives for health plans, specifically stop-loss. The takeaway is that we need to be vigilant about what rules are being considered and how this legislation is going to evolve, because it is very broadly drafted and we just don’t know where it is going to go.
How significant do you think regulatory pressures will be in the domicile choice?
Regulatory experience and geography are perhaps the key differentiators for captive choice. However, you are seeing some domiciles take up a defensive posture, where they seek to protect their turf. If they don’t want the corporations headquartered in their state to locate their captives elsewhere, then they might (and have in some instances) introduce captive laws in order for captives to remain in their state.
In the case of a captive that has substantial premium levels, the tax issue does come to the fore. You can run the numbers and find out where you are going to pay more tax. If it turns out that the state where you are headquartered is one of those states that has adopted the more aggressive form of legislation that says it has the authority to tax as the ‘home state’ under Dodd-Frank terminology and collect the tax for all risks irrespective of where they are located, you may want to reconsider where you are located. If not, you may have to pay your domicile and your headquarter state.
This entails whether the captive can be considered non-admitted and depends upon how aggressive the state in which you are headquartered is on that issue. Sometimes you can’t move your headquarters, so you might consider that you want to pay one state rather than two. Some captives have already moved in light of this— not many, but a few. Again, it speaks to rising regulatory pressure, which is the key concern for the sector at present.
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