28 November 2019

Picking the right captive insurance domicile

The idea of redomesticating captives from traditional captive domiciles to domiciles where taxable risk is located, whether they are experienced or not, has been proposed regularly. This suggestion is not fully considered: numerous captives have moved from one state to another in order to take advantage of more favourable premium or procurement tax situations.

“Captive insurers shine in a hard market where insurance professionals use captives to address and resolve significant pricing issues and coverage deficiencies.”

What could go wrong? For starters, a number of captive domiciles have left, or are in the process of getting out of, the captive insurance regulatory business. We often hear of captives being wooed (or even coerced) to their home state to domicile, only later to have the regulators close off business.

They may have realised they lacked the tools to regulate the companies properly, or that the captives they courted were not strong entities and probably should not have been formed in the first place.

There have also been redomestication surprises. One of the hallmarks of captive insurance is that it is a very flexible and innovative tool for organisations to manage their risk. As the risk and insurance environment evolves, captives can adapt quickly to the specific circumstances of the parent organisation(s), to take advantage of innovations and swift changes to the marketplace.

If the captive domicile regulators are not attuned to this need, captive owners can meet resistance in a number of ways. The failure to obtain prompt responses to regulatory approval requests and six-figure regulatory exam fees are two examples.

Where and how

Notwithstanding the situation described above, some recent analysis on state overreach centres on three captive insurance tax situations. They highlight not only where a captive is domiciled, but also how the captive is managed.

The particulars of each of the cases are very specific to the facts and circumstances of the cases:

First was Johnson & Johnson v the State of New Jersey. The New Jersey Tax Department tried to collect premium taxes based on the activities of Johnson & Johnson’s captive insurer throughout the US. A Tax Court in New Jersey supported that reading of the law.

However, a New Jersey appellate court has recently [RB1] stepped in and held that the New Jersey Tax Department has authority only to collect taxes on New Jersey premiums.

Second, the Stewart’s Shops appeal best articulates the risk of forming a captive insurer in a domicile that is ambivalent about captive insurance. The situation suggests the value of strict diligence in the selection of a captive domicile. Many factors should be considered in this process, not just the possible tax benefits.

I do not profess to know exactly what elements went into this selection process other than to note that Stewart’s Shops have significant New York State operations.

Finally, Alaska Air Group, which owns a Hawaii-domiciled captive, appealed its tax assessment in the state of Washington. It is worth noting that, as a matter of federal constitutional law, risks located in a state may be lawfully insured by a captive domiciled and operating elsewhere.

The real deal

There are approximately 580 active captive insurers in Vermont. On an aggregate basis, these captives have annual written premium of about $22.5 billion and assets of $200 billion. This level of financial commitment demonstrates that premium and procurement tax issues are, at most, relatively small matters in the context of what is happening, both in Vermont and elsewhere.

Captives are the real deal in terms of better claims handling, improved patient safety through state-of-the-art risk management efforts, and innovating how risk is managed. Captive insurers shine in a hard market where insurance professionals use captives to address and resolve significant pricing issues and coverage deficiencies.

It is fairly argued that, over the past five years or so, procurement and premium tax concerns have played too much of a role in public discussion of captive insurers. Premium and procurement taxes are a relevant matter of concern. However, tax avoidance and mitigation strategies pale in importance to the many other benefits provided by captive insurers.

Rich Smith is president of the Vermont Captive Insurance Association. He can be contacted at: