11 March 2019

​How the political climate might affect captives

“It is fair to predict that Congress will have little time in 2019 to attend to issues affecting captives.”
We are certainly being condemned to live in interesting times. Steve Kinion, Paul Owens and I will be speaking on the political climate at the Captive Insurance Companies Association (CICA) conference in Tucson, AZ, and there will be a lot to talk about.

In the US, politics has become a 24-hour obsession (or annoyance). Whether any of it will have a direct effect on the captive insurance industry is the question to be answered.

In only one area—income taxation—are captives directly in the sights of the federal authorities, in this case, the Internal Revenue Service (IRS). Numerous audits of smaller captives are occurring, and several important decisions have recently been handed down, eg, Reserve Mechanical v Commissioner. However, we will leave the discussion of those complex matters to other speakers at the conference.

In the US, insurance is regulated by the states—let’s start there. With two major exceptions, the captives community is rolling along with little overt interference by the states.

First, there is the issue of the state of Washington imposing its surplus lines tax on the Arizona captive owned by Microsoft. Washington followed up the settlement with Microsoft with a bulletin to Washington enterprises to report to the Commissioner previous insurance activity within the state and to pay up—or else face the wrath of the department. The legal basis for this action is questionable, but has not been formally disputed—yet.  

If the Washington Commissioner’s position is followed by other states, it could present the danger of the obligation to pay additional premium tax to any captive with risks outside its state of domicile.

Second, risk retention groups (RRGs) are feeling the effects of the excessively long soft market. Adding to their woes is the propensity of a few states to delay or outright refuse to register some RRGs in a manner that is not permissible under federal law. At the request of the National Risk Retention Association, the National Association of Insurance Commissioners (NAIC) will be looking into this issue. On other matters affecting captives, the NAIC has, at least recently, been relatively quiet.

The federal government—both Congress and the executive agencies (with the exception of the IRS, as noted)—has also been relatively uninterested in insurance, and captives in particular, because they have been spending much of their time fighting with each other over the results of the last presidential election. It is fair to predict that Congress will have little time in 2019 to attend to issues affecting captives.

The Captive Clarification Act will be reintroduced for the purpose of clarifying that captives are not “non-admitted” insurers for the purposes of the Nonadmitted Risk and Reinsurance Act. The Nonprofit Property Protection Act will also be reintroduced for the purpose of allowing certain RRGs to provide property coverage for charities. Unless these bills can be tagged onto an appropriations bill (or another “must-pass” bill), there is little chance that Congress will have time to examine their merits.

Health plans

One matter which has been of significant interest to the captive insurance community is association health plans (AHPs). Advocates of AHPs have thought that they could provide an alternative to at least some of the restrictions of the Affordable Care Act (ACA). The Department of Labor (DOL) published a Final Rule in 2018 which intended, at least in part, to support the use of AHPs.

In fact, the Final Rule makes it easier for an association to sponsor an AHP and treats an AHP as a single large employer plan under the ACA, which can be quite beneficial. An AHP is not subject to ACA rating requirements and the ACA mandate to provide “essential health benefits”.

However, the Final Rule does not definitively preempt state law governing associations and health plans. This results in a classic example of dual regulation (state and federal), which can be a substantial disincentive for a multistate plan. And, just to put icing on the cake, 12 states and the District of Columbia have filed a lawsuit challenging the authority of the DOL to issue the Final Rule.

European complications

The captive insurance movement started offshore and migrated onshore only within the past 30 years. Captives in the EU have been struggling to accommodate the demands of Solvency II. There is also the fulsome disruption of the UK’s departure from the EU which (at the time of writing) appears on a glide path to crash.

Regardless of the outcome, captives domiciled in EU jurisdictions will be confronted with transition and regulatory problems. In addition, captives are going to have to deal with the Organisation for Economic Cooperation and Development (OECD’s) base erosion and profit shifting (BEPS) measures.

There appears to be consensus among EU countries that taxes are going unpaid by captives, which will result in new rules on “transfer pricing” and the issue of a captive’s “substance”, ie, whether it is principally a risk management and financing enterprise or one designed to reduce taxes.

In sum, the captive insurance community will need to be on guard in 2019. The US income tax law is evolving; the state of Washington appears to be challenging the current understanding of the duty to pay premium taxes; and Brexit and the OECD are roiling the waters offshore.