Feature article on Captive Insurance Times

Ben Whitehouse of Butler Snow and Kevin Walters of Tennessee’s Department of Commerce and Insurance discuss regulatory updates and the importance of a symbiotic relationship between the regulator and corporate entities

As the captive landscape evolves to meet the growing interest in alternative risk financing, whether it be in the form of startups, expansion of existing captives, or relocations, it is of paramount importance for parent companies to have a seat based on a strong regulatory framework of communication and collaboration.

The majority of established state domiciles in the United States have active associations that work with their respective regulators. It is essential that regulators have a thorough understanding of captives as a niche sector of the insurance industry of a broader jurisdiction.

It is also important to have ongoing communication between regulators and corporate stakeholders – although this can be easily hampered as the group’s owners are generally not insurance professionals and instead the corporate managers, auditors and actuaries provide the necessary information to ensure that the company operates according to its business plan.

When discussing the nature of the relationship between regulators and captive companies, Ben Whitehouse, senior counsel at Butler Snow, notes that as the corporate domicile matures, regulators require more and more detailed information.

“Five years ago, the popular belief was that certain US domiciles were ‘simpler’ or asked less persistent questions than others. These distinctions have now largely disappeared – I don’t see this as a negative sign, it’s simply because the supervisory authorities across all domiciles have learned from their experience and know more about which questions to ask, ”he explains.

Kevin Walters, of the Tennessee Department of Commerce and Insurance, acknowledges the importance of a State Department’s proprietary insurance division in providing the necessary information, answers, and regulatory support for the domicile’s proprietary industry.

“We believe that having a knowledgeable regulatory team that works closely with industry stakeholders is essential to running a successful proprietary insurance company,” added Walters.

The scores

Regulation is not stagnant and the legislation needs regular updates to reflect the current landscape of captives.

The Biden government’s tax proposals earlier this year advocated an increase in long-term capital gains and the qualifying dividend tax rate to 39.6 percent for taxpayers with adjusted gross income above $ 1 million. This means that a deduction by paying a premium to a captive is more valuable, as scheduling the declaration and payment of dividends to captive owners whose income is below the threshold can result in significant savings.

In addition, the government proposed raising the corporate tax rate to 28 percent (it is currently 21 percent, a significant decrease from the 35 percent rate prior to 2018). This would have a significant impact on captives as it would increase taxes paid on the same level of investment income.

This would also affect the calculation of deferred taxes, which would either have a positive impact on the surplus or net assets of captives with a deferred tax asset at the time of the tax rate adjustment or a negative impact on those with a deferred tax liability.

Also at the beginning of the 2021 legislative period, many US captive domiciles introduced new and updated captive laws into their legislative process.

In April, for example, the Alabama House of Representatives sent Governor Kay Ivey amendments to the bill to add three new alternative venture firms (agency captives, reinsurance captives, and special purpose financial captives) and introduce a new formal redomestication process.

Utah introduced House Bill 54 to lower minimum capitalization requirements for sponsor captives in response to the growing number of small and medium-sized businesses looking for alternative insurance solutions, while Delaware’s Senate Bill 36 in July allowed captives to be classified as registered as well as the option that a prisoner enters the resting phase after 12 consecutive months of inactivity instead of a calendar year.

Walters notes that recent modernizations in Tennessee include approving parametric insurance coverage, incentivizing offshore resettlement through a premium tax credit, and reducing the legal capital required by Protected Cell Companies (PCCs) to start operations , from $ 250,000 to $ 100,000.

In response to this increased interest in cell prisoners, Vermont Governor Phil Scott signed Senate Act 88 in May to update the Domiciliary Prisoner Insurance Act to clarify a cell’s ability to move to a different cell type or type to convert independent prisoners as well as the simplification of the redomestication processes and the necessary documentation for the admission.

On taxes, the March Senate bill in North Carolina proposed 37 changes to the amount of premium tax paid by proprietary insurers in the state, including a provision for special purpose vehicles with a cell or tier structure to pay the same tax as PCCs is imposed.

Most notably, Washington state introduced a new proprietary insurance law to enable the establishment of a framework for registering eligible proprietary insurers in the state -based risk.

Despite the results of a consultative vote against the premium tax, the State Office of the Insurance Commissioner formally passed the regulations last month with effect from December 21st.

The overall aim of these regulatory developments over the past year is to facilitate the establishment and operation of a captive in the respective domicile while complying with the necessary administrative requirements.

Compliance is the key

As with any form of regulatory requirement, despite the diligence of the staff in the relevant government departments, there are potential compliance issues.

Whitehouse notes that all compliance issues faced by the captive industry are more practical than those of staff: “As our industry grows, both regulators and captive service providers need to attract and retain staff. Almost every regulator I know is currently either advertising for vacancies or has recently had an open position. “

He explains that this is partly due to expanding opportunities in the captive industry, where more regulators have been shifted to non-governmental positions.

“Captive owners and managers should ensure that their regulator has adequate, captive-focused analytical resources. The “captive-focused” part is most important, as the alternative – traditional regulators put in place to cover captives or contract regulators – can have nasty consequences, ”warns Whitehouse.

Additionally, Walters emphasizes the importance of engagement and communication between industry stakeholders such as actuaries, attorneys and accountants.

“Regulators rely heavily on the captive manager to ensure that all aspects of the captive are properly maintained and monitored to ensure that all regulatory requirements are met. This includes areas like timely and accurate annual filings, quick responses to government inquiries, and properly engaging key stakeholders, ”he explains.

Walters notes, however, that such collaboration requires two-way communication between the company’s industry and the domicile regulator, with the latter readily available to provide the required standard of expertise and customer service.

Whitehouse adds, “With captive regulators moving around at all levels and in many domiciles, it remains the responsibility of captives to keep lines of dialogue open. It is important to ensure that a new regulator is familiar with a complex or unusual business plan, especially before a problem arises. “

Compliance issues were no longer as explosive in 2021 as in the past, although micro-captives were put back on the Dirty Dozen list for tax fraud and abusive agreements by the Internal Revenue Service (IRS) in July.

After escaping the 2020 list for the first time in five years, the IRS warned financial institutions that microenterprises “lack the characteristics of insurance” because they do not pay tax on technical income under Section 831 (b) of the US Tax Code. However, in May, the U.S. Supreme Court ruled a significant unanimous judgment in favor of CIC Services in the micro-captive manager’s ongoing litigation with the IRS, ruling that the Anti-Injunction Act does not prohibit federal courts from enforcing regulations through the IRS to block consenting reporting obligations.

Last month, a U.S. tax court accepted the IRS’s pre-trial concessions in a lawsuit against a Delaware owner who admitted all but two percent of the more than $ 27 million in tax deficiencies and penalties. Does this indicate a paradigm shift in state regulation of prisoners, or just two fortuitous victories? Only time can tell.

Looking ahead, Whitehouse expects the regulatory landscape to evolve to accommodate more innovative insurance solutions from insurtech entrepreneurs, even if the programs don’t exactly fit into the real auto insurance box due to the captive industry’s reputation for innovation.

He adds, “If the captive industry is to continue to be the home for insurance innovation, we need concessions and precautions from traditional insurance regulators, including those not known to be ‘captive-friendly’.”

“The persistently tough market will encourage more companies to consider alternative risk financing options such as proprietary insurance. We continue to see more startups and business plan changes as companies adapt their captive programs to offer unique solutions for managing their risk, ”concludes Walter.

Comments are closed.