Industry the Jan/Feb 2013 issue

Captive Audience

Who is asking to be exempt from Nonadmitted & Reinsurance Reform Act?
By Scott Sinder Posted on January 29, 2013

Only five states—Florida, Louisiana, South Dakota, Utah and Wyoming—and Puerto Rico are participating in NIMA, the Nonadmitted Insurance Multi-State Agreement. They share surplus lines tax revenue and require allocation calculations (they eliminated tax sharing for most casualty products).

There are also seven states—Hawaii, Kansas, Massachusetts, Nevada, New Hampshire, North Dakota and Vermont—that require brokers to allocate and pay the surplus lines taxes using the prevailing rate in each state where there is risk exposure. At this juncture, there is no apparent benefit to requiring the calculation or to imposing another state’s premium tax rates. The Council is working to eliminate these obligations.

A new threat, however, is emerging: an effort to amend the NRRA to exempt captives. Some in the captive insurance community have been arguing that the NRRA does not apply to captives. While we understand the argument for this assertion, even if we don’t agree with it, we don’t understand why captive insurers (and their insureds) would want to be barred from receiving the core privilege conferred by the act (single-state oversight of surplus lines and independent procurement transactions)

NRRA contains two fundamental rules:

  • Only the home state of an insured can require a premium tax payment for non-admitted insurance. By allowing only one state to tax any non-admitted policy, whether the policy covers single-state or multi-state risks, the NRRA attempted to fix double taxation issues and simplify compliance burdens.
  • The placement of non-admitted insurance is subject only to the regulatory requirements of the insured’s home state.

Neither of these rules confers any new regulatory or taxing authority. They simply take away any such authority from each state except the home state of the insured.

Both rules are limited to non-admitted insurance, which the law defines as “any property and casualty insurance permitted to be placed directly or through a surplus lines broker with a non-admitted insurer eligible to accept such insurance.”

Those who challenge the application of the NRRA to captive insurance argue that captive coverage is not placed and captives do not qualify as non-admitted insurers. They argue that captives are not eligible to accept coverages as the concept is typically understood. Although the “placement” argument may have some resonance in the classic single-company captive context, it clearly loses its appeal with more broad-based captive programs. Regardless of the merits of the argument, though, the question remains: Why is this exclusion preferable?  

The primary concern appears to be based on a misunderstanding (or fear) that states might use NRRA to enhance regulation of captive insurance, yet nothing grants them any new regulatory authority. Other than perhaps raising state regulatory consciousness about captives and focusing their attention on the captive market—a reality that cannot be suppressed now even if captives expressly are excluded from the scope of the NRRA—this concern simply has no merit.

The effect of the NRRA’s reforms on captives will be felt almost exclusively in premium taxation. Captive insureds will reap substantial benefits.

Prior to the NRRA’s implementation, surplus lines and independently procured insurance generally was taxed by every state where risk was located. This scenario led to double taxation and widespread confusion. Many states have extended their independently procured insurance taxation regimes to cover captive insurance. Captive insureds thus generally confronted the same pre-NRRA taxation morass as those purchasing surplus lines or independently procuring non-captive non-admitted insurance coverages.

Captive insureds undoubtedly faced a lower level of state taxation enforcement, and the fact that the question whether independently procured taxation obligations applied to them at all in many states would have aided in any defense to such enforcement efforts. With or without the NRRA, however, it’s clear states believe they can tax captive insurance as independently procured insurance. Without the NRRA, captive insurance is subject to the same compliance problems and burdens that plagued the rest of the non-admitted insurance marketplace prior to NRRA’s passage.

The more illuminating question may not be why seek the exclusion, but who wants it? The answer: those who most benefit from the pre-NRRA status quo. This includes states that have made themselves attractive captive domiciles and their domestic captive trade association staffs—all of whom fear re-domestication of a segment of their captive community to states where captive insureds are domiciled.

These fears may not be ungrounded, but it is hard to imagine they are shared by companies that insure themselves through captive platforms and their captives, all of which clearly will be better off with NRRA than without it.

Scott Sinder Chief Legal Officer, The Council; Partner, Steptoe Read More

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